A Risk Worth Taking

In recent months, conservative economists and editorialists have tried to pin the blame for the unholy international financial mess on subprime lending and subprime borrowers. If bureaucrats and social activists hadn't pressured firms to lend to the working poor, the narrative goes, we'd still be partying like it was 2005 and Bear Stearns would be a going concern. The Wall Street Journal's editorial page has repeatedly heaped blame on the Community Reinvestment Act (CRA), the 1977 law aimed at preventing redlining in minority neighborhoods. Fox Business Network anchor Neil Cavuto in September proclaimed that "loaning to minorities and risky folks is a disaster."

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This line of reasoning is absurd on several levels. Many of the biggest subprime lenders weren't banks, and thus weren't covered by the CRA. Nobody forced Bear Stearns to borrow $33 for every dollar of assets it had, and Fannie Mae and Freddie Mac didn't coerce highly compensated CEOs into rolling out no-money-down, exploding adjustable-rate mortgages. Banks will lose just as much money lending to really rich white guys like former Lehman Brothers CEO Richard Fuld as they will on loans to poor people of color in the South Bronx.

But the best refutation may be provided by Douglas Bystry, president and CEO of Clearinghouse CDFI (community development financial institution), based in Lake Forest, Calif. Since 2003, this for-profit firm in Orange County—home to busted subprime behemoths like Ameriquest—has made $220 million in mortgages in the Golden State's subprime killing fields. More than 90 percent of its home loans have gone to first-time buyers, about half of whom are minorities. Out of 770 single-family loans it has made, how many foreclosures have there been? "As far as we know," says Bystry, "seven." Last year Clearinghouse reported a $1.4 million pretax profit.

Community-development banks, credit unions and other CDFIs—a mixture of faith-based and secular, for-profit and not-for-profit organizations—constitute what might be called the "ethical subprime lending" industry. Even amid the worst housing crisis since the 1930s, 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. Their numbers include tiny startups and veterans like Chicago's ShoreBank, founded in 1973, which now sports $2.3 billion in assets, 418 employees and branches in Detroit and Cleveland. Cliff Rosenthal, CEO of the National Federation of Community Development Credit Unions, notes that for his organization's 200 members, which serve predominantly low-income communities, "delinquent loans are about 3.1 percent of assets." In the second quarter, by contrast, the national delinquency rate on subprime loans was 18.7 percent.

Participants in this "opportunity finance" field, as it is called, aren't a bunch of squishy social workers. In order to keep their doors open, they have to charge appropriate rates—slightly higher than those on prime, conforming loans—and manage risk properly. They judge their results on financial performance and on the impact they have on the communities they serve. "We have to be profitable, just not profit-maximizing," says Mark Pinsky, president and CEO of the Opportunity Finance Network, an umbrella group for CDFIs that in 2007 collectively lent $2.1 billion, with charge-offs of less than 0.75 percent.

What sets the "good" subprime lenders apart is that they never bought into all the perverse incentives and "innovations" of the late subprime lending system—the fees paid to mortgage brokers, fancy offices and the reliance on securitization. Like a bunch of present-day George Baileys, ethical subprime lenders evaluate applications carefully, don't pay brokers big fees to rope customers into high-interest loans and mostly hold onto the loans they make rather than reselling them. They focus less on quantity than on quality. Clearinghouse's borrowers must qualify for the fixed-rate mortgages they take out. "If one of our employees pushed someone into a house they couldn't afford, they would be fired," says CEO Bystry.