Wednesday, May 30, 2007

WSJ subprime story

Today's Wall Street Journal's lead right article entitled "Subprime Aftermath: Losing the Family Home" focused on a middle class Detroit neighborhood that was suffering from the pressure of interest rates and the likelihood of defaults due to subprime lending. It was a series of personal stories that were touching and sad. They are for certain tragic for those involved. There were multiple tales such as: the woman whose 56 year old husband died and she couldn't afford the mortgage payments; the small businessman who stretched for his dream house and couldn't keep up with the payments when the interest rates reset as contracted; the family who signed up for a loan with a margin of more than 9% over LIBOR, the bank funding rate, primarily to make discretionary improvements to their house; and the high school principal who fell behind on payments due to a teacher's strike and due to the fact that she had fallen significantly behind over the years in paying her property taxes. All of these stories are compellingly told, but they are not really the fault of subprime lending. Why that comment?

One by one: the death of working spouse can put financial pressure on any family; overly stretching to buy anything, a house, a car, a vacation or whatever can be a financially unsound decision; agreeing to pay an exorbitant interest rate that's right there in the contract in order to redo a kitchen and other improvements is irresponsible; and not paying taxes or having some reserve finances when one has a reasonably good job is also irresponsible. They are sad stories but they are stories that can happen in any economic or market cycle.

Apart from the sad stories that make no real point, there are two issues raised that are or should be troubling. First, most of the people who took out subprime loans in the neighborhood that was profiled already owned their houses and had substantial equity. They took out the loans because they were marketed to them and they could use them to make improvements to their homes and pay off other debt. In other words, they owned a home and were financially solvent, but to some degree stretched on their credit cards. In order to maintain and improve their lifestyle, they stepped back into the financial jeopardy that characterized an earlier stage of their lives. This is troubling on many levels, but the concern is that this is could be just the beginning of a trend that has negative economic, social and political impacts. The stretched consumer tries everything to keep up appearances, and for some it fails. Second, the role of some mortgage brokers in the subprime market was not the same as in the prime market. In the prime market, a mortgage broker is often a member of a community who is viewed as a human E-Loan. He, or she, will get the best deal for you in the market and will ease the process for you. In the subprime market, some mortgage brokers were hustlers, presenting themselves as a trusted advisor in the prime market model, but taking advantage of unsophisticated borrowers. There can be and are a few crooks in any business, or any Congress, church or whatever, but in the rush for volume it is likely that some mortgage companies had a no questions asked approach to their brokers as long as they produced. It was more than a "few crooks". While those mortgage brokers and companies did not represent the majority of the market, they apparently were far more prevalent than was widely known as long as the housing market continued to rise. They should be held accountable for their actions and states should look at regulatory options for the future.

Everyone sees the advertisements all the time: flat screen television, no money down and no payments for 12 months; new car, lease for three years, no money down, $239 a month; 0% interest for six months on all balance transfers, no fees and maximum interest rate of 9.9% if your card account is in good standing; or finest quality suits, buy one for $199 and get a second one free, and for a limited time two free ties and two free dress shirts. The subprime lending market has been just another part of this consumer culture that has helped many people realize their goals. The marketers tempt consumers to go to the absolute edge of their ability to pay, and many are taking a step too far. When a mortgage goes wrong, however, it's especially serious. You can live without your flat screen, a new car, an extra credit card or extra suits, but you need a place to live.

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