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March 16, 2007
Subprime Borrowers are Suffering for Our Sins
Anyone who is interested in understanding the subprime mess should read Peter Coy's story, "Under The Fed's Hammer
How Fed rate hikes have turned into a regressive tax on weak borrowers."
In past business cycles, when the Fed raised interest rates, the impact was democratic: Companies large and small had to pay more to borrow, and so did most households. Everyone suffered.
This time around, though, most borrowers have been able to escape the Fed's interest-rate hammer. As the Fed has boosted short-term rates by more than four percentage points since 2004--the biggest move since the early 1980s--corporations and households with good credit have easily switched to long-term loans, where rates have barely budged over the past three years. "A prime borrower has options," says Robert Moulton, president of Americana Mortgage Group Inc., a Manhasset (N.Y.) mortgage broker.
Which leaves one group of Americans to absorb the brunt of tight money: families with poor credit. These typically low- to moderate-income families have always relied heavily on short-term borrowing. But they are even more vulnerable today because so many of them bought homes during the boom using subprime adjustable-rate mortgage loans (ARMs) tied to short-term interest rates. As rates have gone up, loan payments are beginning to skyrocket.
To summarize--the entire weight of the Fed's rate increases are falling on subprime borrowers. Everyone else has been able to escape. That explains why the subprime market has been suffering so badly, and why the pain is not likely to spread.
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What will be the impact on consumer spending as these borrowers begin to default on loans?
Also, I read Greenspan discussing some worries with the Credit Derivatives Market, what are your thoughts on that?
Posted by: Pat at March 16, 2007 01:19 PM
Part of this problem is the result of years of brainwashing that buying a home is the "only way to go". What we should be teaching people - of any income level - is how to be fiscally responsible. Buying a home is a nice advantage *if* you can financially handle it. However, just like murder rates rise in times of war (due to the psychological effect of state-sanctioned murder), it is hard to preach fiscal responsibility out one side of our face and out of the other deficit spend by hundreds of billions of dollars per year.
Posted by: Brandon W at March 16, 2007 03:13 PM
You can't denounce deficit spending all together. Granted, deficit spending the way we are currently doing so (billions of dollars on a war) is not a great use of the concept.
However, when a country spends billions of dollars on R&D or some other type of investment that has a better return than dead soldiers and hatred for our country, it is a better deal.
Its the same concept as when a business owner takes out a business loan to start his company. He is spending in the red, but with an expected return greater than what he has put in.
So, on one hand, deficit spending vs. financial literacy is a contradicting argument. On the other, deficit spending as a means of responsible financial literacy works.
Posted by: Eric at March 18, 2007 07:37 PM
I think it is hurting more than the sub primers. I have great credit and a steady income but I can't refinance because my home's value is sinking. I live in Michigan where this problem has been going on for some time. The rest of the country is catching up now.
Right now I'm paying 9.525%. The loan was about 5% or so when I took it. So I've seen my mortgage payment come close to doubling while I've gained 0 equity. While I was out of town, my township decided my home's value went up 20% this year, even though values are sliding. So that means a slightly higher tax bill and more difficulty selling because whoever buys it will have to pay 20% more than me in taxes for the first and most crucial year. That means I'll have to pay that tax in the form of a lower price on my home. In 5 quarters, when I finish My MSF degree, I'm planning on leaving the state to find work. I'm just hoping rate increases don't eat up my ability to pay down my mortgage enough to sell the place--for less than what I paid for it 4.5 years before the potential sale.
I know this is a personal story but this story is repeated by the thousands around here. People here can't sell, but they have to leave to find work. So they go into foreclosure. Then they leave.
Posted by: Joe Cushing at March 19, 2007 04:41 PM
The deterioration of our financial infrastructure has many causes; 1) a chronic mismanagement of our institutions; 2) financial permissiveness without adequate supervision; 3)a mis-allocation of funds for housing; 4) extensions of credit with essentially no restraints; 5) accommodation of special interest groups; and 6) an excessively easy monetary policy.
Managements have been given more and more freedom, or license, to compete. Managements, responding to apparent economic necessity, or because of greed and/or incompetence, have engaged in reckless financial practices. Little wonder that many managers abuse these discretionary powers to enrich themselves and their collaborators.
In retrospect, these institutions should have been subject to more intense, not less, regulation. In re-organizing our financial institutions the first requirement is to recognize that the competitive freedoms of the mercantile marketplace cannot be applied to the institutions that create our money, or protect our savings.
The scope of the operations of these institutions must be severely circumscribed and subject to rigorous and informed supervision.
Posted by: Spencer Hall at March 19, 2007 05:13 PM
You are right...the pain of high rates hits anyone who cannot afford to refinance, not just the subprime borrowers. I still think it's a regressive tax, though.
Posted by: Mike Mandel at March 19, 2007 05:51 PM