2015 Law Student Writing Competition Winning Article: Mitigating the Ongoing Impact of the Subprime Mortgage and Foreclosure Crisis: Lessons from Oakland and Richmond, California

• Jurisdiction: California,United States,Federal
• Citation: Vol. 33 No. 3
• Publication year: 2015
• Author: Victoria Wong
• topic: Civil Rights,Banking and Finance Law,Federal,Real Estate

2015 Law Student Writing Competition Winning Article: Mitigating the Ongoing Impact of the Subprime Mortgage and Foreclosure Crisis: Lessons from Oakland and Richmond, California

Victoria Wong

Victoria Wong graduated first in her class from U.C. Davis School of Law in the Spring of 2015 and is a member of the Order of the Coif. While in law school, she was a judicial extern to the Honorable Justice Louis Mauro (Third District Court of Appeal), and worked as a summer associate in the Mountain View office of Fenwick & West. After graduation, Victoria will join Fenwick & West as a corporate associate. Victoria received her B.A. in Social Welfare from U.C. Berkeley.

I. Introduction

In 2007, the U.S. housing bubble burst and triggered a nationwide banking emergency.¹ The practice of granting loans to borrowers with problematic credit history, known as subprime lending, flourished in the years leading up to the Great Recession.² At the same time, excessive optimism regarding the value of unregulated mortgage-backed securities and ever-increasing housing prices led to the housing boom and oversupply.³ These developments were coupled with longstanding federal laws encouraging homeownership and allowing relaxed lending and underwriting standards.⁴ All of the factors described above contributed to the real estate crash, when housing prices plummeted and many subprime borrowers found that they could not refinance their homes and were underwater, resulting in millions of foreclosures.⁵

Although the subprime mortgage and foreclosure crisis sparked a national and global recession,⁶ it did not impact everyone the same way. The crisis disproportionately affected minority communities, due largely to predatory lending practices that targeted racial minorities.⁷ Not only were African-Americans and Latinos foreclosed upon at nearly twice the rate of Caucasians,⁸ median wealth for these groups declined dramatically during the recession.⁹ Segregation exacerbated the impact of foreclosures in poor minority neighborhoods, where reduced property values, decreased tax revenue, and blight took hold and formed a vicious cycle.¹⁰ The link between property and race in this context is clear.

This article explores how the mortgage foreclosure crisis impacted two highly segregated cities in Northern California—Oakland and Richmond. These cities were major sites of the mortgage and foreclosure crisis, where the fallout continues to unfold, and are also sources of innovation to address the ongoing effects of the real estate crash. For example, in the early 2000s before the real estate market collapsed, Oakland enacted a local ordinance to prohibit predatory lending within its borders. However, in 2005, the California Supreme Court held that Division 1.6 of the California Financial Code, a less protective state statute addressing the same subject matter, preempted local attempts to enact more protective ordinances.¹¹ Richmond's city council took a different approach to this issue, recently passing an ordinance permitting the city to use its eminent domain powers to purchase mortgages from banks that are allowing properties to become unkempt and blighted.¹² Bank trustees challenged Richmond's eminent domain approach on constitutional grounds in 2013,¹³ but their claims were dismissed as unripe and the trustees have since withdrawn their appeal.¹⁴

[Page 31]

This article advocates a legislative solution at the state level to address the predatory lending practices that disproportionately impacted Oakland and Richmond's minority residents. Specifically, this article argues that certain provisions of Oakland's municipal ordinance should be incorporated into Division 1.6 of the California Financial Code, California's statewide legislation addressing predatory lending. The statute should be revised to require independent home loan counseling for borrowers, prohibit lending without regard to the borrower's ability to repay the loan, and prohibit refinancing a mortgage without borrower benefit.

Part II of this article describes the factors leading to the housing bubble and subsequent crash at the national level. Part III discusses the uneven racial impact of the crisis, how California cities attempted to prevent the predatory loans that precipitated the crisis, and how the crisis affected Oakland and Richmond in particular. Part IV analyzes solutions devised in Oakland and Richmond to address ongoing foreclosures and proposes model state legislation that draws on lessons from Oakland.

II. The Growth of the Housing Bubble and Why It Burst

While there are multi-causal and complex explanations for the subprime mortgage and foreclosure crisis, scholars and politicians have posited two main theories of causation.¹⁵ Some claim that the government encouraged home ownership to low-income and minority buyers, which led to lax lending and underwriting standards in the mortgage market.¹⁶ Others claim that financial institutions took large risks by promoting and granting subprime mortgages, securitizing those obligations,¹⁷ and selling them as high-grade investments.¹⁸ These claims can be reconciled, as aspects of both can explain what led to the housing bubble and its aftermath.¹⁹

Subprime lending is the practice of granting loans to borrowers with "subprime" or problematic credit histories (e.g., payment delinquency, bankruptcy, or inadequate collateral).²⁰ Subprime mortgages are not "bad" in and of themselves, as they allow for the extension of credit to groups that have historically been denied access to credit markets, such as racial minorities and low-income individuals.²¹ The problem with subprime lending during the financial crisis was lax government regulation that allowed lenders to abuse the market by predatorily targeting low-income borrowers and over-optimistically speculating on housing trends.²² This is not to say that all subprime loans are predatory, but as this article explains, a large proportion of subprime loans were granted in a predatory fashion to minority and disadvantaged borrowers.²³

Predatory loan techniques quickly infiltrated the subprime lending market from the early to mid-2000s.²⁴ Lenders took advantage of unsophisticated borrowers who needed financing but did not understand complicated loan terms. According to a joint report from the U.S. Department of Housing and Urban Development and the U.S. Department of Treasury, predatory loans have some combination of the following characteristics. high interest rates, abusive terms and conditions, a failure to consider the borrower's ability to repay, or loans which target women, minorities, or the elderly.²⁵ For example, many subprime mortgages were structured as adjustable-rate mortgages ("ARMs") that started off with low "teaser" rates that expired after a specified period, often rising to interest rates that borrowers could not afford after the expiration.²⁶ Lenders also structured loans with balloon payments²⁷ and interest-only payments.²⁸ Moreover, refinancing options were predicated on the assumption that housing prices would continue to rise indefinitely.²⁹

In the years leading up to the crash, subprime loans increased due to an influx of foreign investment³⁰ and the Federal Reserve's decision to promulgate low interest rates for an extended period of time.³¹ These factors, coupled with unregulated mortgage securitization, led banks to engage in a race to the bottom to attract borrowers.³² Access to credit was inexpensive and easy, which raised housing prices and drove demand for housing development, ultimately resulting in the real estate bubble.³³

Controversially, some have claimed that federal law also contributed to the rise of subprime mortgages, primarily the Community Reinvestment Act of 1977 ("CRA").³⁴ The purpose of the CRA was to address the negative and discriminatory effects of redlining, the commercial banking practice of refusing to lend money to certain borrowers based on geographic area (typically, refusing to lend to minority borrowers living in urban areas).³⁵ The CRA requires federal regulators to evaluate banks' extension of credit to low-income and minority individuals in their local communities.³⁶ Critics have blamed the CRA for its contribution to the subprime mortgage crisis because it "forced" banks to loan to less-than-creditworthy borrowers.³⁷ However, scholars have estimated that less than twenty percent of subprime loans were granted as a result of the CRA.³⁸ Other federal laws that may have contributed to the crisis include the Deregulation and Monetary Control Act of 1980 (allowing lenders to charge higher interest rates to borrowers with low credit scores),³⁹ the Alternative Mortgage Transaction Parity Act of 1982 (allowing for ARMs and balloon payments as alternative mortgage terms),⁴⁰ and the Tax Reform Act of 1986⁴¹ (allowing for mortgage interest deductions and encouraging taxpayers to pursue mortgage loans).⁴²

[Page 32]

From the late 1990s to 2006, the housing bubble artificially increased average home prices by 124%, with housing prices peaking in 2006.⁴³ As long as housing prices continued to rise, securing ARMs or balloon payment loans with low monthly payments were good investment strategies for borrowers who could later refinance their homes at a lower rate or sell at a profit.⁴⁴ The housing bubble burst between 2006 and 2007, when home values began to decline rapidly as ARMs granted in the early 2000s "reset," meaning that teaser rates expired and higher monthly payments went into effect.⁴⁵ Subprime borrowers could not refinance their loans in the face of decreasing home values, and could not sell their homes profitably.⁴⁶ Thus, many homeowners were "underwater," which occurs when a loan amount exceeds the property value.⁴⁷ In a wave of defaults from 2007 to 2011, more than 10.5 million properties went into foreclosure.⁴⁸

Aside from the direct impact of the crisis on foreclosed homeowners and the near-collapse of the financial industry, today communities...