Subprime Lending Only Partially Cause of American Economic Crisis

Subprime Lending Only Partially Cause of American Economic Crisis
Beginning in late 2006, Americans began to hear news of a weakening real estate market and the expected collapse of the sub-prime lending market. More currently the news is reporting that the American economy in general is in trouble and we are headed for a recession. Most of the reports on the American economy go back to the sub-prime lending market and the increase in sub-prime delinquencies and foreclosures as the reason for the decline in our economy. Many say that, as a result of the collapse of the sub-prime market, companies have been forced into bankruptcy, the housing market has collapsed, and the American economy has suffered. But can this one market be blamed for the current state of the American economy, or are the other factors which have caused the economy to pull back significantly? This paper is intended to look at the possible causes of America?s current economic crisis and to determine whether the sub-prime lending was the main reason for the problems plaguing America today.
Since the economy weakened beginning in early 2007, fingers have been pointed many different possible causes ? first to the sub-prime lending market, with lenders selling unaffordable loans to unsuspecting borrowers and offering inflated loans to borrowers who would never be able to pay them back, to the bust of the housing bubble, to the government for keeping interest rates low and allowing Americans to ?free spend? for too long, and finally to the American people for letting their free-spending habits put the U.S. dollar in a weak position against the rest of the world.
The issue that has received the most criticism is the sub-prime lending market that was a hugely popular and rapidly growing segment of the mortgage lending market. Sub-prime lenders offered the dream of homeownership to borrowers who would otherwise be denied credit. Borrowers who could not qualify for a prime loan with a traditional lender were offered many different risk-based mortgage products based upon their credit history and down payment availability. These products included fixed rate mortgages with a higher overall interest rate, mortgages with no down payment, interest only mortgages, and adjustable rate mortgages with an initially low interest rate and corresponding low monthly payment, but over time the interest rate increases to a rate well above prime. The needs for sub-prime products grew as the American housing market grew. From 1998 through 2005, home prices in certain areas of the country increased significantly. Prior to 1998, home prices had increased proportionally with the overall rate of inflation. But through 2005, home prices increased 60 percentage points greater than inflation. During the increase in the housing market, everyone was trying to get a piece of the mortgage market. Not only were some buyers able to purchase for the first time, but existing homeowners saw the value of their homes increase dramatically, spurring them to refinance to take equity out, or flip homes to make quick money.
The reason the housing market was so attractive to many the Federal Reserve kept the federal funds rate below 3 percent from 2001 through mid-2005 in order to keep the U.S. economy on an upswing. The low interest rate encouraged borrowers to take on more debt without fear of overextending their budget. As a result of the low interest rates, Americans increased their credit debt by 300% since 1990. This debt, funded by foreign investment, decreased the value of the American dollar. The euro is now worth $1.47, up from $0.85 just a few years ago.
It is obvious that the American economy was greatly overextended for most of the decade. So what caused the economy to turn? The Federal Reserve Board started increasing interest rates in 2003 from 1 basis point to a high of 5.25 in June of 2006. The rate increases made borrowing more difficult and, as a result, the U.S. housing market began to soften. Not only did the value of homes stop increasing at phenomenal rates, they began to actually lose value. Many borrowers who had taken high interest or adjustable rate sub-prime mortgages were now faced with loan balances higher than the actual value of their homes. Because their home had lost value, they were unable to refinance to a fixed rate loan. As a result, many homeowners either decided or were forced to let the lender foreclose on their home. This, along with the already anticipated high number of defaults on sub-prime mortgages, caused the collapse of the sub-prime market. When the sub-prime market collapsed, a number of sub-prime mortgage lenders were forced into bankruptcy. This ripple effect finally hit Wall Street as the bankruptcy of these lending institutions caused heavy losses to investors of popular mortgage backed securities, including big financial institutions such as Bear Stearns.
It is important to realize, however, that during the housing bubble and the sub-prime frenzy, Americans were spending the money freely and carelessly. The prevailing thought in America was, however, that the value of property will surely continue to increase and they will be able to refinance to a more affordable loan or sale their property at a huge profit. Americans began believe that debt was a right, not a luxury. Unfortunately, mortgage debt isn?t the only debt vehicle used by most American consumers today. Consumers are overextended like never before with sub-prime mortgages, 5-year auto loans on luxury cars, credit cards, personal loans, home equity lines of credit, even loans against retirement savings or reverse mortgages for seniors with no mortgage. The average American household has credit card debt of $9,200, with an average interest rate in between 14-19%. And the government has encouraged the belief that debt is a good thing by keeping interest rates low. It worked so well for America; the government is able to keep the economy moving by keeping interest rates low, Americans respond by borrower?s large amounts of money due to the low interest rates, companies continue to supply the consumer goods for Americas to spend their credit dollars on. But now that the economy has slowed, America is seeing the end of the debt party of the past decade and the American prosperity which was created from unsecured debt.
It is hard to imagine that a promising financial tool such as a sub-prime mortgage which allows families the opportunity to own their own homes could cause such havoc on the financial industry and the American economy. But listen to the news reports or the candidates in this election year, you will hear that the sub-prime industry is getting the majority of the blame. Hilary Clinton, candidate for U.S. President, accused Angelo Mozilo, Founder and Chief Executive Officer of Countrywide Financial Corporation, of being one of the ?principal architects? of the sub-prime lending market which she said was a ??house of cards?,? also saying that Mozilo and others created the problems America is facing today. Democratic senators have urged Mozilo to donate some of his earnings to help distressed homeowners. Obviously, Clinton and other politicians have a motive for playing the blame game. It is an election year and they need a ?bad guy? to fight against to prove they will stand up for American citizen?s rights. Clinton makes a hasty generalization in her argument that the sub-prime market and Mozilo created the problems that America if facing. Further, her call for Mozilo to donate his earning to help citizens who may be losing their homes is confusing. She is basically accusing Mozilo of committing a crime worthy of monetary punishment. However, she provides no proof that Mozilo is the culpable party. Another example of the blame game is that Corporate Accountability International (cai), an independent consumer rights group, is urging consumers to vote for Countrywide Financial Corporation as the worst lender in the country. The group alleges that Countrywide relies on ?predatory? mortgages for profits, mainly selling to the elderly and non-English speaking borrowers. They offer no statistical information confirming that Countrywide focused its lending practices on these groups, or that there have been any findings that Countrywide used predatory practices. These allegations are wholly unfounded and do nothing but scar the image of Countrywide. Additionally, in early March, 2008, the New York Times ran a story alleging that Countrywide was the subject of a fbi inquiry into the mortgage industry. In fact, there were as many a fourteen companies being investigated as a result of the sub-prime mortgage crisis, not just Countrywide. However, both The New York Times and the Wall Street Journal listed the Countrywide name alone in their headlines. In each of these situations, the Countrywide name has been used to blanket the sub-prime mortgage banking industry, with no real facts to prove that Countrywide, or its ceo, have done anything specific to create the economic turmoil we are currently experiencing.
In order to make sense of America?s current situation and move forward into a more manageable economy, America must look at the larger picture. Sure, sub-prime lending is one of the reasons our economy is in recession but the problems that America faces today result from a number of events occurring over time. I believe it is absolutely imperative that the American consumer re-evaluates what are ?necessities? and learn to spend more wisely, create less personal debt, and save more money. It is the simple law of supply and demand ? as long as mortgage vehicles such as sub-prime loans are desired by the American consumer, they will be available. But, for consumer free will to be successful, the consumer must show self-control and planful action, otherwise consumer decision making is impaired. Secondly, I believe it is the responsibility of the government to limit the nation?s reliance on foreign investment. As of April 25, 2008, the total U.S. federal debt was approximately $9.5 trillion, which averages out to $31,100 per U.S. resident. The government needs to stop looking at the trees and look at the forest ? meaning stop taking steps to keep America?s economy on an upswing at the expense of our reliance on foreign cash. Until Americans and their government stop spending and start savings, even though our situation may seem improved, it is simply a house of cards, ready to tumble with the smallest wind.

Subprime Lending Only Partially Cause of American Economic Crisis 9 of 10 on the basis of 1754 Review.