One bank refers to it, in the great recent tradition of using meaningless jargon to describe unpalatable things, as "risk-based asset creation." Translated, that means charging huge fees and interest rates to poor people, racial minorities, and folks with spotty credit histories. It's also known as "predatory lending," and it's a big problem across the country.
In April, the federal Department of Housing and Urban Development released a study showing that racial minorities - even wealthy ones - are disproportionately served by the "subprime" mortgage industry in big cities. (The "subprime market" includes people with imperfect or no credit histories, and the institutions lending money to them aren't generally conventional banks.) The study focused on urban areas, partially because that's where the problem is thought to be worst, but also because of HUD's responsibility to monitor and combat racial discrimination.
But studies in Iowa - the state as a whole, the Quad Cities, and rural areas - are showing that predatory lending is a major problem in the heartland, too.
The National Community Reinvestment Coalition (NCRC), as an advocate for financial institutions using their assets within their communities, has become something of a bank watchdog. The group analyzed mortgage statistics in the Quad Cities and Muscatine, and also profiled the activities in Iowa of Green Tree Financial, a subprime lender that many activists consider predatory because of the high interest rates and fees it charges.
NCRC found that approximately 60 percent of the homes bought in Muscatine in 1998 were financed by subprime lenders, and that Green Tree in 1998 financed the third-highest number of home purchases in Iowa, lending more than $60 million.
"We found evidence of high-interest loans," said Josh Silver, the NCRC's vice president of research and policy. The group looked at more than 4,000 loans that Green Tree was selling in August 1999, and 28 percent were "balloon loans" on which the principal was due in full in less than 10 years, and about half had interest rates higher than 12 percent - a level that borders on predatory.
These results raised a key question, Silver said: "Are traditional banks abandoning this market [low-income people, minorities, and women] and creating a void" that's being filled by subprime lenders?
The answer, according to the NCRC study of lending practices in the Davenport area, is yes. One finding of the study was that while home-purchase loans to the general population increased 2 percent between 1996 and 1998, loans to African Americans dropped 4 percent. Furthermore, while blacks make up 4.4 percent of the household population, they received only 1.2 percent of all conventional home-purchase loans in 1998.
Those studies suggest a grim situation, but they don't paint the full picture. "We don't know in Iowa," said Shelley Sheehy, a local housing activist and also an NCRC board member.
"I don't think anybody really knows" the extent of predatory lending locally, said Brian Hollenback, director of housing services for Rock Island Economic Growth Corporation. "There is evidence of it here. ... I am consistently aware of people leaving their closing very upset" because they felt the terms of their mortgages were different than what they were promised.
It's important to note that while nearly all predatory lending happens in the subprime market, not all subprime loans are predatory. Nonetheless, a study by the North Carolina Fair Housing Center found that "more than half of the [subprime] borrowers ... interviewed have experienced some of the indicators of predatory lending," the organization's Web site claims.
"Predatory lending" covers a range of practices that can include charging excessive fees or interest rates; hiding high fees and closing costs in the loan amount instead of requiring them up-front; frequently refinancing a loan to drive up the balance with little or no benefit to the borrower; and making monthly payments so low that at the end of the loan period the borrower still owes the entire loan amount or more at one time and is forced to refinance, possibly even at a higher rate.
"All we're doing is setting up people for failure," Hollenback said.
There is a certain risk involved in the subprime mortgage market, and that's why somewhat higher interest rates for such mortgage loans are considered standard and fair. Fair-lending advocates say that charging higher-risk people between one and five percentage points above the prime lending rate does not amount to predatory lending because of the higher rate of default among people with lower credit ratings. But lenders charging beyond those five points, or charging large fees, are considered predatory because their return is far greater than the risk, and because the loan is also secured by the property.
"Just because I have a worse credit rating than you doesn't mean I should be a victim," said David Runkel, communications director for U.S Representative Jim Leach (R-IA). "The risk is offset by the value of the property. You don't need to load up on fees."
Leach chairs the House Committee on Banking and Financial Services and has asked regulators to beef up their efforts to stamp out predatory lending. Leach has identified laws that allow banking regulators and the Federal Reserve Board "to deal with some of these predatory lending activities," Runkel said.
It's been working over the past few months, he added, because people overseeing financial institutions have been enforcing existing regulations that restrict what lenders can and cannot do. "Regulators are taking a more aggressive stance," Runkel said. "Things seem to be moving in the right direction."
The extent of the problem of predatory lending is just now becoming clear on a national scale. The market for subprime mortgages grew from $10 billion in 1993 to $150 billion in 1998. The HUD study in April found that subprime loans accounted for 51 percent of mortgage refinancings in African-American neighborhoods in 1998, compared to 9 percent in white neighborhoods. More surprising, 39 percent of refinanced loans in high-income African-American neighborhoods were in the subprime market.
But the problem extends far beyond the inner city for several reasons.
Sheehy said that NCRC's study of the Muscatine market proves that because so few banks serve rural areas, having closed outlying branches, subprime lenders have moved in. That would help account for Green Tree's standing as Iowa's third-largest lender in terms of number of loans.
Furthermore, most subprime lenders - especially those who advertise heavily - are national companies that offer 24-hour service by telephone, and they make the process less arduous. Many people are afraid to apply at banks because they expect to be rejected, Sheehy said. "If you get an 800 number ... and do it over the phone, you don't know [about exorbitant rates and terms] until you're signing the papers," Sheehy said.
"There are a lot of bait-and-switch tactics," Hollenback said.
It's unfortunate that many people have turned to deceptive subprime lenders, Hollenback added, when many local and national banks have a commitment to community-development lending and offer subprime loans at fair, reasonable rates. "We have a lot of very strong lenders in the Quad Cities," he said. Predatory lending, as a result, "is not as rampant here" as in big cities, he said.
But Sheehy was skeptical. "The banks have a few small programs" to reinvest money in underserved areas, but these programs aren't doing enough. If banks were serious about serving minorities, women, and low-income people, predatory lending wouldn't be nearly so prevalent.
But even though predatory lending has shown itself everywhere, including agricultural communities, the government's focus has remained on urban areas.
William McNarney, state coordinator for HUD, said he has heard few complaints about predatory lending in rural areas. "We do not have a specific initiative underway in rural areas," he said. He added that he has heard of some predatory lending in Davenport, but a representative of the City of Davenport said that a situation it reported to HUD was a contract-for-deed agreement and not a conventional home mortgage.
Beyond recognizing the extent of the problem, the impact of predatory lending isn't fully clear to governments, even those that should know better. The State of Iowa is set to release a draft of its housing-needs assessment this week, yet Sheehy expects it will not address predatory lending or "how people get money."
Predatory lending started growing in the early 1990's. The 1994 passage of the Home Ownership and Equity Protection Act was designed to protect consumers, but it did little.
Part of the challenge in combating predatory lending is that it is often legal, and it doesn't help that there's a fragmented regulatory structure. HUD's only concern is discrimination in lending, such as an African-American family being charged higher interest rates than a white family with similar incomes and credit histories. Beyond that, "we don't have any enforcement authority," McNarney said. Similarly, the Federal Reserve and banking regulators have narrowly prescribed oversight. As a result, there are several bodies with very specific interests, but no single entity looking at all aspects of the problem.
Runkel said Leach will wait and see if increased regulation can "shut down the more egregious activities." If not, he said, "he hasn't ruled out the possibility of additional legislation."
Predatory lending is not risk-free, though, and the past few months suggest that the financial model on which many subprime lending companies are based is not a sound one. In other words, legislation might not even be necessary to end the predatory-lending boom.
In late June, First Union Corporation announced it was shutting down The Money Store, which it purchased in 1998. The company reported that it would take a $2.7 billion hit against earnings. (Mortgages held by the Money Store will be sold.) In March, Conseco announced that it planned to sell off Conseco Finance, was previously known as Green Tree Financial.
U.S. Senator Charles E. Grassley (R-IA) has been concerned about predatory lending for several years and held hearings in March 1998 in the Special Committee on Aging committee he chairs. Although no legislation came of those hearings, Grassley is presently considering introducing a bill that would require lenders to provide "mandatory counseling" on the terms of mortgage loans made in the subprime market, said Jill Kozeny, a spokesperson for the senator.
That's just one idea, and it's the type of legislation that has the best chance of passing Congress. Lobbyists for the financial sector are unlikely to let more restrictive measures get through.
But Sheehy expects some type of regulation will become law, and banks are hesitant to get any father into the subprime market. "They see the writing on the wall," Sheehy said. "There's going to be legislation."
Education is a key, and some lenders are taking the lead. Firstar paid $20,000 for materials for a "train the trainers" financial literacy program. Such programs give consumers the information they need to determine whether they're getting fair terms from financial institutions. "People are going to know they're getting a bad deal" if they're financially literate, Sheehy said.
Firstar is one example of a bank that sees an opportunity in the subprime market. Somewhere between the prime mortgage rate and the rates being charged by predatory lenders are reasonable rates that will net financial institutions a decent return and also protect them against the higher risks of the subprime market. That's what Firstar is offering, Sheehy said. "They don't want to miss that market," she said.