Sunday, May 11, 2008
News

Understanding the lingering mortgage crisis

 

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By Josh Clark

1. First and foremost, what does subprime mean?

Contrary to what it sounds like, the term subprime doesn’t have anything at all to do with the interest rate given on a mortgage loan. It actually refers to you—if you happen to be a high-risk borrower. With our consumer economy, it’s not too terribly difficult to achieve subprime status. If your debt-to-income ratio is lopsided toward the debt end, you, my friend, are a subprime borrower. Have a credit score below 720? Yep, you’re among the unwashed subprime masses. (Before the subprime mortgage fallout—read: utter and complete clusterpolka—the credit score cutoff for subprime status was 680; it’s since been raised by our lender friends). Same goes for things like bankruptcy history, lack of ability to put money down and verifiable identity.

These things didn’t pose a problem for the lending industry back before the swingin’ 1990s; the presence of any of these factors meant you weren’t getting a loan. But the mechanisms had been in place for the subprime mortgage crisis long before President Bill Clinton took over. It was the Depository Institutions Deregulation and Monetary Control Act of 1980 that allowed lenders to raise interest rates and institute balloon payments. (Thank you, President Carter.) But don’t hiss just yet. The administration had good intentions, mainly to increase home ownership among Americans. But once the ’90s hit, the gates were fully opened, the mortgage wolves came pouring out, and house-hungry, newly cash-flush, upwardly mobile Americans met them head-on in a blood orgy of borrowing. It was like Saturday night at the Trapeze Club.

As a result, all sorts of industries ancillary to home lending ramped up. House builders constructed homes as fast as they could. Building supply companies increased orders. Plumbers, electricians, roofers, landscapers—all saw more work than they could handle. The increase in housing demand lured more people into real estate speculation (thanks in large part to “Flip This House”). More homeowners’ insurance policies were sold, and more people needed Realtors. These businesses were making more money, so their owners and employees had more money to spend. Which means that the entire economy was stimulated—from televisions to cars to food to Barbies. It was a boom. And then it busted.

2. So how did subprime mortgages end up crippling our economy?

When the subprime mortgage collapse began, any economist worth his salt predicted the effects would trigger a slowdown in related sectors of the economy. Newly built house rates (and all of the plumbers, electricians, etc.,) would begin to feel the pinch. Same too with the other industries tied to housing. And so it came as no surprise when these industries became leading sources for unemployment in America; all of those folks hired during the boom were the first fat to be trimmed during the bust.

But the subprime mortgage fallout was hardly a simple slowdown in the housing industry. It pretty much single-handedly brought the United States economy to its knees. The debacle wouldn’t have had so much of a far-reaching effect had it not been for that same easing of federal restrictions over lending that allowed for subprime lending in the first place. Part of this also included allowing for adventurous use of these mortgages. Whereas in the days of yore, the mortgage you took out stayed in your bank (or was burned in your bank by one John Wisdom in the 1986 Emilio Estevez vehicle “Ransom”). After lessened government oversight, however, new financial instruments came into vogue.
 
One of them was purchasing subprime mortgages and rolling them into securities. These were traded like stocks and used as collateral for other investments. And since your bank was planning on selling its subprime mortgages to investors anyway, they really didn’t give a Shih Tzu whether you could pay back the loan. This encouraged predatory lending practices, with loan officers pulling people off the street and shoving them into homes.

Subprime mortgages as securities were making money like crazy, and investors were gaga over them. So everybody—from the day trader to the retiree who leaves her mutual fund investments in the hands of the day trader—ended up with securities backed by mortgages in their portfolios. Once the loan institutions started seeing record rates of default, the result on the U.S. economy was like a cyclone over Burma.

3. So who’s to blame?

Almost everybody. The common thread, however, is greed. If you took out a loan that was more than you could pay back, you’re guilty. If you pushed a home buyer into that loan, you’re guilty. If you invested in an unproven and risky security, you’re guilty.

Those loans that largely comprised the subprime mortgage crisis were issued to people who couldn’t afford them. “No money down” was the mantra, and interest rates were kept low—at first. But most subprime mortgages came with an adjustable rate, meaning that after a fixed number of years, the interest rate reset to a higher rate, which caused monthly payments to skyrocket. If you accepted loans on such terms and can no longer pay your mortgage bills, well, that’s your fault.

For a loan to work, however, both parties have to respect the money at stake. Lenders didn’t care any more than borrowers did about the fine print. Hence the aptly titled NINJA loan, a cynical acronym for “No Income, No Job, No Assets (no problem).”

And those “Flip This House” viewers who took out shady loans to buy rental properties are as complicit as anyone else. With just a few grand invested, it’s easy for them to simply walk away from a property they can no longer afford.

The worst part of this whole mess (in addition to unemployment and recession)? It appears the predatory lending that was a trademark of the subprime salad days of a couple of years ago is still in use among some of those lenders who managed to survive the fallout. An NPR report in May outed Countrywide for continuing aggressive lending practices. SP

To suggest a topic for Josh Clark or to ask him a question, email him at 3questions4josh@gmail.com.