Economists worry that if
more Americans lose their homes and
home prices continue to drop, people
will lose confidence and
spend less money -- creating a slow period for American
which could, in turn, lead to layoffs and further economic uncertainty.
More than two million Americans are
expected to lose their homes in the next few years.
Subprime lending became a $625 billion market by 2006.
Many of them have "subprime"
mortgages -- loans made to people who often do not qualify for traditional (prime
interest-rate) loans, usually because they have poor credit history. These loans
are considered high-risk because there is a greater chance that borrowers wont
pay them back.
The practice of subprime lending didn't really exist a decade
ago, but became a $625 billion market by 2006, when it comprised 20 percent of
the total mortgage industry.
The growth coincided with an unprecedented
expansion in the housing market-- home prices increased by 80 percent between
2000 and 2006. With home values increasing, lenders were more willing to offer
And as more lenders got into the business, they tried
all kinds of incentives, including low teaser interest rates, to attract
customers. The initial low rates of these adjustable rate mortgages (ARMs) would
later reset to a higher level, making it much harder to meet the monthly payments.
When the housing bubble collapsed in late 2005, and home prices started
leveling off or dropping, more that 16 percent of subprime borrowers defaulted
on their loans.
Wall Street in trouble
The fallout of the subprime mortgage
market has had an impact on the global economy. The reason is securitization
a popular new investment tool that generates large returns quickly.
Big name Wall Street firms such as CitiGroup and Morgan-Stanley invested in mortage-backed
securitization, mortgages are not owed to a single lender like they were in the
past. Instead, lenders resell their mortgages to larger banks, who bundle the
smaller loans into more complex investments, called mortgage-backed securities.
The appetite for mortgage-backed securities grew on Wall Street, and a
lot of buying and selling went on without government supervision. More than half
of the original subprime loans were made by organizations that are outside the
government's regulatory system.
Securitization is a marvelous thing.
It has lubricated the market and made mortgages more affordable, Princeton
Economics professor Alan Blinder wrote in the New York Times. But securitization
sharply reduces the originators incentive to scrutinize the creditworthiness of
When the subprime mortgage market began to unravel in
late 2006, several of the worlds largest banks were left with bundles of
mortgages quickly losing value. The stock market plunged and major banks, including
Merrill Lynch and Citigroup, announced billions of dollars in losses.
As the consequences of the subprime
mortgage meltdown began to mount, the Bush Administration came under increasing
pressure to intervene.
Reserve Chairman Ben Bernanke criticized irresponsible mortgage lenders.|
In October, Treasury Secretary Henry Paulson announced
a cooperative deal with banks and lenders that would allow some low teaser rates
to stay fixed for up to five years. This would give up to two million borrowers
more time to pay off their loans.
Meanwhile, the U.S. Central Bank, called
the Federal Reserve, is trying to clean up the mortgage industry.
and deceptive acts and practices hurt not just borrowers and their families, but
entire communities, and, indeed , the economy as a whole, Federal Reserve
Chairman Ben Bernanke said in a statement. They have no place in our mortgage
Critics say the government's response does not do enough
because it only helps people who wont be able to pay when their interest
rates go up while doing nothing for people who already cannot pay back their loans.
Michael Shea, director of the Chicago-based housing advocacy group Acorn
Housing says the proposal is bowing to big investment banks.
crisis is likely to be the worst we've seen since the Depression, but [the plan]
is only dealing with the easiest slice of borrowers," Shea told BusinessWeek.
"What they are proposing won't help a single soul who is currently
delinquent on their mortgage or facing foreclosure. We need bold proposals like
the ones set by FDR during the Depression."
The Bush Administration is currently
considering other measures to respond to a slowing economy, but the president
says he remains optimistic.
President Bush said that the fundamentals of the economy are strong, despite the
"My view of the economy is that the fundamentals
are strong, that we've had strong growth for a reason: that we're competitive,
we got flexible workplace, that we kept taxes low, exports are up," President
Bush said in a December news conference.
Advisers say the president may
announce an economic stimulus plan when he gives his State of the Union Address
on Jan. 28.