Just WHO is responsible for the Subprime Crises?

[stusegal]

OK,  so we're all suffering with a struggling economy as a result of the "subprime mortgage crises".  Well to understand who's responsible for this mess, you need to understand what it is . . . .

It starts with the term "subprime mortgage" which you may, or may not, have realized is a misnomer.  Most people seem to think it's a type of mortgage  -  since the term "prime" is usually used in financial circles to represent the "prime rate" I think many people have drawn the conclusion that a "subprime mortgage" is a mortgage at a rate lower than the prime rate.  This is not the case; the term "subprime mortgage" has nothing to do with the rate.

The term instead has been used to describe many types of mortgages, at varying rates and terms, that all have one thing in common . . . these are mortgages that were given to borrowers who would not, if sound lending practices were observed, be qualified to borrow the money.  So it is the borrowers who are subprime, not the mortgages.

Which gets to . . . exactly why did the mortgage companies and banks start lending to unqualified borrowers?  The answer is obvious; this is an extension of a culture that believes in borrowing rather than owning, that building a financial life around the the notion that being able to handle a certain monthly payment qualifies an individual to purchase a thing.  Unfortunately, this is not always true.

When I was a young person in the market to buy a home, there were 3 ways to do so:

1. Pay cash - of course no one could afford to,
2. VA Mortgage - only available if you were a Veteran, and then you could put 5-10% down to buy your home.
3. Conventional mortgage, and this is what most people were compelled to do . . .and generally the required down payment was at least 20%.

This meant that most young couples simply could not afford a home until they saved.  Kathy and I were married nearly 6 years, and Stephen was 1 year old, before we could afford the downpayment on a home.

So what happened?  It started in the 70's with credit cards.  As "revolving credit" become more commonplace, people became even more comfortable with the idea.  This led to "home equity loans", which allowed you to borrow against whatever equity you had built up in your home by paying down your mortgage, so you could buy more stuff today.  And as it continued people became even more comfortable with living on credit . . . and even worse than that, it fostered a culture where many people actually believe that if they can afford the monthly payment, then there's no need to save.  Not for anything - - home, car, TV, cosmetic surgery, you name it, you can have it now.

So back to subprime mortgages.  In the meanwhile, now that everyone is getting more and more comfortable with things like home equity lines (which reduce the homeowner's equity), the value of real estate is rising.  Everyone (mostly) is making their monthly payments, life is good, and everyone is happy.  So someone in the mortgage industry who has been lulled into a sense of wellbeing and security decides to lower the equity requirement for borrowers - meaning instead of requiring 20% down on a conventional mortgage only 15% is required.  And the logic is . . . it's just a few "points" (percentage points), and after all the healthy real estate market will cause a natural increase in the value of the home and will ultimately result in the same equity anyway.

A brilliant idea, but with one minor flaw.  By loosening credit standards more people now qualify for mortgages and enter the arena as first-time home buyers.  Which drives up the value of real estate (greater demand+same supply=higher values).  And since the value of real estate has risen, this seems to justify the ridiculous lending practice which brought the first wave of just-barely-unqualified buyrs into the market, so the credit requirements are loosened even further.  etc. etc. etc.

To the point that the real estate market is superheated, and certain lenders are lending with virtually no downpayment from the buyer, and on the basis of the increasing value of the real estate.  So there are loans with 0 equity, to people who are absolutely unqualified (by any sane lending standards).  Of course there are also all kinds of even more ridiculous schemes to keep monthly payments as low as possible  -  some so outrageous as to allow the borrower to make "interest only" payments, and never pay down the principal of the loan.

So by this point you think I'm going to say the Banks and Mortgage Companies created the crises?  Actually no  -  the banks and mortgage companies have put themselves in the same position as any industry which offers an unprofitable product, and they are now taking their (financial) lumps.

And maybe you think the government should have stepped in when it all began?  Somehow I doubt that there's a politician on the planet that would be willing to step in and tell a first time home buyer that, for the good of the economy, they can't have the mortgage they just qualified for.

The answer is painfully obvious.  Painfully, because now we are suffering as a result of the irresponsibility.  The blame lies solidly with the borrowers, who all knew they were buying things they couldn't afford.  Before you send me hate mail, please think about this  -  exactly whose responsibility is it to manage your finances - yours, or the someone who's trying to sell you something (like a house or a mortgage)?  Whose responsibility is it to understand the terms of a mortgage and the concepts of equity and value?  And if it's so complicated that you can't understand?  (Well then get far away - after all, it's the largest purchase of your life).

There was surely a time when your Mother said, "Well if all your friends jumped off a bridge . . . "  And that is the sad fact - - a bunch of idiots thought because something was offered, and other people were doing it, it must be OK.  None of these idiots took 5 seconds to think about the cost of the home they were buying, the lack of equity, or the ridiculous position they were putting themselves in.  All they were concerned about was continuing a hedonistic lifestyle in which they "deserve" to have all these things today, regardless that they can't afford them.

So let me close by saying I have no compassion for these subprime dunderheads.  Actually, I am angry at them, because their need to satisfy their hedonistic desires is largely responsible for the economic mess which we are now all suffering through.

Comments

[alanashinean.livejournal.com]

Thanks for this post. I am one of those people who has heard this term bandied about but didn't quite understand what was behind it, or who was responsible.

I don't think you deserve any hate mail for pointing out what is a fact: we are responsible for the money we borrow, the credit we are using- not some bank or the government. Financial responsibility was drilled into me by a militant grandma who never owned her own home, or really ever had much money. I owe her a lot for those teachings.

[stu-segal.livejournal.com]

Where would we be without grandparents?

Your Grandma represents a different era; one when people were realistic and bought what they could afford. I had several aunts and grandaunts who never owned their own homes; they lived in apartments. Today there are a very lot of people under the misguided notion that they "deserve" to own a home (along with a new car, an annual cruise, a 50" TV, etc).

How goes it across the pond?

[alanashinean.livejournal.com]

Its rainy and cold, which is almost a relief after Denver :p Having a lot of fun though! Hope things are well with you :)

[stephenhsegal.livejournal.com]

"This American Life" did a really good one-hour show, tracing the whole thing from the inside perspective of some of the mortgage professionals: http://www.thisamericanlife.org/Radio_Episode.aspx?episode=355

...but obviously you're right about the basic problem of people acting foolishly.