The US Mortgage Crisis: An American Dream Gone Sour

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This is just a beginning, economists claim the crisis is going to linger on for a long time, IMF sees US falling into a recession, economy in a total meltdown, banks’ profits shrinking By Faryal Virk

An American Dream Gone SourThis is just a beginning, economists claim the crisis is going to linger on for a long time, IMF sees US falling into a recession, economy in a total meltdown, banks’ profits shrinking

By Faryal Virk

In almost every country, home ownership is something most people desire. It is no different in the United States, where an established mortgage industry has made credit available to millions, making it easier for them to own their own home. Depressed economic conditions in the 1970s and 1980s subdued the mortgage market, but with the boom of the 1990s, mortgage volume experienced dramatic growth, and from 2000 onwards, there was an unprecedented increase in credit available to home buyers at attractive interest rates. One of the factors that facilitated this expansion was the securitization of mortgage portfolios. Banks packaged their mortgages into different types of securities and sold them to investors. The price of the securities depended on what the investors were willing to pay for the type of asset and its risk profile. This process freed up the banks’ capital, allowing them to generate more mortgages and to use cash for investment in securities that included mortgage obligations.

With the increased capacity to lend, banks competed vigorously to generate mortgages and create a cycle of securitization and lending. Different types of mortgages were aggressively marketed to prospective home buyers and credit standards were relaxed, with some banks lending up to 100 percent of appraised value. ‘Ninja’ (no income no job and assets) and ‘stated income/stated assets’ (as stated by borrower without independent verification) loans became commonplace. Adjustable rate mortgages (ARMs) that re-priced in 3-, 5- or 7-years became popular because of their low introductory rates compared with conventional fixed rate mortgages. These products were particularly attractive to subprime borrowers who were previously excluded from home ownership. By 2005 sub-primes made up almost 13 percent of mortgages compared with less than 5 percent ten years before.

An American Dream Gone SourWith so many more borrowers in the market, demand for homes increased and prices kept rising. In their efforts to cross-sell products, banks also marketed Home Equity Lines of Credit (HELOCS), which targeted the unfunded part of home purchase prices. These were used by consumers to spend on home improvement and other expenses (such as cars and appliances). But all good things must come to an end. By 2006, the first round of ARM re-pricing began in a rising interest rate environment, causing the interest component of monthly mortgage payments to increase, which impacted borrowers’ ability to repay. Banks began to experience an increase in mortgage delinquencies and defaults, and started tightening up their credit standards. This initiated a vicious cycle where people trying to sell their homes in order to avoid foreclosure found fewer buyers. At the same time, the economy began to falter, causing job losses and consequent mortgage defaults. Loan to value ratios became inverted, especially on sub-prime loans. Many borrowers decided it was not worth their while to pay back loans that exceeded the value of their homes, and simply began mailing their keys to lenders after vacating their homes.

As financial institutions struggled to come to grips with their asset portfolios that consisted of both mortgages and mortgage backed securities, they endured losses and the prospect of capital inadequacy. New funding for mortgages declined, while existing mortgage defaults increased. The first round of defaults involved sub-prime loans, but given current economic forecasts the wider market may soon be impacted. All these events have adversely impacted the financial sector and the real estate market. Builders have new home inventories that are being sold at deep discounts compared with pricing that was possible a few years ago. Existing homes are coming on the market, many due to foreclosure, which is also lowering prices. However, with the credit crunch, there are few buyers for these properties, and in the short term it seems that the mortgage crisis will deepen.

Faryal, who lives in Texas, has an interest in banking and finance. (Pun intended)

This article was originally published in the print edition of Valuemag, issue 2, June 2008.

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Fareeha Qayoom
Fareeha Qayoom
Publisher and editor-in-chief of Tkfr.com and former print editions of The Knit-Xtyle Fashion Review (tkfr), a trade newsletter for the textile and apparel industry of Pakistan. In short, Publisher, editor, and a blogger. In addition, she has served as Managing Editor of MIT Technology Review Pakistan, print and web editions (2015-16). Total of 7 editions were published under her leadership by ITU, Punjab's first public technology university under the license of MIT Technology Review (USA). She has also managed Value Mag in the same capacity, a real estate and lifestyle magazine for Value TV - 2008-9. Published freelancer for The News on Sunday 1994-96. Fareeha has over 21 years of solid management experience – of managing brands (like Harley Davidson, Munsingwear, Chaps, Chaps Ralph Lauren etc.,), Retailers (like Target, Mervyns, Kohl's, Marks and Spencer etc.,), customers (VPs, Product Managers, Unit Managers, and Buyers), and products (apparel - woven, knits, men's, women's, children's, Print and online publishing units), projects, teams, and processes, information, content, and data, staff, vendors, and time. Versatile and adaptable with international exposure, communication and language skills (oral and written), and a consistent track record of achieving company targets and objectives, plus a MA in Political Science from Punjab University, a MSc in Economics from La Salle University, Louisiana, USA, and a BA in Economics from Kinnaird College for Women.

7 Comments

  1. […] Fareeha Qayoom wrote an interesting post today onThe US <b>Mortgage</b> Crisis: An American Dream Gone Sour | TKFR.comHere’s a quick excerpt […]

  2. Obama administration revises anti-foreclosure strategy
    By Dina ElBoghdady and Renae Merle
    Washington Post Staff Writer
    Saturday, March 27, 2010

    The Obama administration Friday tried to manage expectations about its newest foreclosure-prevention efforts, while consumer advocates and others who track the housing market praised the initiative but questioned whether it would succeed in curtailing the foreclosure epidemic.

    http://www.washingtonpost.com/wp-dyn/content/article/2010/03/26/AR2010032604603.html

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  3. Bailout watchdogs slam Obama housing programs
    By David Lawder
    WASHINGTON | Wed Jul 21, 2010 4:47pm EDT
    (Reuters) – Obama administration housing rescue programs have been ineffective at preventing a rise in home foreclosures even as the government’s support for the mortgage market grew by nearly $700 billion in the past year, U.S. bailout watchdogs said on Wednesday.

    Neil Barofsky, special inspector general for the Troubled Asset Relief Program, heaped more criticism on the Treasury for its failure to adopt more realistic goals for the number of people expected to benefit from its program to modify mortgages and slash monthly payments.
    http://www.reuters.com/article/idUSTRE66K0I520100721?feedType=nl&feedName=ustopnewsearly

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  4. Home sales at 3-month low
    (Reuters) – Sales of previously owned U.S. homes hit a three-month low in June while new claims for jobless benefits surged last week, the latest indications that the economy is on the ropes.

    Another report on Thursday showed an index of leading indicators, a gauge of the economy’s future prospects, fell last month, consistent with views the recovery was cooling and the slowdown could persist through the end of the year.

    With the data stream continuing to be weak, fears have escalated that the economy may be slipping back into recession, but both private economists and Federal Reserve officials see the recovery still intact.

    http://www.reuters.com/article/idUSTRE65M2WK20100722?feedType=nl&feedName=ustopnewsearly

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  5. Home sales surge in June with inventory at 42-year low

    By Lucia Mutikani
    WASHINGTON | Mon Jul 26, 2010 6:21pm EDT
    (Reuters) – Sales of new homes rebounded strongly in June from May’s record low, pushing the number of houses on the market to the lowest level in nearly 42 years.

    But downward revisions to sales estimates for April and May in Monday’s report left in place a picture of a weak housing market and perceptions that economic growth moderated somewhat in the second quarter.

    Sales of new single-family homes vaulted 23.6 percent to a 330,000 unit annual rate, the Commerce Department said. Still, the sales pace last month was the second lowest since records started in 1963.

    “We can’t take too much joy in one month’s figure. The roadblocks to a healthy housing market are high, the most important one being the still high jobless rate,” said Jennifer Lee, a senior economist at BMO Capital Markets in Toronto.

    http://www.reuters.com/article/idUSTRE65M2WK20100726?feedType=nl&feedName=ustopnewsearly

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  6. Mortgage demand dips on rising rates
    By Lynn Adler
    NEW YORK | Wed Jul 28, 2010 7:37am EDT
    (Reuters) – U.S. home loan demand cooled last week as rising mortgage rates curbed refinancing requests that had soared to a 14-month high, the Mortgage Bankers Association said on Wednesday.

    Loan requests to buy homes rose for the second straight week to the highest level since the end of June, but hovered just above 13-year lows. Refinancing still represents nearly 8 out of every 10 mortgage applications.

    Many consumers doubt that job market improvement is around the bend, and lending standards remain tight, putting home buying out of reach even with borrowing costs near record lows.

    http://www.reuters.com/article/idUSTRE66K1Z320100728?feedType=nl&feedName=usbusinessearly

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  7. Racial predatory loans fueled U.S. housing crisis: study

    By Nick Carey

    CHICAGO | Mon Oct 4, 2010 7:44am EDT

    CHICAGO (Reuters) – Predatory lending aimed at racially segregated minority neighborhoods led to mass foreclosures that fueled the U.S. housing crisis, according to a new study published in the American Sociological Review.

    Predatory lending typically refers to loans that carry unreasonable fees, interest rates and payment requirements.

    http://www.reuters.com/article/idUSTRE6930K520101004?feedType=nl&feedName=ustopnewsearly

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