There’s no Place like Home: Americans lose as Mortgage Bubble Bursts

The U.S. may be facing a sharp economic downturn, or, recession, which means tight pockets and even financial crises for many Americans in the form of unemployment, job security, and hard-to-reach credit. Many families are already feeling the crunch, having lost jobs and defaulted on their non-traditional or “exotic” mortgages, which are to blame for the slump.

For the past few years, exotic or subprime mortgages have been hot, allowing borrowers with bad credit to get loans with no down payments, higher interest rates, or low introductory rates that then jump substantially after a few years.

When the housing market was booming, borrowers could manage their mortgages and borrow against their homes if they ran into trouble. But when the housing market went bust, the assets that backed these subprime mortgages – the houses themselves – lost their value, leaving borrowers with inflated loans and deflated assets.

Nickeled and dimed

So what do you do when you can’t pay your mortgage? You call up the lending company and work out a deal, right? Well, subprime borrowers are finding it hard to refinance because these loans are often bundled together and resold as bonds to all sorts of different buyers, including foreign banks and hedge funds.

The consequence is 15 to 20 percent of subprime borrowers behind in payments. That’s a lot of people and a lot of money. Two point two million in loans are already in foreclosure, a situation that’s bad for lender and borrower alike. And it’s not just personally devastating to millions of Americans; the crisis also has a global effect via Wall Street.

Wall Street and the Fed

“It wasn’t supposed to happen: The problems in the $600 billion subprime market, a relatively small corner of the overall $3 trillion mortgage business, should have been isolated – or so some of the smartest minds thought. But as it turns out, toxic mortgages had far greater reach, infecting other layers of finance.” – Matthew Goldstein of Business Week

Not just tied to economic indicators, the stock market responds to fear, and traders worry that the mortgage crisis will turn into a full-blown economic crisis. The fear has resulted in a plummeting market, with Wall Street looking towards upcoming job and housing reports for a glimmer of hope.

Of course, when Federal Reserve Chairman Ben Bernanke lowered the interest rates that the central bank charges for loans to smaller banks (called “the discount rate”) from 6.25 percent to 5.75 percent, it eased market worries, allowing the Dow and NASDAQ to become more stable. He also encouraged four very large banks which didn’t need loans to take them – to try to trigger others to keep lending. However, Bernanke hasn’t said if he will lower the better-known federal funds rate, which stands at 5.25 percent.

Congressional response

Members of Congress are calling for government to do more. Senator Christopher J Dodd (D-Connecticut), Chairman of the Banking Committee, wants the government-sponsored lending agencies Fannie Mae and Freddie Mac to lift the cap on the amount of mortgage debt they can buy. Fannie Mae and Freddie Mac are limited in the types of loans they can purchase. And such legislation could take weeks or even months to pass. Currently, they can only take over mortgages worth $417,000; therefore, mortgages above that amount are hard to obtain.

The White House is not in favor of raising the limits because it amounts to more government insurance of the private sector, or public interference in the market.

New York Senator Chuck Schumer (D) would like the government to offer protection to less savvy and experienced buyers. He wants Congress to crack down on abusive lending practices, “predatory lending,” where terms and conditions are complicated and unfair. Subprime borrowers don’t always understand what they’re getting themselves into.

Some experts say that subprime loans don’t have to be a problem – making available mortgages to the less qualified and less fortunate increases homeownership, which has a positive impact on the economy. It’s the abuse of subprime lending (offering a mortgage to anyone with a pulse) that’s caused this crisis, some say, and Congress should set standards that prevent predatory lending.

What do you think?

How has the mortgage crisis affected you? What should government do, if anything, to stay the crisis and prevent future problems? Let your representatives know what you think?

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Article Posted on: 8/5/2006