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New study estimates effect of predatory-lending law
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By Zach Fox
A new study has offered an estimate of the effect predatory lending practices might have had on default rates and
explores the consequences of an intervention program.
The study, released last week as a working paper for the National Bureau of Economic Research, focused on
legislation implemented in Chicago at the end of 2006, near the peak of the real estate boom. The pilot program
required borrowers with poor credit seeking subprime loans to go through a counseling program.
It was short-lived, as the program faced vociferous opposition from real estate groups arguing it would restrict credit,
as well as from community activists claiming it would disproportionately harm minorities. As such, the study
focuses on the time the program, known as H.B. 4050, was active, from September 2006 through January 2007.
The study looks at loan performance and lending volumes across time periods as well as against a control group of
Chicago ZIP codes not included in H.B. 4050.
In general, the authors — Sumit Agarwal, a professor at the National University of Singapore; Gene Amromin, an
economist at the Federal Reserve Bank of Chicago; Itzhak Ben-David, a professor at The Ohio State University;
Souphala Chomsisengphet, a researcher at the OCC; and Douglas Evanoff, a researcher at Chicago's Federal
Reserve — concluded that the program did reduce delinquency rates for loans made under the program, but at a
considerable cost.
The program targeted subprime borrowers and only applied to state-licensed lenders, as opposed to federally
chartered institutions such as money-center banks. For that population, the study found a decrease of 6 to 7
percentage points in the 18-month default rates.
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However, the authors did find that the default rate improvement came at a cost of restricted credit. On average, the ZIP codes affected by the legislation saw 912
purchase mortgages per month leading up to H.B. 4050. During the implementation window, purchase mortgages averaged 294 per month, a 67.7% decrease.
However, the control ZIP codes saw a decrease of 30.4% for the same metric and time period. Using a difference-in-differences approach, the authors estimate the
legislation reduced the amount of purchase mortgages originated by 37.3%.
With such effects, it presents an open question as to whether H.B. 4050 offered a net benefit.
"It's really hard to say. It's really for the reader to judge," Ben-David told SNL. "Is it worthwhile to reduce the default rate by 6% and the market shrank by 40%? It
depends on whom you ask."
In addition to the reduction in liquidity, the authors argue the benefits were not that great, since the default rate for loans affected by H.B. 4050 was still close to
20%.
Perhaps most interestingly, the study found that the legislation had a more noticeable impact on reducing delinquency rates among borrowers who did not enter
into counseling. Since the counseling requirement only kicked in if a borrower selected a high-cost loan, borrowers could pick a different product and avoid the
counseling session. In this manner, the counseling requirement acted like a tax, Ben-David said.
"This effect is much stronger than the effect of financial education," said Ben-David. "There is something ironic about this mortgage counseling program working
best on those who didn't actually go to the counseling."
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