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Subprime Lending

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Subprime Lending

Discuss in detail the event, the people involved, and its background and impact of America.
Before 1930, features of Housing loans presented significant challenges. To obtain a home loan a down payment of half the value the house was required. Further issues with these loans were large balloon payments and short maturities. The pricing for mortgage loans varied widely due to no nationwide housing market. The main funding for these loans was provided by life insurers, thrifts, and commercial banks.
By 1932, a housing crisis was wreaking havoc on home loans. The estimated defaulted loans were rising to twenty –five percent. In response to this crisis, the FHL Bank System was designed to provide relief to lending institutions and homeowners. In 1933, President Roosevelt birthed two Acts regarding the housing market. The first was the Home Owners Loan Act. This act established the HOLC, which was designed to slow down the quickly rising foreclosure rate. Under this act, long-term self-amortizing fixed rate mortgages became the new norm. The second act in the New Deal was the National Housing Act. The FHA was created in this act. This protective measurement was used to help the lenders maintain foreclosed homes by adding automatic insurance payments to active loans. The FHA also expanded the use of a fixed rate long-term home loan.
In 1938, the American government formed Fanny Mae to provide a secondary market for home mortgages. This secondary market gave lenders the opportunity to sell mortgage notes to fanny when the bank needed funds for new mortgages. Up to 1938, all mortgages were privately owned. With the addition of the secondary market, both private and government agencies bought bundled bank mortgage packages. This secondary market also provided lenders with cash to fund additional home loans.
There were no new changes in Fannie Mae In 1948. The GI Bill prompted a change in Fannie Mae with the influx of Vietnam soldiers returning home. The Veterans Administration mortgage assistance program was created to help veterans purchase home loan with long term and low cost mortgages. With the purchases of these VA loans, Fannie Mae increased business rapidly.
In the 1950s as the funds started to dwindle Fanny Mae was acquired by the Housing and Home Finance Agency as a constituent unit in 1950. Four years later the Federal National Mortgage Association Charter Act turned Fanny Mae into a mixed-ownership corporation. This exempted Fannie Mae from all taxes except pay property taxes.
The Housing and Urban Development Act of 1968 morphed Fannie Mae yet again. The prior change to a mixed-ownership corporation was voided. HUD made Fannie Mae a for-profit, shareholder-owned company. This took Fannie Mae off the government books and into stock and bond marketing funding. Regulatory authority was given to HUD and required lenders to devote a reasonable portion of their loans to low and moderate- income housing.
HUD affected the housing market a third major way by creating the Government National Mortgage Association. Also known as, Ginnie Mae, which is the only one backed by the government
Ginnie Mae sole purpose is to guarantee bonds backed by home mortgages. These home mortgages have been guaranteed by FHA and the VA. Ginnie Mae does not own or purchase any home mortgages. It bundles several home mortgages and gives government insurance the bond will be paid. Regardless of the mortgage status, Ginnie Mae requires the lender to make the pass through payment. In 1970, The Emergency Home Finance Act helped create Freddie Mac. Freddie Mac was formed to keep Fannie Mae from functioning as a monopoly by purchasing private mortgages. Freddie Mac mirrored Ginnie Mae in the fact that mortgages were bundled as mortgage-backed securities to investors. This was done to generate funds back to the secondary market. Freddie Mac focused on decreasing the interest rate risk by passing it to the investor, while Fannie Mae was responsible for ballooning the risk. In 1974, the Equal Opportunity Credit Act was created to enforce lenders to not discriminate against things like race, religion, sex, age and more. Another act was passed in 1977 to further encourage lenders to approve loan to minority groups. This was called the Community Reinvestment Act.
In the late1970’s and early 1980’s, there were many inflations, recessions and rises interest rates. These events affected Fannie Mae more than Freddie Mac because of their differences in lending practices. A large financial strain was put on Fannie Mae. During this period, they received assistance from the federal government through tax benefits and regulatory forbearance.
Over the next twenty years, many changes took the lending system down to new lows until the economy-hit rock bottom in 2007. The serious subprime crisis began in June of 2007 when two Bear Stearns hedge funds collapsed. This had a rapid effect on other parts of the financial markets worldwide, which reached the crisis level and the number of foreclosures for sale in August-September of this year and temporarily froze the money market sector that is critically important to banking and financial operations.
The subprime mortgage market continued to be solid as long as the housing market continued to escalate and interest rates did not go up. Meanwhile, the homeowners continued to incur more debt until it reached a level of $700 billion or 5% of the US GDP in 2004. By 2006, housing prices started to taper off after rising nearly 40% between 200 and 2006. They are expected to continue their decline through 2007 and most of 2008.
Who was Involved:
Bill Clinton got the ball rolling by repealing the Glass Steagall Act and signing the Commodity Futures Modernization Act. He also beefed up the Community Reinvestment Act by forcing lenders to take a relaxed approach to poor borrowers trying to experience the home buying process.
Alan Greenspan was the Chairman of the Federal Reserve for eighteen and a half years. In2002, he was thought to be reason for our economic stability and praised. However, in 2006 after an investigation into the subprime meltdown, Alan Greenspan was found to be the leading cause. This was due to his super low interest rates and refusal to regulate the derivatives market. He took a firm liking to “Ninjas” and apparently thought they should be homeowners despite not having any savings much less a steady stream of income.
Lewis Ranieri was the one who pioneered the mortgage-backed bonds. In 1981, he formed an alliance with David Maxwell to influence Fannie Mae to increase the use of these bonds. He once claimed that he made more money from bonds than all of Wall Street combined.
Many Wall Street bankers, bosses, and analysis contributed to the subprime meltdown. Many of them were in charge of multi-million dollar companies. Companies such as Countrywide, CitiMortgage, AIG, Northern Rock, Meryl Lynch, New Century Financial, and Lehman Brothers had owners that were enticed by commissions. As a result, many of these companies earned billions of dollars in commissions on subprime loans.
The America Public was also played a key role in the housing bubble burst. Although the banks giving the loans were responsible, so were the borrowers. Knowing that their budget could not afford the loan, they accepted the responsibility. With the adjustable rates throwing buyers into bigger loans, many of the consumers lived on the edge of insolvency. While it seems odd to blame the American public, common sense says if you cannot budget it in your lifestyle, than do not buy it. The ignorance of consumers not only fed the greed of the lenders, but also Wall Street. This caused the housing collapse when the borrowers were unable to repay their mortgages. The combination of all these events created the perfect storm that brought the economy to its knees.
President Obama played a huge role when he was an attorney. He was part of the first lawsuit towards Citibank for rejecting mortgages. The lawsuit claimed that they were discriminating against minorities. He is currently now trying to pass more acts that would force banks to engage in more risky lending.
After centuries of relaxed policies and third party involvement, the housing market finally fully collapsed with no resistance from President Bush. At the height of the meltdown, President Bush had options to control the situation. President Bush failed to tighten regulations and stop the boom in lending to no job and no income applicants. He also failed to bar Sarbanes-Oxley.
The Impact:
The impact was devastating to the economy. The ripples from this demoralizing practice were felt from every walk of life and in many sectors. These undulate shocked the Stock Market as the funds that held the bundled mortgage bonds suffered massive losses because of payment defaults. The investors that put their life savings into these funds were left with nothing. The blow hit industries that had little ties into mortgages lending. Some of the worst hit industries were metal and mining companies. The buyers who were already tittering close to insolvency took their last punch as the rates from their adjustable loan skyrocketed. Many of them tried to hang on by turning to credit cards or selling everything they had including the kitchen sink. Most who tried to refinance to escape from the dreaded inclining of interest rates were turned away due banks tighten their lending standards. With all means exhausted, the homeowners had to swallow their pride, pack up what was left and simply walk away from the place they called home. The houses that were once filled with energetic families were stripped of their upgrades to help families progress to their next stage of life. As the foreclosed homes grew, the neighborhoods took a turn for the worst, as these deteriorating homes became a welcoming mat for crime. This made it harder to get homeowners insurance for other houses in the neighborhood and often the premiums went up making it harder to make ends meet. Another problem homeowners had to face was the fact that they owned more on their home than what it was worth.
Many large banks had to buy the failing lending companies adding more risky loans and foreclosed homes to their portfolio. Banks are also responsible for the up keep of these houses, which added extra burden to them. Banks were also being sued left and right because homeowners eyes were bigger than their pocket books.
Another ripple that was that cause by the meltdown was property values went down which lead to less funding for the schools, police protection, and several other services. Schools have been shut down and after school activities were cut.
References:
http://www.theguardian.com/business/2012/aug/06/financial-crisis-25-people-heart-meltdown http://business.cch.com/bankingfinance/focus/news/Subprime_WP_rev.pdf http://www.federalreserve.gov/pubs/feds/2012/201225/index.html

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