Sweeping changes surround the financial world
Do you remember the R.E.M. song “Losing My Religion?” With apologies to the band, I thought of that song recently while watching the angst that has wracked Wall Street and millions of investors the past few weeks.
Indeed, money is a form of religion (though hopefully not the only form) to many people. We worry about our money, pray for it and defend it as if it was the Holy Grail. I think it would be fascinating for some photographer to spend a few days on the floor of the exchange capturing the angst and drama in the faces of those who trade there. Many of us will tell our children and grandchildren about the winds of change that swept the country in 2008, and it will be looked upon as a profound event.
Many aspects of our economy may never be the same. The government has assumed an unprecedented role in areas that were sacred to the private sector since the inception of our nation. Banking, insurance and the securities markets will have to learn to operate as quasi-governmental operations for the next several years at least. Just like a parent who doles out money to children, the feds will use the purse strings to get cooperation from those who take their money.
Until the economy revives and new private empires rise to compete with those vested with the government (assuming the government allows such enterprises to rise to such heights), things will never be the same.
How did we get here?
There are a million places to point fingers at where this all started, but a lot of it can be traced to the politicians trying to allow as many Americans as possible to fulfill the American dream of owning a home. Fannie Mae and Freddie Mac were created to fuel this dream and given the tools to promote home ownership. Initially, they were operated as common-sense lenders. If you wanted a loan, you had to prove you had an income and were responsible about credit. That worked well for decades. But it wasn’t enough for many people.
There was a large sector of the population who wanted to own a home but could not qualify under traditional guidelines. This included the retired, who had assets and good credit but inadequate income. It also included small-business people who had a lot of legal tax write-offs but had the means to make their payments. People working on commission, who had fluctuating income from year to year, also were in this category. Many wealthy individuals with complex returns did not want to be bothered sending in hundreds of pages of information to get a loan.
To serve this sector, the investment banks began to offer alternate loan programs called “stated-income” loans. These emerged during the 1980s and were restricted to those groups mentioned above. The loans performed well, and the banks funded these loans through securities that were paid back from the mortgages’ repayment stream.
Treading risky ground
Knowing a money maker when they saw it, Wall Street banks started to offer other programs to what became known as subprime borrowers. This was the start of offering stated-income loans to salaried workers, who unlike the self-employed or commissioned, had finite, as opposed to fluctuating, cash flow.
These loans carried a higher interest rate and were very profitable initially for the investment banks that first offered them. Eventually about $6 trillion would be committed to private loan offerings. Subprime mortgage- backed securities became the McDonald’s hamburgers of Wall Street.
However, there was also another group that wasn’t getting its apparent fair share of home loans. Blacks and other minority groups complained that they were often only offered subprime loans, and in the interest of social justice for all, Congress and the White House became concerned.
The New York Times reported on Sept. 30, 1999, that Fannie Mae had been under increasing pressure from the Clinton administration to expand loan programs offered to lower- income and minority families and was developing its own guidelines for subprime loans it would purchase. These included stated income loans for salaried workers and relaxed credit profiles. Many point to his as a defining moment when the current crisis started developing.
There is no doubt that in their quest for market growth and increased profits that these loan programs were expanded relentlessly and the standards were continually lowered. Far from the original intent of serving the retired, self-employed and commissioned borrowers, it became acceptable for a clerk at Target to claim he or she made $50 an hour. In addition, loan programs became increasingly exotic and subjected borrowers to unconscionable rate and payment increases. These rate increases were often masked by payments that did not even cover the accrued interest, causing borrowers to lose equity even if they made every payment on time.
The rest, is as they say, history. But it is also the future because we are now at the day of reckoning. Our economy will survive and make it past this but it will leave a lot of wreckage in its path.
Chris Neuswanger is a loan originator with Macro Financial in Avon and welcomes mortgage related inquiries from readers. He may be reached at 970-748-0342.
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