by Gary Rivlin
The payday lenders, the check cashers, and others catering to those on the economic fringes had been worried that somehow a crackdown on subprime mortgage lenders could threaten the way they conduct business. They were right to worry. The centerpiece of the Obama administration’s financial reform package was an idea that Elizabeth Warren of Harvard first proposed in mid-2007: a Consumer Financial Protection Agency, or CFPA. The impetus behind this new regulatory body may have been the need to rein in abusive mortgage practices and complex products such as collateralized debt obligations that Warren Buffett had dubbed “financial weapons of mass destruction.” But this proposed, new consumer protection agency for financial products would also have jurisdiction over payday loans, the pawn business, subprime credit card companies, and pretty much any Poverty, Inc. enterprise. The CFPA consolidated enforcement into a single, stand-alone agency that would have broad authority to investigate and react to abuses. The agency would also promote better financial education. Predictably, virtually every business in this sector lined up against the Obama proposal. How could they not in the face of a new federal agency that would suddenly be poking into their business? The CFPA was “redundant,” a “waste of money” (actually, under Obama’s plan, the businesses being regulated would be assessed a fee to pay for the agency), and an “extra layer of bureaucracy.” Lynn DeVault, the Allan Jones lieutenant heading up the payday lender trade organization, told Cheklist that her group had quadrupled its federal lobbying budget.
The scope of this proposed new regulatory body was made plain by the breadth of interests aligned against it, a roster that included banks and payday lenders, of course, but also pawnbrokers, car dealers, real estate developers, the U.S. Chamber of Commerce, and even utility companies. By the time the debate over the agency began in mid-October, the financial services industry had already spent more than $220 million lobbying against Obama’s proposed agency.
FEDERAL AGENCY A NEW THREAT—that was the headline in the fall 2009 issue of Cheklist. The author of the article checked in with the check cashers, a pawn chain, and a payday proprietor. There may have been a time when the poverty industry wasn’t a single entity so much as splintered, competing interests fighting over the same clusters of customers. But the pawnbrokers became check cashers and the check cashers ventured into payday, as did rent-to-own. And more recently the payday lenders started getting into check cashing, money orders, refund anticipation tax loans, and any other business that might bring in additional revenues. They all learned the same tricks for maximizing revenues from the same sources, each category of business grew plump with profits due to the same set of broader economic factors: stagnating wages while home and health prices soared, the loss of good-paying manufacturing jobs, the widening gap between the wealthy and those on the bottom half of the wage pyramid that economists have been observing for thirty years. If nothing else, the fight against a new consumer agency underscored the unified nature of the country’s Poverty, Inc. sector—and its clout. JPMorgan Chase underwrites the loans for a large share of the instant tax market, the country’s biggest banks funded the growth of the payday industry, and pretty much every large investment bank has had its hand in one of these businesses or another. And what are overdraft fees, which generated $24 billion for the banks in 2008 according to the CRL, but another way a business is feasting off those living on the financial margins?
“If it was just us, we’d get killed here,” payday spokesman Steven Schlein said of Obama’s proposal for a consumer agency. But the interests of his clients and the country’s largest financial institutions are aligned. “Our hope is that the banks will beat this bill back,” Schlein said. As written, the Consumer Financial Protection Agency Act of 2009 didn’t give this new agency the power to cap interest rates. But it was Schlein’s great worry, and the worry of many within the Poverty, Inc. field, that an interest rate cap will be slipped in at the last minute or tacked on to a completely unrelated piece of legislation.
Obama said he wanted a financial reform package signed by the end of 2009 but that deadline came and went—and with it the Democrats’ filibuster-proof majority in the Senate. The House had done its part, authorizing the CFPA in legislation it dubbed the Wall Street Reform and Consumer Protection Act. Barney Frank, the liberal congressman from Massachusetts and chair of the House Financial Services Committee, had angered consumer activists by granting the federal government the power to preempt the states from regulating the national banks in some circumstances, but President Obama, anxious to see legislation pass by year’s end, immediately issued a press statement lauding the committee for its swift action.
The House bill passed without a single Republican vote. A rival proposal passed out of the Senate Banking Committee, chaired by Connecticut’s Christopher Dodd, but with health-care reform taking center stage and other issues crowding out the agenda, the full Senate failed to vote on the measure by year’s end. Then, shortly into 2010, Dodd announced he would not be running for reelection, introducing another X factor into the debate. Early in 2009, the Los Angeles Times had reported that Dodd had raised more than $44,000 in campaign funds from high-interest lenders like payday and pawn, and later that spring there were news accounts of the senator eating dinner with members of the industry group representing the online payday lenders. Despite a reputation for being too cozy with the banks and other financial institutions under his committee’s jurisdiction, or perhaps because of it, Dodd announced his support for a consumer regulatory agency shortly thereafter. What the lame-duck senator might do now that he wasn’t worried about raising more money or winning votes—and whether Obama’s proposed new agency could survive a filibuster threat—was anyone’s guess.
Ameriquest would be the first big subprime lender to flop. Its ignoble end in mid-2007 came when the company posted a curt message on its website informing people it would be taking no new applications for loans. Its assets would be sold, fittingly, to Citigroup. JPMorgan sold off much of its subprime mortgage holdings at the start of 2007 and, not long afterward, H&R Block and General Electric put its subprime mortgage units up for sale. But, finding no buyers, the two companies shut them down and absorbed the losses. Wells Fargo made a similar announcement, and New Century, which made $37 billion in loans in 2006, declared bankruptcy the next year. In 2008, Bank of America purchased Countrywide and JPMorgan Chase bought Washington Mutual. What was left of the subprime lenders boiled down to billions of dollars in debts and a raft of legal cases, including the lawsuit the city of Baltimore filed against Wells Fargo accusing the bank of steering black customers into subprime loans even when they qualified for lower-rate mortgages and home equity lines of credit. (A federal judge dismissed the charges against Wells at the start of 2010.) Perhaps the most shocking news of all came when HSBC announced, in March 2009, that it was shutting down Household Finance, despite the $14 billion it had paid for the company just a half-dozen years earlier.
Yet no bank seemed to take it on the chin as hard as Citigroup. Citi would remain on government life support longer than most of its competitors, and the stock price of this once-mighty global institution that as recently as May 2007 traded for more than $50 a share dropped to $1.02 a share—a 98 percent plunge. Citigroup’s primary problem was that it had full exposure on both sides of the subprime debacle: Through CitiFinancial, it was one of the country’s leading subprime mortgage originators and on the investment banking side its people had aggressively pursued a derivative product called a collateralized debt obligation that was based on underlying portfolios of mortgages. Citigroup wrote off tens of billions of dollars in bad mortgages and a new CEO split the company in two: those units they would keep and those they would sell once there was money back in the system. This second category included any number of divisions (insurance, the brokerage business) that Sandy Weill had brought to Citigroup. Citi would cut 110,000 jobs (around one-third of its workforce) and sell off $350 billion in assets by the start of 2010.
Yet ther
e was little joy inside the Center for Responsible Lending over the demise of the predatory subprime lender. The value of real estate in the United States had shrunk by $1 trillion in a matter of months, and there was more bad news coming as the rates would reset on all those explodable ARMs written in 2006 and early 2007. There was another new foreclosure every thirteen seconds through the early months of 2009, the Mortgage Bankers Association reported, and while the Obama administration promised help, it was slow in coming. Under its $75 billion Home Affordable Modification Program, created in March 2009, the government announced that it would pay mortgage companies $1,000 for each loan they modified and then another $1,000 a year for up to three years. But as 2009 was coming to a close, the institutions controlling these loans had renegotiated the home loans for only a tiny fraction of the 4 million eligible homeowners—66,000 in ten months. The CRL estimated that homeowners in neighborhoods with a high ratio of subprime loans saw the collective worth of their homes drop $500 billion in value because of nearby foreclosures.
“In the last twenty-five years, the United States made tremendous progress integrating poor families into the middle class, largely through home ownership,” Martin Eakes told me. “But now we’ll lose about half of that progress because of subprime abuses that were permitted to continue despite the best efforts of a lot of people. The subprime lenders have basically destroyed the communities that we were targeting. It’s a tragedy.” Compounding that tragedy, Eakes said, were the likes of Rush Limbaugh, Dick Cheney, and editorial writers for the Wall Street Journal repeatedly blaming the Community Reinvestment Act, or CRA, which required banks to make loans in any neighborhood where they had branches, as the cause of the crisis. It was absurd to blame a law that was written more than thirty years ago and didn’t apply to many of the biggest subprime lenders, including Ameriquest, Countrywide, and Household Finance. Yet Neil Cavuto declared on the Fox Business Network in the middle of the subprime meltdown in the second half of 2008, “Loaning to minorities and risky folks is a disaster.”
“If the extremists succeed in putting forward this view, then we’ll lose all hope for the next generation,” Eakes said. Equally disconcerting were those blaming the poor for the financial woes facing both Fannie Mae and Freddie Mac. Fannie and Freddie both played a big role in helping to cause the Great Recession of 2008. In September of that year, the federal government felt obliged to announce a $200 billion rescue of the two government-sponsored mortgage finance companies. But its true motivation for buying up all those home mortgages and either holding them in a portfolio or reselling them to Wall Street investors seemed less about helping those of modest means purchase a home—a large portion of those subprime loans, after all, involved middle-class and upper-middle-class borrowers—and more about profits and remaining relevant. Both Fannie and Freddie had gone public in 1989 and the seemingly unquenchable appetite for subprime loans in the 2000s seemed primarily about justifying the hefty salaries and even bigger bonuses the executives paid themselves.
There was at least one subprime lender still in business: Self-Help. Its own loan portfolio was performing blessedly well despite the global financial meltdown. By September 2009, roughly 4 percent of the country’s prime borrowers were delinquent on their mortgage payments compared to 20 percent of subprime borrowers. At Self-Help, that figure was 8 percent. The mortgages Self-Help bought on the secondary market it created in the mid-1990s were also faring much better than the typical subprime loan, in no small part because of the standards the organization used when evaluating a portfolio. Self-Help, Eakes said, would only buy portfolios where the points and fees were in line with conventional loans and would avoid writing mortgages that included onerous terms, such as a prepayment penalty. “We’ve always been about creating sustainable loans,” Eakes said.
There are still people, and not just Allan Jones, who blame Eakes and Self-Help at least in part for the subprime meltdown. Self-Help, after all, created the first subprime market and it was Self-Help who pushed Wachovia so hard to enter subprime lending (the bank ultimately hit bottom because of subprime). One problem with that argument is that Self-Help ended up being dwarfed by the larger subprime market. Over fifteen years, Self-Help bought $6 billion worth of subprime loans on the open market—or what Ameriquest, Countrywide, or Household Finance wrote individually in two months in 2005. “We were just a flea on this giant elephant,” Eakes said. Self-Help’s David Beck also disputed the notion that Self-Help’s secondary market served as a kind of gateway drug, giving established banks a taste for subprime. “The dirty little secret about subprime was already out there,” Beck said. “We didn’t have to give banks any idea of the obscene profits they could be making because they already knew.”
Despite its successes, Self-Help’s allies weren’t universal in their praise of the group. “They told me when we were fighting to save the Georgia Fair Lending Act, ‘We’ll negotiate to one iota of something just to be able to say we have a victory,’” Bill Brennan said of the role the CRL played in Georgia after the defeat of Roy Barnes. “We ended up dropping out of negotiations way before them. To be honest about it, we were appalled they were continuing to negotiate long after the bill had been gutted beyond recognition.”
Vincent Fort was even harsher in his assessment of CRL. “I’m down here dealing with people every day talking about foreclosures and predatory lending,” Fort said, “but here this group flies in here, they’ve received tens of millions of dollars from some predatory lenders, and they’re working on a bill with Republicans that’s a total piece of shit because they want to go back and say ‘We’ve accomplished this.’ I wasn’t very happy with the CRL.”
Then there’s the perspective of those who are part of a group that Newsweek dubbed the “ethical subprime lenders”: community development financial institutions and other nonprofits mainly. These lenders expose as overly simplistic the claim that the CRA was to blame for the global financial meltdown of 2008 or Neil Cavuto’s line that lending to minorities or those with blemished credit is a “disaster.” “Even amid the worst housing crisis since the 1930s,” Newsweek’s Daniel Gross wrote near the end of 2008, “many of these institutions sport healthy payback rates. They haven’t bankrupted their customers or their shareholders. Nor have they rushed to Washington begging for bailouts.” One person quoted in the article, Cliff Rosenthal, the head of an organization representing more than two hundred credit unions that lend primarily in low-income communities, said that delinquent loans were about 3.1 percent of assets in the middle of 2008 compared to a national delinquency rate at the time of 18.7 percent among subprime loans. The article also quoted Mike Loftin, the head of Homewise, a Santa Fe, New Mexico–based nonprofit that lends exclusively to first-time, working-class homebuyers. Of the five hundred loans on Homewise’s books in the fall of 2008, only 0.6 percent were ninety days late, Loftin said, compared with 2.4 percent of all prime mortgages nationwide.
Loftin is a good friend and I’ve been hearing about his group since the early 1990s, when he took over as its executive director. Technically, Homewise is not a subprime lender. His group focuses on potential homeowners with blemished credit scores but rather than put them in loans with a higher interest rate, Homewise provides prospective homebuyers financial counseling and also helps them get into the habit of setting aside some savings each month. (The Home Ownership Center of Greater Dayton, Beth Deutscher’s group, has the same approach as Homewise.) Typically it takes six months to a year for the serious homebuyer to boost his or her credit score and also scrape together the 2 percent down payment his organization wants to see before making a loan. “If customers build a savings habit to save that money on a modest income,” Loftin told Newsweek, “it says a lot about them and their financial discipline.”
Loftin thinks the world of Martin Eakes. I’ve heard him describe Eakes as having a rare moral clarity in a jaded world and he expresses great admiration for Eakes’s effectiveness, his creativity, and his integrity. He
’ll hear Eakes speak and he’ll feel invigorated. “He has this ability to remind us why we do what we do,” he said. The two have often been featured speakers at the same conferences and usually find themselves on the same side of an issue. The exception is the use of subprime loans. Through the subprime boom, Loftin watched as more than a few nonprofits embraced such loans. Colleagues confessed to him that they were moving into subprime because that’s where the action was and boasted about the fees they were earning writing those loans. He saw groups he had respected profoundly lose their way as they accepted money from Ameriquest, Citigroup, and other large lenders. Eakes never did so but it was Eakes who had been an inspiration for many and Eakes who served as the pied piper for responsible subprime lending. “Martin has to take some of the blame for giving credence to this notion that the best or only way to serve lower-income households is to charge them more,” Loftin said. From his perspective, the real shame of it was that all the energies of a group as talented and creative as Self-Help went into the development and growth of the subprime home loan.
Loftin trained as community organizer, and seems to have a preternatural ability to pose the kind of fundamental questions that get you thinking differently about an issue that had been settled in your mind. “Risk-based pricing” is supposed to be one of the great innovations in finance. Where in the old days, only those with good credit could secure a loan, risk-based pricing meant the extension of credit to everyone—so long as you’re willing to pay more to cover the greater risk in lending money to you. “The underlying logic of subprime mortgages and payday loans is the same: that the only way to expand credit to minorities and lower-income people is to dumb-down credit standards and charge them more for the added risk,” Loftin said. “But there are other tools in the box”—including financial literacy. “No one is born with poor credit,” he continued, “and teaching people how to manage their finances is a tool that has proven itself to work and to work over the long haul.” But it’s easier and quicker to charge people more than to go through the hard work of teaching people good habits.