Defaults? Who Goes Into Foreclosure,\"

¶ … defaults? Who goes into foreclosure," the recent subprime mortgage crisis did not affect all borrowers equally. Individuals of nonwhite backgrounds were more likely to be affected by the crisis, even more so than whites of similar economic circumstances. The authors based their conclusions upon newly-available data from the Home Mortgage Disclosure Act (HMDA) and pre-foreclosure filing notices (PFF) to delinquent borrowers. They compared loans that resulted foreclosures to those that did not.

Their analysis yielded several interesting findings, including the fact that middle-income rather than low income borrowers were more likely to default, and non-white households were more apt to be in this middle-income bracket. High-cost loans -- loans where the rate of interest was above that of the yield of U.S. Treasury Bond -- and loans without a fixed rate had a higher default rate, and blacks and Latinos were more apt to take out such loans. Members of historically-discriminated against groups within the United States also tended to borrow more money. "Subprime lenders' market share was also positively correlated with percentage of minority residents within a given census tract" (Doviak & MacDonald 2011: 5). Even before the real estate bubble, data from 2000 indicated that subprime lending had expanded rapidly and disproportionately into minority communities. The sharp decrease in interest rates subsequently then caused such lending to proliferate and increase exponentially. Gaining money from higher interest rates later on justified the risk that banks took to extend adjustable-rate mortgages to subprime borrowers.

Of course, one possible response to the idea that banks were 'targeting' minority communities to encourage prospective borrowers to take out less-than-desirable loans is that minority populations often tend to be of lower socioeconomic status because of historical circumstances within the U.S., such as long-standing segregation and discrimination within the job market. However, the disproportionate number of middle-class members of historically-discriminated groups within the population sample suggests otherwise. Furthermore, "high-income black neighborhoods were twice as likely as those in low-income white neighborhoods to take out a subprime loan," counteracting the possible thesis that economics alone determined the likelihood of being targeted as a potential candidate to take out a subprime loan (Doviak & MacDonald 2011: 6). Only 6% of borrowers; 39% of borrowers in upper-income historically black neighborhoods had subprime loans, "more than twice the 18% rate for borrowers in low-income white neighborhoods (Doviak & MacDonald 2011: 6). This finding is particularly significant given that while an individual high-income black borrower's credit score could theoretically be lower than a high-income white borrower's credit score, it is impossible to explain in a neutral fashion "how the average credit score of a high-income black neighborhood could be lower than the average credit score of a low-income white neighborhood" other than discriminatory targeting of African-Americans (Doviak & MacDonald 2011: 6-7).

When analyzing the data, the clearest pattern emerged that the more an individual borrowed, the more he or she was likely to default. 65 of individuals who "entered the foreclosure process with a lis pendens filing borrowed more than $250,000, whereas only 56% of the borrowers who did not go into foreclosure borrowed more than $250,000" (Doviak & MacDonald 2011: 15). But this did not mean that there was a perfect correlation between a high income and default rates, as 56% of the borrowers who defaulted had incomes in excess of $80,000, whereas only 52% of the borrowers who did not receive a pre-foreclosure filing had incomes over $80,000 (Doviak & MacDonald 2011: 15).

The authors of the article called this 'puzzling,' although it does suggest that individuals who were desperately trying to obtain houses that would enable them to have the appearance of entering the upper middle-class were seeking to borrow more money than their home was actually worth. Predictably, adjustable rate mortgages had a higher rate of default than non-adjustable rate mortgages, given the increase in interest rates in the years before the crisis, after many borrowers took out loans during an era of unusually low, near-zero rates. But another puzzling finding was that loans below $100, 000 and loan amounts in the $250,000 to half-million range had higher interest rates than loans of a half-million and above, once again suggesting that while middle-income individuals who might otherwise appear to be 'good' risks had been targeted for loans that were not advantageous to them.

"The finding that blacks and Latinos tended to borrow more helps explain why they received a disproportionately high share of high-cost loans, but the larger amounts borrowed by Asians contradicts the hypothesis that loan amount explains the rate spread differentials the best predictor that a borrower would default is the amount borrowed" as Asians tended to borrow more than either group, but had a lower rate of default (Doviak & MacDonald 2011: 20). Other suggestions of impropriety upon the part of lenders are manifest in the fact that the interest rate on a loan originated to a black borrower was as much as 1.36 percentage points higher than a the interest rate originated to an equivalent white borrower and 0.92 percentage points for a Latino (Doviak & MacDonald 2011: 26).

Adverse selection, simply stated is the idea that market imperfections -- discrimination, lack of alternatives, etc. -- may cause individuals to make economic decisions they might not otherwise decide upon. In this instance, the statistical evidence seems clear that lenders encouraged low-risk borrowers to take subprime loans for discriminatory reasons. The reasons for this are not immediately clear from the data. But it is possible to speculate why this might be the case. Because of discrimination in the housing market in the past, members of historically discriminated-against groups often do not have a long-standing tradition within their families of home ownership and thus may not be familiar with the nature of what constitutes a favorable loan for a home. The determination to 'milk' the housing boom by encouraging individuals to take out mortgages on 'more home than they could afford' caused lenders to engage in unjust practices that ultimately hurt themselves in the long run as well as borrowers. "the default that progresses to foreclosure reduces the value of a lender's portfolio of home mortgages" (Doviak & MacDonald 2011: 26).