Subprime Crisis

To start off, I think its important to clarify the vague over simplifications you hear in the news describing the "Subprime Crisis" or the "Credit Crunch." The story begins with commission hungry brokers and ends with consumers struggling to keep their homes as their adjustable rate mortgages (ARMs) begin to reset after their teaser rate period expires. After a quick look at the players in the lending industry it becomes clear what happened to the Subprime market.

Subprime Market

Subprime lending is typically for borrowers that have lower credit scores and do not qualify for prime rates. Understandably, the bank requires a higher interest payment for taking on a higher risk of default. Now as a borrower, if you wanted a loan you would seek out a broker that works with the loan originator (local bank branch) to close your loan. Keep in mind that most brokers are paid on commission for loans that they close. The approval and submission of loans that may not be credit worthy appears to be the broker's logical decision if they believe that not all of their loans will close. Tying the broker's compensation to their loan volume with in all likelihood increase the amount of loans they submit.

Secondary Subprime Mortgage Market

After these subprime mortgages made it past the originators lending internal controls the local bank sells it bundled with other loans in order to get more capital in order to issue more loans. Typically the bundled sale is a repurchase agreement where the originator agrees to buy back the loans under certain conditions (ie. irregular amounts of default. These mortgage pools are held by a wholesale bank that then groups the mortgages into different types of financial products such as mortgage backed securities, asset backed securities, interest only strips, etc. The final buyers of these products vary from pension funds, hedge funds, to foreign investors. Subprime mortgages have created a problem thats impact has spread by allowing them to exchange hands rapidly without tightening regulations. Ultimately, the important thing to realize is each successive owner of the subprime mortgage bases their valuation of the mortgage and the default risk on the broker's biased decision to close that loan.

Federal Reserve & Federal Debt Fuel Credit Crunch Fire

During the entire period of increasing subprime lending, the United States has continued the war in Iraq. Political views aside, the war has brought the country into a period of record high national debt and requires large amounts of money just to pay the interest. In order to raise money to pay the interest, the government allows the Federal Reserve, a private corporation, to print and issue new financing to banks at higher interest rates which in turn create higher consumer rates. Although this time it appears banks could not have predicted that the Federal Reserve would increase rates 17 times over just a few years. With all these increases in interest rates and printing of money the danger of inflation becomes an eminent reality. The Federal Reserves attempt to create liquidity in the market is in essence a bandaid solution to a long term failure in monetary policy.

It was in realizing these things that I began to wonder who was really responsible for the subprime failure? Who is it that will be held responsible for taking innocent borrowers homes? When the lawsuits begin, it appears all parties involved will be pointing their fingers at the person that sold them the mortgage. Tracing the mortgage back to the person that was in the best position to prevent the default would lead to the broker who has already been rewarded for a loan that had closed several years ago.

Awareness of what it means when they say subprime crisis is necessary to have public discussions about the same problem. Our country too often takes the "buy now, pay later" attitude that has put us in the situation we are in today. By becoming aware you are able to speak out against deficit spending and predatory lending practices that put an unfair burden on the average tax payer because the government and/or broker acted in their own self interest.

It will be interesting to see in the future how the courts will handle this type of mortgage fraud.