Wikipedia Foreclosures
Subprime Mortgage Lending
Not everyone in the United States is well off financially so it is no surprise that people decide to get subprime mortgage loans. Subprime mortgage lending is when banks loan people money that have poor credit history and don’t have access to prime rate loans. “Subprime mortgage lending became popular in the 1990’s. There was an outstanding debt of thirty three billion dollars in 1993 which increased to 332 billion dollars in 2003. In 2006 twenty percent of all mortgages in the United States were considered to be subprime mortgages and in March of 2007 there was an estimated 1.3 trillion dollars in outstanding subprime mortgages.”(Hinton) Subprime mortgage lending comes with high risk to both the lender and the borrower and yet many people still take part in it each year. Almost twenty five percent of United States citizens have poor credit history and have a difficult time trying to get prime mortgage loans. Most subprime mortgage loans are classified as high interest rate loans and in 2006, two thousand five hundred banks, mortgage companies and other lenders made 1.5 trillion dollars in high interest loans. That doesn’t mean that all high interest loans are subprime mortgage loans but I’m sure they contributed a lot to that 1.5 trillion dollar profit. Many people that borrow money from subprime mortgage lenders end up defaulting on their loans because of the falling property values that make the value of their homes less than what they owed on their mortgages. Most of these homes are then foreclosed upon and these foreclosed homes then come back up for sale at low prices which drives down the selling prices of new and secondary homes. “In 2007 there were a total 2,203,295 foreclosure notices, auction sale notices, bank repossessions and default notices reported” (RealtyTrac) and there are about forty five thousand foreclosures occurring every month many banks are being forced to file bankruptcy while others are “storing cash or investing it in things like treasury securities instead of lending money for business growth and consumer spending.”(Hinton) There are some problems with this; let’s assume that foreclosures are at eight percent and foreclosure losses are at thirty percent, “if you change the foreclosures from eight percent to fifteen percent and foreclosure losses rise from thirty percent to fifty percent then instead of splitting 2.8 percent of excess profits the major financial players will be splitting a 2.3 percent loss. Which means that would be a twenty seven billion dollar loss instead of a thirty three billion dollar gain in profits.”(Amerman) “What is so bad about this is that there wasn’t really any stress put on the market, like a recession or a natural disaster such as hurricane and look at what happened, it shows that the securitization and credit ratings didn’t work and the bond insurance might not have worked either.”(Amerman)
Let’s look at what might happen if some of these stresses were to occur. “If there was a recession let’s say that the foreclosure rate doubles to thirty percent and the loss per foreclosure increases from fifty percent to sixty percent. The amount of losses increases by a factor of five to almost 154 billion dollars.”(Amerman) Let’s see what would happen if interest rates were to go up. “Let’s say that the subprime mortgage rates go from ten percent to thirteen percent, which means that the foreclosure rate increases from fifteen percent to thirty percent and the average loss from foreclosures will decrease from fifty percent to forty percent. This means that the overall losses triple from twenty seven billion dollars to eighty one billion dollars.”(Amerman) Let’s see what would happen if property values were to keep falling. “We’ll say the foreclosure rate rises from fifteen to twenty percent and the foreclosure loss rises from fifty to seventy percent. The annual total losses will be 105 billion dollars.”(Amerman) Finally let’s look at what might happen if all three were to occur at the same time. “If all three hit at the same time we’ll say the foreclosure rates go from fifteen percent to forty five percent and the loss per foreclosure goes up from fifty percent to seventy percent. This means that the subprime losses increase almost twelve times from twenty seven billion dollars to 315 billion dollars. If real subprime losses increase by six or twelve times then the system wide financial losses will most likely increase by twenty four or thirty six times.” (Amerman) “The best way to think about it is to picture dominoes knocking each other down, but not dominoes in a straight line. Instead picture one domino hitting two dominoes hitting four dominoes, the increase is exponential and is a major reason for concern.”(Amerman) Bear Stearns Companies lost 3.4 billion dollars to subprime investments as well as a thirty percent drop in price of their stock. Morgan Stanley was expected to have 3.7 billion dollars in losses but reported a much larger 9.4 billion dollars in losses to subprime investments” (Hinton) and an 11.5 billion dollar total loss.
We need to face the fact that the subprime mortgage market is collapsing if it hasn’t fully collapsed already. Lenders seem to have been hit the hardest because of the ridiculous amounts of money they have lost and because they have no way of offloading their loans that are becoming devalued, due to a lack of investors. “For borrowers it may be cheaper to default on their mortgages if their home has negative equity. This is because the collateral for the loan is pretty much gone and if the bank forecloses on the house and tries to resell it with negative equity the bank will lose money.”(Hinton) “The markets were made worse when agencies like Moody’s and Standard & Poor’s slashed their ratings on billions of dollars of subprime related bonds and collateralized debt obligations. Credit rating companies like Moody’s and Standard & Poor’s have been accused ignoring major credit risks and compromising their standards for ratings by giving investment grade ratings to collateralized debt obligation tranches without properly testing their modeling methods.”(Hinton) Standard & Poor’s says they think the housing crisis won’t peak until 2009 and that total defaults could reach 150 billion dollars but I believe that it will be much more than that especially if we go into a recession.
Now what we need to do is focus on how we can take action to try and protect ourselves against any large potential losses if an even larger economic crisis should occur. The first thing to do is limit ownership of stocks and bonds especially in banks and mortgage companies. The second to do is to see if there is any way to turn a potential economic crisis into an opportunity to make money by researching and learning about every investment you make. Something you should never do is assume that your stock broker or financial advisor knows all and always has your best interests in mind, because either way what happens to your money doesn’t really affect him financially. Make sure you do your own research for all your investments especially now that we are potentially going to be in a recession and if you’re investing for retirement you need to be extremely careful. Investing for retirement is a very risky thing if you put too much into investing and don’t keep enough in savings. That’s when really bad things can happen especially with an economy that is in a weakened state. You could not only lose all your retirement money with one downturn of the market but your house, cars and any other assets. There will most likely be a large increase in foreclosures and defaults on mortgages but hopefully the Federal Reserve and the Government can fix the problems so the adverse effects of the subprime mortgage crisis won’t turn a potential recession into a bad depression.
Works Cited
Amerman, Daniel R. “The Subprime Crisis Is Just Starting.” Financial Sense University 20 March 2008. <http://www.financialsense.com/fsu/editorials/amerman/2008/0320.html.>
Brooks, Rick, and Constance Mitchell Ford. “The United States of Subprime.” Wall Street Journal. 11 Oct. 2007 <http://online.wsj.com/public/article/SB119205925519455321.html.>
Hinton, Sean, Darv Gosal, and Irvin Sha. “Subprime Lending.” Wikinvest. 28 April 2008. <http://www.wikinvest.com/concept/Subprime_lending>.
Reuters. “U.S. Subprime Crisis Will Not Peak Until 2009: S&P.” CNBC. 9 Oct. 2007 <http://www.cnbc.com/id/21202780/>.
“Subprime mortgage crisis.” Wikipedia. 29 April 2008 <http://en.wikipedia.org/wiki/2007_Subprime_mortgage_financial_crisis>.
“Sub-prime Mortgage Lending In U.S. Real Estate Market.” Foreclosure1. 29 April 2008 <http://www.foreclosure1.com/sub-prime-mortgage-lending-in-us-real-estate-market.php>.
“U.S. Foreclosure Activity Increases 75 Percent in 2007.” RealtyTrac. 29 Jan. 2008. <http://www.realtytrac.com/ContentManagement/pressrelease.aspx?ChannelID=9&ItemID=3988&accnt=64847>.
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