Subprime Mortgage Crisis

Subprime lending ('second chance" lending) offered by many credit lending financial institutions are mortgage loans available to borrowers, less likely qualify for a mortgage at a higher interest rate, compared to other borrowers, better credit score rating. The interest rate applied for subprime loans based upon the borrower credit score (below 620 considered for subprime loan) previous bankruptcies, histories of payment deliquesces, and size of down payment. Accepting the terms of a subprime loan, the borrower must agree to a higher interest rate (The interest rate often is referred to as teaser rates, substantially adjust higher after the first few years (Yahoo - news - Foreclosures up subprime mortgages by Jeannine Aversa - June 14, 2007)), reflected by the lender offering credit to a borrower with a high credit risk. The terms of a subprime loan often have a prepayment penalty, a balloon payment or both. When the borrower is unable to make a balloon payment, refinance of the loan maybe an option (however if interest rates have increased since the origination of the loan, cost of financing maybe prohibited for the borrow) or sale the home (Unfortunately by this time the property value may have depreciated below the original sale price) (Bankrate.com - Subprime mortgages - May 1, 2006). Also, borrower must agree to any up front charges or fees. The change of payment schedule for an adjustable rate subprime loan occurs in the first three or five years. Subsequently, the loan payment could drastically change or be adjusted if interest rates (particular the Federal Funds Rate - The rate the Federal Reserve controls by adjusting higher or lower. The rate is charged to banks when borrowing money for short period of time) during the following first three to five years increase substantially. From 2004 - 2005, subprime loans were approximately twenty-one percent of all mortgage originations, because of favorable low interest rates offered. These loans appealed to low - income borrowers or low credit borrowers, especially first time home - buyers. In 2006, subprime mortgages totaled $600 billion contributing to one -- fifth of the United States home loan market. (Wikipedia - Subprime lending)

In 2006, 'meltdown' of subprime loans began a domino effect for lenders as interest rates climbed during the past few years, made adjustable rate loan payments increase dramatically, more than most borrowers could offered to pay, and subsequently many borrowers failed to make further payments or became deliquent and thus properties went into foreclosure. Many regions of the United States including California, Florida, Nevada and Arizona (Yahoo Asia News - Forclosures Up Subprime Mortgages - June 15, 2007), subprime loans went into foreclosure, these properties substantially depreciated below the original sale price. During 2006, greater than Two - dozen subprime mortgage lenders filed for bankruptcies, because of many foreclosures or delinquency of payments, including second biggest subprime lender New Century Financial Corporation (Wikipedia - Subprime lending). Also, contributing to the 'meltdown' of subprime loans, unscrupulous loan predators offered subprime loans at interest rates for exceeding, expected interest rate charge, borrowers with good credit score rating, offered refinancing frequently as interest rates changed, and charged high closing fees each time, added to the cost of the mortgage amount. (Bankrate.com - Subprime mortgages - May 1, 2006). Eventually many subprime borrowers were financial unable to continue making monthly payments.

The dilemma many subprime loan borrowers have in common, after their loans were adjusted (reflecting a higher interest rate payment), managing their finances to make their payments on time. In June 14, 2006, the Mortgage Bankers Association reported, regarding borrowers of subprime mortgage adjustable loans were thirty or more days past due, increase of 15.75 percent from January to March quarter, compared to rate of 14.44 percent during late 2006. Late payments subprime loans may further intensify, as analysts predict nearly two million adjustable subprime -- rate mortgages will reset, higher rates this year, reflecting the past years of interest rate increases. Chairman Ben Bernanke of the Federal Reserve commented regarding the troublesome subprime market, predicts troublesome situation will unlikely effect the broader U.S. economy and financial system (Yahoo - news - Foreclosures up subprime mortgages by Jeannine Aversa - June 14, 2007). However many private and public investments have in their portfolio (underlying) subprime mortgages, which many investors have been informed and reflecting a lower net worth. Freddie Mac (second -- largest financier of home loans) Treasurer Timothy Bitsberger expressed his opinion regarding subprime mortgage lending as the worst housing market since Great Depression is "severe but contained" (ContraCostaTimes.com - Mortgage Slum called 'severed but contained' by Neil Unmack and John Glover - June 6, 2007).

Financial institutions effected by subprime mortgage crisis included Swiss Bank hedge fund arm Dillion Read Capital Management, reported (May 2007) a loss of $122 million from bad investment related to U.S. subprime mortgage market. In June 2007, Bears Stearns (One of the most recognizable investments firms on Wall Street) announced one of their managed funds - High Grade Structured Credit Strategies Enhanced Leverage Fund (second (Enhanced Leverage fund) of two struggling hedge funds with assets invested in financial subprime mortgage lending) reported a substantial financial loss. Bear Stearns will provide $1.6 billion (previously Bear Stearn said would provide up to $3.2 billion in financing) of financing to save its High - Grade Structured Credit Strategies Fund. The infusion of capital prevents investors from a sizable loss. The financing is supposed to help stabilize the depreciating collateralized debt obligations of the fund, essential portfolio of debt. Subsequently, at least thirty others financial lenders with subprime loan investment exposure, forced to sell their assets or file for bankruptcy (Yahoo News - Bear Stearns taps managers to save hedge fund by Dane Wilchins and Walden Siew - June 27, 2007).

Solving the crisis of subprime mortgage market has no simple and no fast remedy.
Mr. Bernankee said the Federal Reserve consider tougher rules to curb abusive loan practices and improve disclosure terms, thus preventing unscrupulous lenders from offering subprime loans. Also, borrowers be required to present proper documentation to be considered for subprime loans. However, Fed Governor Randall Krozner said during a public hearing on subprime lending: "We must determine how we can help to weed out abuses while also preserving incentives for responsible lenders." (Yahoo! Asia News - Foreclosures Up Subprime Mortgages - Associated Press - June 15, 2007). In March 2007, Federal bank regulators informed subprime lenders new "guidance" how to judge if a new borrower is qualified for a subprime loan adjustable rate mortgage. Regarding the new policy, lenders must determine if the borrower can afford to pay a higher payment when interest rates are adjusted, contrary to previous guidelines, qualifying to pay only the "teaser rate" (npr.org - New Federal Rules on Subprime Loans Issued by Scott Horsely - March 5, 2007).

Commentary:

Problems associated by subprime loans continuously being evaluated by financial institutions (including hedge funds) and investors regarding total net worth and number of deliquences (and forclosures). Finnancial institutations may have to provide additional capital to prevent investors from significant losses, such as the action taken by Bear Stearns, which not likely an isolated case. If short - term interests continue to increase and properties secured by subprime loans continue to depreciate in value, resolution to solve this financial crisis will only get worse. If interest rates decline, subprime mortgage borrowers benefit or ease the cost of monthly payments. When prices of homes fall significantly, buyers have the opportunity to purchase homes at deeply discounted prices (especially first time home buyers) and prospect of future appreciation of these homes. As a result, basic equation of supply and demand, results by fewer number of homes available for sale or continue in foreclosures. Certainly, new federal banking regulations will prevent problems associated to subprime loans, but new guidelines should not over regulate the subprime market and thus prevent honest low income borrowers (especially first time home owners) and honest participating financial lenders from owning a home and extending credit.