What's Behind the Sub-Prime Disaster

[Joanne98]

What's Behind the Sub-Prime Disaster

The current high-risk mortgage mess is not so much a new crisis as the result of decades of government deregulation of the financial industry.

Robert Kuttner | August 29, 2007 | web only
http://www.prospect.org/cs/articles?article=whats_behind_the_subprime_disaster

The calamity in "sub-prime" mortgages has exposed the underlying weaknesses of an economy built on too much speculative borrowing. It's not clear how all this will end, but for now credit is drying up for blue-chip corporations as well as for high-risk mortgage lenders.
With financial tremors spilling over into the wider economy, major retailers like Home Depot and Wal-Mart are reporting softer sales, and hedge funds, banks, and broader real estate values are all under siege. Every investor, from retirees to university endowments, is at risk if the inflated stock market turns out to be another bubble. Even if the wider damage is contained, some two million mortgages are scheduled for rate increases this fall, and foreclosures are expected to soar.

The mortgage business has long been a tug of war between a social commitment to broad homeownership and the schemes of private financial operators looking to make a quick buck. In the wake of the Great Depression, the U.S. government devised a strikingly effective system for bringing homeownership to the masses. Since the late 1970s, however, this system has been dismantled in the name of deregulation, causing a string of disastrous results.

The sub-prime mess is not so much a new crisis as it is a resumption of the saga that began with the savings and loan scandal of the early 1980s, when executives of S&Ls went on a risky lending binge with government-insured money. Then, as now, there were many individual culprits, but the real problem was the ideology of deregulation and the capture of public policy for private gain by the financial industry.

Most mortgage loans today are originated by largely unregulated mortgage companies, which are not banks and which have little of their own capital at risk. They are free to devise complicated, far-fetched mortgage products and to lend to people who can't afford the payments, as long as they think they can turn a profit by selling off the paper. Mortgage companies circumvent the entire system of government bank regulation, which ordinarily keeps close watch on banking standards.

When loans started going bad at higher-than-expected rates, banks, hedge funds, and other investors in sub-prime stopped advancing credit to the offending mortgage companies. Several have now gone bankrupt, and others are under stress. But this is no happy case of the market correcting itself, because the wider damage lives on. This all could have been prevented if deregulation had not been embraced so fervently as a national economic creed.

Homeownership is at the core of the American dream. Since the era of the American Revolution, property ownership has been considered the mark of a solid citizen who is a stakeholder in the community. Mortgages enable ordinary people, who do not have the cash to buy a home outright, to join the propertied class. For most people, even today, their prime financial asset is the equity in their home.

The Republic's founders believed that a self-governing people needed to be a society of freeholders. President Jefferson sponsored a land-tenure system that largely kept the frontier out of the hands of land speculators and favored yeoman farmers. With the passage in 1862 of the Homestead Act under President Lincoln, ordinary people could get title to 160 acres for free if they worked the land. By 1900, in several western states, more than 60 percent of people were already homeowners.

In the early 19th century, immigrant, ethnic, and labor groups began creating "building and loan" societies, modeled on British cooperatives that originated in Birmingham in 1774. These mutual aid societies enabled people of modest means to pool savings and borrow money to build or buy homes. While these societies offered more flexible terms than banks, the typical mortgage was relatively short-term -- three to five years was common -- with much of the principal still owed at the end.

During the Great Depression, the wave of foreclosures inspired the Roosevelt government to invent the long-term, fixed-rate, self-amortizing home loan. This new kind of mortgage was part of a larger strategy to spread homeownership and protect the system from catastrophic failures.

Congress first acted Continued>>>>
http://www.prospect.org/cs/articles?article=whats_behind_the_subprime_disaster

[no_hypocrisy]

1. P.S. By allowing easier access to money via home equity, the

economy has been artificially "rosy". More money means more consumerism which is the true factor that fuels this economy. It is no longer farming. It is no longer manufacturing. It is not even technology. It is simply people buying stuff they otherwise could not afford to buy, save for easy credit. Inventories have been kept moving. Services have been provided and expanded. Homebuyers could live in larger houses than they needed or could afford. Contractors could make kitchens and dens worthy of Architectural Digest. Because all that was needed was liquid capital, money.

[nealmhughes]

2. Tulipomania, emu breeding for fun and profit, the Yazoo Bubble, the South Sea Bubble,

a bubble is a bubble based upon "benign neglect" by regulatory agencies and public mania.

[bemildred]

3. One Ponzi scheme is much like another.

The only real difference is the "product".