The second development that has transformed the world of credit is the ascendance of capital markets—markets where debts with maturities of a year or
more are bought and sold.
In the past, lenders held credit they extended in their
own portfolios and serviced it as well.
Over the past fifty years, loan originators increasingly have become separated from those ultimately investing in loans.
In
addition,
loans have been pooled to back securities that bring added liquidity to
the market.
The efficiency of capital markets in matching debtors with certain
risk profiles to investors with certain risk tolerances is unparalleled.
But this effi
ciency comes at a cost: it requires heavy reliance on third-party agents to con-
nect investors and debtors. In theory, these intermediaries work on behalf of
investors and in the interests of debtors, but in reality their incentives may not
be aligned with either one.
Nevertheless, a powerful aspect of the global markets that dominate modern
mortgage lending is that in many respects they are blind to race, ethnicity, and
religion.
A neighborhood banker often no longer makes a face-to-face decision
on how much to lend an applicant.
Instead, the financial history of the appli-
cant is usually fed into a computer, which renders a score that is a financial cali-
bration of risk.
Each day lenders (no longer just banks, but mortgage brokers,
too) issue thousands of mortgages, which are then sold on the secondary mar-
ket.
Indeed, the global markets care only about risk and return, not race and
religion.
To the degree that the scores and other information used to underwrite
loans predict risk accurately, and arrive at an interest rate that compensates
investors for the level of risk assumed, investors are satisfied.
The blindness of the capital markets to much of what goes into credit deci-
sions cuts both ways, though, as it has both positive and negative aspects.
On
the plus side, with the protections of better colorblind risk assessment and man-
agement tools, lenders have abandoned near-exclusive reliance on the classic 20
percent down, fixed-rate mortgage.
Today, lenders offer a remarkable array of
products to borrowers with a wide range of past credit histories, and even offer
products to borrowers without documented credit histories.
These products
include: low to no down payments; adjustable-rate loans; hybrid loans that fix a
rate for a number of years and then reset to current market rate; loans that
require low or no documentation of income and assets; and loans that allow for
larger ratios of debt to income.
As a result, people with low incomes (and mini-
mal savings) can get mortgages.
People with major blemishes on their credit
records can get credit. Indeed, the poor no longer face a scarcity of credit; they
face a surfeit of it.
With a few clicks on the computer mouse, or calls to toll-free
numbers, a person can take a first step toward homeownership. Easy mortgages
have made many Americans homeowners. And for most of them, homeowner-
ship has been the first step in the accumulation of genuine equity, giving them
an asset to list on their balance sheet.
On the minus side of the ledger are several items that, if not addressed,
could diminish the potential value brought by the revolutions in information
technology and capital markets.
First, investors in mortgage-backed securities
are remote from the lenders or brokers that initially underwrote the loans.
Thus discrimination and fraud can plague the system if investors fail to manage the risk that loan originators or servicers will not act in their interest.
Second, investors do not care whether there might be better models that distin-
guish price risk more advantageously for low-income communities and minori-
ties.
Their main concern is whether borrowers are willing to pay mortgage
interest rates that fairly compensate the investor.
This can lead to charging bor-
rowers for lax underwriting, servicing, and even fraud that suppliers may intro-
duce into the system.
As long as the borrowers are willing to cover the costs of
those missteps or misdeeds in the form of interest rates and fees, investors are
satisfied.
Third, in a world in which mortgage products have proliferated to
such a degree—and the price points for mortgages along with them—it
becomes harder for consumers to know the best deal for which they qualify and
easier for lenders to take advantage of this fact.
Therefore, borrowers may be
overcharged as a result of a lack of efficiency and accessible consumer informa-
tion in the system.
Furthermore, in a world in which loans have higher prices
and fees than a conventional prime loan, opportunities to prey on hapless con-
sumers mount.
As a result, not all homeowners have benefited equally (or at all) from open-
ing the spigots of mortgage and other credit. Some owners have not been build-
ing wealth as much as they might because they are being overcharged.
Others
are getting credit even though they have high probabilities of missing payments
and lack a safety net on which to fall back when they do.
Other owners are
building the asset-portfolios of an array of predatory lenders, brokers, and
agents, rather than their own.
more are bought and sold.
In the past, lenders held credit they extended in their
own portfolios and serviced it as well.
Over the past fifty years, loan originators increasingly have become separated from those ultimately investing in loans.
In
addition,
loans have been pooled to back securities that bring added liquidity to
the market.
The efficiency of capital markets in matching debtors with certain
risk profiles to investors with certain risk tolerances is unparalleled.
But this effi
ciency comes at a cost: it requires heavy reliance on third-party agents to con-
nect investors and debtors. In theory, these intermediaries work on behalf of
investors and in the interests of debtors, but in reality their incentives may not
be aligned with either one.
Nevertheless, a powerful aspect of the global markets that dominate modern
mortgage lending is that in many respects they are blind to race, ethnicity, and
religion.
A neighborhood banker often no longer makes a face-to-face decision
on how much to lend an applicant.
Instead, the financial history of the appli-
cant is usually fed into a computer, which renders a score that is a financial cali-
bration of risk.
Each day lenders (no longer just banks, but mortgage brokers,
too) issue thousands of mortgages, which are then sold on the secondary mar-
ket.
Indeed, the global markets care only about risk and return, not race and
religion.
To the degree that the scores and other information used to underwrite
loans predict risk accurately, and arrive at an interest rate that compensates
investors for the level of risk assumed, investors are satisfied.
The blindness of the capital markets to much of what goes into credit deci-
sions cuts both ways, though, as it has both positive and negative aspects.
On
the plus side, with the protections of better colorblind risk assessment and man-
agement tools, lenders have abandoned near-exclusive reliance on the classic 20
percent down, fixed-rate mortgage.
Today, lenders offer a remarkable array of
products to borrowers with a wide range of past credit histories, and even offer
products to borrowers without documented credit histories.
These products
include: low to no down payments; adjustable-rate loans; hybrid loans that fix a
rate for a number of years and then reset to current market rate; loans that
require low or no documentation of income and assets; and loans that allow for
larger ratios of debt to income.
As a result, people with low incomes (and mini-
mal savings) can get mortgages.
People with major blemishes on their credit
records can get credit. Indeed, the poor no longer face a scarcity of credit; they
face a surfeit of it.
With a few clicks on the computer mouse, or calls to toll-free
numbers, a person can take a first step toward homeownership. Easy mortgages
have made many Americans homeowners. And for most of them, homeowner-
ship has been the first step in the accumulation of genuine equity, giving them
an asset to list on their balance sheet.
On the minus side of the ledger are several items that, if not addressed,
could diminish the potential value brought by the revolutions in information
technology and capital markets.
First, investors in mortgage-backed securities
are remote from the lenders or brokers that initially underwrote the loans.
Thus discrimination and fraud can plague the system if investors fail to manage the risk that loan originators or servicers will not act in their interest.
Second, investors do not care whether there might be better models that distin-
guish price risk more advantageously for low-income communities and minori-
ties.
Their main concern is whether borrowers are willing to pay mortgage
interest rates that fairly compensate the investor.
This can lead to charging bor-
rowers for lax underwriting, servicing, and even fraud that suppliers may intro-
duce into the system.
As long as the borrowers are willing to cover the costs of
those missteps or misdeeds in the form of interest rates and fees, investors are
satisfied.
Third, in a world in which mortgage products have proliferated to
such a degree—and the price points for mortgages along with them—it
becomes harder for consumers to know the best deal for which they qualify and
easier for lenders to take advantage of this fact.
Therefore, borrowers may be
overcharged as a result of a lack of efficiency and accessible consumer informa-
tion in the system.
Furthermore, in a world in which loans have higher prices
and fees than a conventional prime loan, opportunities to prey on hapless con-
sumers mount.
As a result, not all homeowners have benefited equally (or at all) from open-
ing the spigots of mortgage and other credit. Some owners have not been build-
ing wealth as much as they might because they are being overcharged.
Others
are getting credit even though they have high probabilities of missing payments
and lack a safety net on which to fall back when they do.
Other owners are
building the asset-portfolios of an array of predatory lenders, brokers, and
agents, rather than their own.