The Subprime Mortgage Crisis

author : Tillman Clark topic : Mortage | Economy

by Tillman Clark

Recently, if you follow any sort of news source, the subject of the economy and its recession is one heard often. A common buzzword heard alongside this topic is that of the “subprime” mortgage crisis. But what exactly is the subprime mortgage crisis? What does subprime mean and why is it so important to the economy and this looming recession that everyone is talking about? Why isn’t the overwhelmingly disastrous effects that it is having on people of color, lower, middle and working class, and American citizens on the front page everyday? Because of the mainstream media’s failure to accurately describe the underpinnings of the subprime mortgage crisis, and what it means for the economy and the people of this country, it is important to shed some light on the subject.

To start, subprime lending is a financial term for high-interest loans to people who would otherwise be considered too risky for a conventional loan. These borrowers, who do not qualify for the best market interest rates because of poor credit history, include middle-class families who have accumulated too much debt and low-income working families who want to buy a home. To try to ensure a covering of the risk, lenders charge such borrowers higher than normal interest rates or they make “adjustable rate” loans, which offer low initial interest rates that jump sharply after a few years in the form of resets.

How the subprime crisis has been able to develop to near-nationwide catastrophe lies primarily in an arrangement made between mortgage lenders and Wall Street. The arrangement was considered mutually beneficial for several reasons. The mortgage lenders would start by giving a loan to a family with a decent income but not a lot of wealth. They would then guide them into a high priced loan for a property they could not afford. In the past, mortgage lenders would not sign on to something like this because they would be concerned about getting their money back. But the deal they worked out with Wall Street is that Wall Street could buy this debt, and sell it again and again and again so a group of different people on different layers were making money off bad loans. Eventually, mortgage lenders didn’t care if they were actually going to get the money back from the people they lent it to because they knew they were making their money by selling it to Wall Street, so both parties were happy.

Which is where the current crisis emerges. Even though a lot of wealthy people have made even more money off this process, major financial institutions are suffering consequences across the country because this debt had to be paid off sometime and somewhere. Merrill Lynch, the world’s biggest broker, has posted a record loss after writing down $19 billion on assets dealing with subprime mortgages. Citigroup, another huge lending institution, posted an $18.1 billion write-down on subprime related assets, and also eliminated 4,200 jobs in what is expected to be the beginning of a series of layoffs stretching through this year.

But even worse is that the middle and lower classes involved with this are having their credit ruined, their homes foreclosed, and are watching already weakened financial communities slide into much worse conditions. According to the Center for Responsible Lending, 7.2 million households currently have subprime mortgages, and more than 14 percent of those are in default. It projects that one of every five of those loans issued in 2005-2006 will end in foreclosure, with 2.2 million families losing their homes.

The current crisis’ convincingly negative effect on people of color is obvious. Lenders like to claim that there is no deliberate racial discrimination involved in subprime loans and that there is just a large number of people who had bad credit in communities of color that make the mistake of taking out loans that they cannot afford. But subprime lending industries have a propensity to target the weak and financially insecure in our society to take advantage of their desire for affluence and/or security, among other reasons.

It just so happens that the people they target are disproportionately people of color. In a report, issued by United for a Fair Economy, entitled Foreclosed: The State of the Dream 2008, it is stated that, according to federal data, people of color are more than three times more likely to have subprime loans.

High cost loans account for 55% of loans to African Americans but only 17% of loans to Whites.

African Americans and Latino Americans, in particular, trying to become home owners (which is the number one source of wealth for most Americans), were duped by private companies putting them into loans that they could not afford. According to the Foreclosed report, the subprime mortgage crisis will cause people of color to lose up to $213 billion dollars, leading to the greatest loss of wealth for African Americans in modern US history. So whether or not the lenders admit that they are deliberately targeting people of color, it is impossible to ignore the institutionalized racial inequality perpetuated by the practices of subprime lending industries unless you turn a blind eye to the statistics—which many industries are most likely doing in the name of profits.

So if you aren’t a direct victim of subprime loans, why does this matter to you? Over the last 30-40 years we have witnessed government policies that have brought more wealth to the already wealthy while leaving the middle and working classes with stagnant wages and skyrocketing costs like that of housing and health care, to name a few. As people look for ways to try to cover those costs, too many have been talked into refinancing their homes with loans they cannot afford and then end up losing their homes and being worse off than they were before.

The subprime crisis is going to lead to the foreclosures of many homes and thus decrease home values in the neighborhoods where homes are foreclosed and, eventually, housing in general. Decline in the value of housing means a decline in wealth for homeowners, which means a big loss for the consumption spending that drives our economy. The fact that the majority of consumption spending was, and is, financed by debt, and the industries connected with housing (washing machines, furniture, etc.) will now see a much smaller market, only makes the likely onset of a recession worse.

As housing values go down, the property taxes go down as well, leading to less revenue for city and state governments to provide services for their constituents (most likely public schools, which also perpetuate inequality). Also recently, the Dow Jones industrial average lost more than 300 points. This means a decrease in consumption spending of wealthy people and a decrease in investment. All these factors combined could lead to a nation-wide depression that could have vastly broad effects on all of us in terms of jobs, education, and standard of living.

President Bush made an announcement about his plans for an economic stimulus package of approximately $150 billion dollars that included and focused on tax cuts and rebates. This is basically designed as a quick fix to spur people into spending money and cause the economy to grow and the crisis to be averted. But this really is just a quick fix. There is no guarantee that a slight increase in consumption spending will offset this crisis. In fact, we have not seen the worst of the storm. Remember what subprime lending entails. Some are made as “‘adjustable rate’ loans, which offer low initial interest rates that jump sharply after a few years in the form of resets.” There have been a large number of mortgage resets in the past few months, but unfortunately most of the resets will be occurring starting right now. In Dec. 2007, there were 58 million Adjustable Rate Mortgage Resets, up from 22 million in Jan. 2007. Between January and June of 2008, it is expected that 521 million Adjustable Rate Mortgages will be reset. That is an average of 87 million per month with a high of 110 million in March. Many of those loans will supposedly be refinanced, but even if they are, it does nothing to help the credit situation and only stalls and worsens the inevitable recession tied in with this crisis.

Basically what the subprime mortgage crisis points to is not some sort of blemish on the smooth surface of our system that can be solved with economic stimulus packages and reforms. Instead, it points to the exploitative nature of capitalism. It points to a system that fosters an inequality of wealth and debt while blatantly encouraging aggressively predatory institutions in the name of profit and economic growth. These institutions are unchecked from prospering off the ignorance, need and poverty of the majority of people of color and the lower, middle, and working class—all of whom are desperately, at every turn, scratching and clawing for a meager piece of the pie. The subprime crisis requires radical solutions to help alleviate a looming disaster.

Short term solutions include more public spending on human needs like health care, affordable housing and mass transit, low or no interest government loans to families in need, not allowing evictions or foreclosures, and a higher tax on the wealthy. Long term solutions include talking about an economic system that does not encourage predatory industries to flourish and does not rely primarily on ever-increasing consumption. We have just touched the surface of the subprime mortgage crisis, and if things continue as they are, and wealth is not distributed more equally and debt burdens eased, more and more of us will see our livelihoods squelched and our futures darkened. And that is a crisis that cannot be refinanced by any loan.

Tillman Clark is a student at The Evergreen State College in Olympia.