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5

SUBPRIME LENDING

CONTENTS
Mortgage securitization: “This stuff is so complicated how is
anybody going to know?” ..............................................................................
Greater access to lending: “A business where we can make some money”.............
Subprime lenders in turmoil: “Adverse market conditions”..................................
The regulators: “Oh, I see” ...................................................................................

In the early s, subprime lenders such as Household Finance Corp. and thrifts
such as Long Beach Savings and Loan made home equity loans, often second mort-
gages, to borrowers who had yet to establish credit histories or had troubled financial
histories, sometimes reflecting setbacks such as unemployment, divorce, medical
emergencies, and the like. Banks might have been unwilling to lend to these borrow-
ers, but a subprime lender would if the borrower paid a higher interest rate to offset
the extra risk. “No one can debate the need for legitimate non-prime (subprime)
lending products,” Gail Burks, president of the Nevada Fair Housing Center, Inc., tes-
tified to the FCIC. 
Interest rates on subprime mortgages, with substantial collateral—the house—
weren’t as high as those for car loans, and were much less than credit cards. The ad-
vantages of a mortgage over other forms of debt were solidified in  with the Tax
Reform Act, which barred deducting interest payments on consumer loans but kept
the deduction for mortgage interest payments.
In the s and into the early s, before computerized “credit scoring”—a
statistical technique used to measure a borrower’s creditworthiness—automated the
assessment of risk, mortgage lenders (including subprime lenders) relied on other
factors when underwriting mortgages. As Tom Putnam, a Sacramento-based mort-
gage banker, told the Commission, they traditionally lent based on the four C’s: credit
(quantity, quality, and duration of the borrower’s credit obligations), capacity
(amount and stability of income), capital (sufficient liquid funds to cover down pay-
ments, closing costs, and reserves), and collateral (value and condition of the prop-

erty). Their decisions depended on judgments about how strength in one area, such
as collateral, might offset weaknesses in others, such as credit. They underwrote bor-
rowers one at a time, out of local offices.
