Posted by Steve Markowitz on May 18, 2015
In 2008 the world economies encountered the worst financial crisis since the Great Depression. In a supposedly effort to repair the economies, governments transformed them through huge stimulus spending, low interest rate policies and bailouts. These interventions have contributed to the ongoing weakness in economic recovery since.
The main cause of the 2008 meltdown was the subprime mortgage lending practices that led to loans being hustled to millions who could not afford to pay them back. When the housing market slowed leading to depreciated housing values, homeowners could no longer refinance, further eroding housing demand that led to many homeowners owing more on the homes than they were worth. Many walked away from the loans leading to the meltdown, putting at risk nearly most of the world’s largest financial institutions.
Given 2008 is only eight years ago, logic would dictate that we learned a lesson about imprudent financial behavior, at least for a generation. However, once governments intervene, logic and economic reality take a backseat. In fact, we are currently traveling down the same road, again fermented by governmental policies.
News.investors.com reported that the US government is again cajoling financial institutions to give mortgages to those that cannot afford them. Specifically, the Consumer Financial Protection Bureau warned (threatened) lenders that they would be investigated for discriminatory practices if they do not count government assistance payments to lower income individuals as real income. In announcing this policy, Bureau Director Richard Cordray used the following incredible logic:
“The bureau has become aware of one or more institutions excluding or refusing to consider income derived from the Section 8 HCV Homeownership Program during mortgage loan application and underwriting processes.” …. “Consumers should not be put at a disadvantage just because they receive public assistance.”
So, using the government’s logic, individuals who need governmental payment assistance are worthy of obtaining mortgages.
Once again politicians and bureaucrats are manipulating economic practices and reality in order to further social goals. Prudent financial practices not only protect financial institutions, but also borrowers. Instead, the government is placing people in mortgages they are unlikely to be able to repay. In addition, this policy leads to bad investments decisions for some consumers when housing prices depreciated in the future. If this occurs on a large enough scale, it will create another housing bubble and melt down mirroring that which occurred in 2008.
There is a flaw in the premise used by the Consumer Financial Protection Bureau. Inherent in this policy is the view that lending institutions discriminate on people based on noneconomic factors, which is economic lunacy. Those in the mortgage industry make money offering mortgages. The more they write the higher the profits, assuming that the mortgages are prudent. Forcing lenders to make imprudent mortgages will improve the short-term profitability of the mortgage industry, but ultimately hurt those that invest in buying these assets on the secondary market; i.e. pension funds, etc. That is precisely what in the meltdown of 2008.
Posted in Debt, Mortgages | Tagged: Government, Mortgage, subprime, US | 1 Comment »
Posted by Steve Markowitz on March 21, 2015
It was just six years ago that the world was at the brink of economic Armageddon. The crisis was brought on by the cheap loans made available to borrowers including those rated as subprime with credit scores below 640. The cheap mortgages to those with limited assets helped create a huge bubble in the housing market. When the economy slowed down and home values began to depreciate, many borrowers began to default on the mortgages, which placed at risk major financial institutions worldwide that invested in these bundled mortgages.
Banks and others that owned the collateralized mortgages then required bailouts from the government to stave off failure. This did not eliminate the debt, but merely moved it from the private sector to governments; i.e. taxpayers. In addition, the bailouts inordinately benefited companies and their shareholders who made the imprudent loans. Without the bailouts they would have encountered substantial financial losses.
There is also been a more incipient result of the bailouts of investors who made imprudent loans in the subprime market. Without suffering losses investors have had short memories and in fact they are back at it again in the subprime financing business, once again supported by low interest rate central-bank policies with interest rates worldwide remaining at artificially and historic lows.
Last month, the Wall Street Journal highlighted the growth of subprime loans in an article titled Borrowers Flock to Subprime Loans. Today, subprime loans are not in the housing market, but in consumer goods. The Journal published the following:
- Subprime loans are at the highest level since before the 2008 financial meltdown.
- Approximately 4 out of every 10 loans for autos, credit cards and other personal borrowing in 2014 were in the subprime category.
- During the fourth quarter of 2014, total US household debt increased by over $300 billion.
The Federal Reserve’s low interest rate policies are pushing investors to greater risk as they seek returns. This, coupled with the availability of cheap capital has offered incentives for nontraditional lenders to enter the credit markets. For example some venture backed funds are fueling the growth of subprime lending, such as Lending Tree, Inc., an online auto loan marketplace. These lenders are not regulated and are likely to use leverage and other financial games to pursue even more subprime lending, a repeat of the actions behind the 2008 financial crisis.
Subprime lending is fueling economic unsustainable growth. For example US auto sales topped 16.5 million in 2014, a nearly 6% increase from the previous year and up nearly 60% from 2009. When the inevitable slowdown occurs, an increasing number of subprime borrowers will be unable to repay their loans, a repeat of what led to the 2008.
History has demonstrated that booms and busts, and yes bubbles, are at normal part of economic cycles. However, major macroeconomic bubbles have generally been a once in a generation occurrence that is self-correcting and serves as a reminder to that generation of the pitfalls of imprudent economic behavior. The collapse of 2008 was different with many investors being bailed out and equity markets returning to their highs within a relatively short period of time. This has shortened capitalists’ memory who are now once again making imprudent loans in search of returns. This will lead to another significant downturn in the relatively near future, a probability that investors are ignoring in the belief that when it occurs the government will again come to the rescue. However, this time the government and the Federal Reserve are themselves deep in deep. It remains to be seen how this huge sovereign debt will affect the outcome.
Posted in Bailouts, Bubbles | Tagged: Bailouts, Fed, Federal Reserve, lending, loans, subprime | 1 Comment »
Posted by Steve Markowitz on September 27, 2014
USA Today reported on the growing number of subprime auto loans being made in the United States. Such loans are made to high-risk borrowers with poor credit scores. According to USA Today:
- Since 2009 the number of auto loans made to high risk borrowers with credit scores below 660 has doubled.
- In the past year the repossession rate for automobiles has increased by 70%.
- The amount of interest paid by consumers for auto loans is staggering. For those purchasing automobiles on credit in 2009, an aggregate interest of nearly $26 billion will be paid on those loans.
- In most states more than one half of the consumers have some form of subprime credit.
It is remarkable that only six years after the subprime mortgage fiasco caused a worldwide economic meltdown, similar high- risk loans practices are gaining momentum. In addition, subprime auto loans are being bundled by Wall Street into risky securities and sold to naïve investors.
While the size of the subprime auto loan market is significantly smaller than that of the subprime mortgage loans, a significant amount of failure amongst these loans will damage the overall economy to some extent.
The subprime mortgage market and the bubble it created were a result of governmental and Fed policies that included artificially low interest rates. The current subprime auto loan market is being created by similar policies. Once again, artificially low interest rate policies promoted by the Federal Reserve support predatory lending practices to those who should not be given loans. In addition, this low interest rate environment offers fertile ground for the sale of the securitized loan portfolios to investors seeking higher returns through risk.
In addition, the moral hazard has been damaged by the government’s bailouts that saved imprudent lenders and banks from disaster in 2008/2009. These lenders and their investors expect the government to cover their backs during the next meltdown, even if caused by their imprudent lending practices.
Both political parties avoid discussion of debt the damage it causes. This is by political necessity given the ever-expanding debt financing used by the US government. Debt is inappropriate if used to create wealth today at the expense of tomorrow’s economic growth potential. It becomes a tragedy when such debt is promoted by imprudent governmental policies.
Posted in Debt | Tagged: auto, Fed, Interest, loans, subprime | Leave a Comment »