An Investment Worth Making: Financing the New American Dream


In her new book How the Other Half Banks, Mehrsa Baradaran, a law professor at the University of Georgia, tells the true story of three borrowers.

The first, named Tanya, is a single mother of two. She had to take off work to take care of her son after he had emergency surgery. She fell behind on her bills, and she didn’t have anyone to help her. She went to a payday lender and got just enough money to cover the bills. She couldn’t pay it back by the next payday, so she took out another loan. And another and another and another. Until she owed $2,000 in fees and interest. She was earning $11 an hour at her job.

The second borrower is named Thelma. She worked two jobs, lost one, pawned the gifts her grandchildren gave her, and still couldn’t pay her bills. She went to a payday lender and wound up in the same position as Tanya, taking out loan after loan, until she “lost her bank account and ruined her credit.”

The third is a much happier story. This borrower, named Steven, found himself in Tanya and Thelma’s position after the financial crisis. He lost a lot of money in the crash, and he couldn’t pay his bills. So he too went to a lender, but this lender was much more forgiving than Tanya’s or Thelma’s. They gave him low interest rates and lots of time to pay it back. They made sure he didn’t go deeper into debt, and he wound up paying it all back and becoming quite rich and successful in the process.

I like to call this the Parable of Steven, and it raises and important question: How do we turn predatory lending victims like Tanya and Thelma into success stories like Steven?

Well, in crafting an answer, it might help if I told you a bit more about these borrowers. Tanya and Thelma were low-income Americans, as you probably suspected, but Steven…well, his name wasn’t really Steven. And he wasn’t low-income at all. Steven was actually the big banks on Wall Street, and his generous lender was the U.S. government.

In my last post, I talked about the predatory lending schemes that ensnared homeowners during the recent bubble, and I argued that we can prevent another financial disaster by giving borrowers access to affordable credit that won’t bankrupt them in their quest for the American dream. Baradaran’s story shows that it’s possible.

We live in a world where people who need credit the most have the least access to it—a world where “the less money you have, the more you pay to use it,” says Baradaran.

In this world, interest rates vary from 20 percent up to 400 percent. The average borrower renews their payday loans at least ten times, paying the lender for 1999 days. The average title borrower gets a loan backed by their car and then proceeds to renew that loan eight times, “paying $2,142 in interest for $951 in credit.” Nonbank lenders, the kind who made the risky subprime loans that I talked about in my previous post, have taken over 20 percent of the market from the regulated banks since the Great Recession.

The greatest tragedy of all isn’t just the fact that these loans are risky. It’s that, in addition to the damage they do, they make policymakers and voters think that these borrowers can’t be helped. In the wake of the Great Recession, public debate seems to have convinced itself that low-income Americans can get either risky loans or no loans at all.

That leap of logic is both sad and untrue.

When I was at the Federal Reserve, the Congress  assigned us with the task of evaluating lending associated with the Community Reinvestment Act, which was passed in 1977 to encourage banks to lend to low-income communities. Our exploration provided answers that should cause everyone to question this view of low-income Americans where credit is concerned. Congress had passed We found that, after more than twenty years, the CRA was successful at getting banks to give loans to borrowers who had limited options—and the vast majority of those loans were profitable!

Low-income households, it turns out, can access the American dream. But only if they are given an affordable path.

So I shouldn’t have been surprised fifteen years later when my colleagues and I found that homeownership actually increased in the communities with the biggest influx of “nontraditional” mortgages during the housing bubble. Even after the bust, we found a slightly positive effect.

Unfortunately, these success stories have been overshadowed by the many tragic losses that roiled the global economy and devastated millions of homes. My colleagues and I are determined to find ways to foster the former without the latter.

One of my latest efforts, a forthcoming chapter with Anthony W. Orlando that will appear in a book being published by Cambridge University Press, reveals a long history of profitable lending to low- and moderate-income homeowners by American institutions.

We learn from John Creswell, who first had the idea for the U.S. Postal Service to open savings banks for all Americans—a successful 56-year experiment that attracted many millions of dollars in deposits with “virtually no bank withdrawals” from private banks.

We learn from the buildings and loan associations, or “thrifts,” which overcame the risk problem of lending to low-income homeowners by knowing the borrowers personally.

We learn from the South Shore Bank in Chicago, where a few inspiring bankers found that they could profitably invest in community development in low-income areas if they didn’t have shareholders demanding immediate returns.

Significantly, all three institutions either died or saw significant declines. The Postal Service closed its savings banks.  Deregulation drove the thrifts into risky lending that bankrupted most of them. South Shore Bank failed in the Great Recession. But these failures offer an important lesson: Our free market has never offered affordable financial services to all Americans without supportive public policies.

The Parable of Steven shows that even the big banks could not stay afloat without the collective action of the American taxpayer. I do not believe it is too much to ask that the same cooperative spirit be applied to the next generation of homeowners. Indeed, the evidence I’ve seen—and the consequences we have endured from the absence of affordable credit—suggests that it is one of the best investments we can make.


When Bad Loans Happen to Good People: The Horror Story of the “Monster”


While much of my academic career has been spent studying how families get credit to buy homes, the past few years have made me much more aware that simply getting credit isn’t a goal in itself. No, if the credit isn’t sensible and sustainable, the pain can be far worse than any gain that could have resulted.  Consider these stories…

You would have never known, unless you were trained to look for the signs, that Clarence and Wendy Wincentsen were a good mark. They weren’t poor. They weren’t uneducated. They had $300,000 in savings, and they had a perfect credit score. Almost nobody has a perfect score. These were good borrowers. They never should have gotten a bad loan.

But Greg Walling found opportunities where other loan officers might not. He noticed the little things, like how they forgot their reading glasses. That was good because he didn’t want them to read the loan documents.

Plus, he had the Track.

The Track was more than a sales technique. It was psychological manipulation, honed to a precise algorithm. The company called it, innocently enough, “A Loan Officer’s Track to Run On.” The loan officers knew better. They weren’t trying to make loans. They were trying to “find the pain.” They were taught to leave the room and come back and reintroduce themselves twice because customers would subconsciously see them as friends if they’d met them multiple times. Then, they’d leverage this friendship to ask them about their marriage, their bills, their savings, all in the pursuit of finding that pain point where they could be talked into “needing” money. When customers had objections, they’d evade. They’d change the topic. And they’d be so smooth, you wouldn’t even notice they were doing it.

For the Wincentsen’s, it was their car loan. They wanted to pay it off, but they didn’t want to spend so much all at once.

Greg Walling had a solution. He’d refinance their mortgage, and they could take out enough cash to pay off the car loan. In order to make a profit himself, however, he’d have to convince them to pay a higher annual percentage rate (APR) than they were currently paying.

When they got to this point in the Track, the training manager would leave the room. A new guy would come in. One of the company’s top sellers. “Put down your pens and pencils,” he would say. “Cut off your tape recorders.”

Then he would teach them the Monster.

The trouble with APR, from an unscrupulous loan officer’s perspective, is that it includes the entire cost of the loan—not just the interest and principal payments, but the upfront points and fees too. That’s why the government requires them to report it. It tells the borrower the true cost they’ll be paying. It makes it harder for guys like Walling to pad the loan with hidden costs.

The Monster was the loan officer’s way of convincing the customer that APR didn’t matter. He’d show them a hypothetical comparison of two borrowers with the same interest rate and the same fees. One would have a fifteen-year mortgage, and the other would have a thirty-year mortgage. He’d point out that the thirty-year borrower would wind up paying more, even though their APR is the same, because they’re paying the same interest payments for twice as many years. Then he’d get them to admit that short-term loans are better, even if they came with a higher APR, because they’ll save in interest payments in the long run.

When the Wincentsen’s walked out of Greg Walling’s office, they had refinanced their mortgage and cashed out $15,000, and they owed $12,000 in points. The Monster worked.

The Wincentsen’s were one of many caught in this trip.

There was Michael Austin, the 48-year-old machinist who wanted to refinance his mortgage but didn’t want to pay the APR he was being offered. So the loan officer told him it wasn’t binding and convinced him to sign the documents. Austin went home and changed his mind, but the loan officer told him he couldn’t back out now. “You’re going to lose your house,” the officer said to Austin, who was on the verge of tears. “You’re going to ruin your credit forever… C’mon Mike, this is a good deal… This is what you want. This is what you need.” Austin signed the final loan, which wound up costing $20,000 more than he thought it did.

There were the Berringers, who after 56 years of marriage tried to pay off their credit card debt by refinancing their mortgage, only to find that they now owed $18,000 in points and fees that they couldn’t afford. So they took out a reverse mortgage, which allowed them to keep the home but took away all their equity, including their ability to pass their home on to their kids and grandkids.

These stories, and many others like them, come from Michael W. Hudson’s The Monster, one of the great feats of investigative journalism to come out of the recent housing bubble. Hudson’s work makes clear that predatory lending is real, which many people know. What makes the book particularly eye-opening is that each of these borrowers suffered at the hands of one of the largest, most prominent mortgage lenders in the modern era. Predatory lending is real, and it is more pervasive than most Americans realize.

“Every closing that we had really was a bait and switch,” said one loan officer. “’Cause you could never get them to the table if you were honest.”

To be fair, I don’t ascribe to the view that all loan officers behave in this shameful way, and don’t think you should either. There are many upstanding and honest people in the industry. But when I studied the history of mortgage lending, and sadly, I discovered schemes like these were certainly nothing new.

In a new paper with my colleague Anthony W. Orlando, I trace the ebb and flow of these predatory lending schemes over time, each one landing the nation in a financial crisis when the borrowers inevitably default on loans they didn’t understand and couldn’t repay. No amount of innovation in the market has stopped these rip-offs. On the contrary, the more complicated our financial instruments have become, the more education we as consumers need in order to protect ourselves.

Unfortunately, most Americans aren’t getting that education. Over 40 percent of Americans don’t even understand enough of the basics to qualify as “financially literate”.

Fortunately, we did not end the paper there.

We found hope in a number of promising programs that have recently been evaluated by top researchers. One pilot program, tested during the bubble in Chicago, required risky borrowers to meet with a financial counselor before they signed the loan. Another program in Tennessee required homebuyers to attend classes. A similar experiment by the Federal Reserve Bank of Philadelphia offered a two-hour counseling session to first-time homebuyers. In all three cases, the result was a significant improvement in borrowing behavior and outcomes.

These programs were temporary and small, and they do not overturn the results of other programs that have not worked as effectively. But they provide a glimmer of possibility from which we should draw strength. The fate of the Wichtensen’s and the Berringer’s and Mrs. Pittman and Mr. Austin need not be the fate of the next generation. Nor should it be.

By the time Greg Walling finally came forward as a whistleblower—“even a thief has morals and ethics,” he said—countless homes had been ruined. In our next post, we will propose ways to prevent this tragedy from recurring—not just by reducing these risky, expensive loans, but by replacing them with affordable options that treat each person and their home with the dignity and respect they deserve.