Subprime Mortgage Tremors: An International Issue
Lander, Gerald H., Barker, Katherine, Zabelina, Margarita, Williams, Tiffany A., International Advances in Economic Research
Abstract The subprime mortgage crisis has negatively affected individuals, investors, lenders, and economies worldwide. This paper first examines contributing factors of the crisis: predatory lending, predatory borrowing and mortgage fraud, unethical practices, unregulated mortgage brokers, off-balance-sheet activity, and the infusion of capital from Asia that provided the fuel for subprime mortgage activity to continue. International markets have both suffered from and contributed to the crisis. Legislation that has been enacted or recommended in the U.S. and the European Union is reviewed. We then make recommendations which could begin to restore confidence of consumers and investors worldwide; however, it is clear that laws and regulations must be enacted quickly to correct the situation and bring stability to investment markets.
Keywords Subprime * Mortgage * Lending
JEL F30 * F39 * G10 * G15
The current subprime mortgage crisis has caused much concern internationally as homeowners, lenders, financial institutions, and investors worldwide have felt the negative effects of the crisis (Greenspan 2007; Kuttner 2007; Bernanke 2008). A wide array of factors including but not limited to predatory lending practices, predatory borrowing and mortgage fraud, unethical practices, unclear or lax rules and regulations, and conflicts of interest have caused this international crisis. The various causes must be examined and understood in order to formulate protective measures against future occurrences.
Causes of the Subprime Mortgage Crisis
Predatory vs. Subprime Lending Practices
To begin, subprime lending practices must be defined and distinguished from predatory lending. Subprime lending involves loans offered at rates greater than the prime rate to individuals who do not qualify for prime rate loans due to poor credit and who therefore are viewed as high risk (Smith 2007), Subprime lending is viewed as ethical since it gives those with lower credit ratings the opportunity to obtain loans and mortgages--although at higher interest rates. However, as lenders apply unethical or illegal procedures to subprime loans, the classification changes from subprime lending to predatory lending (Bond 2002, p. 34). Predatory lending is abusive lending "targeting the elderly, people of low income, minorities, and individuals with limited understanding of financial transactions" (Bond 2002, p. 34). The predatory loan market is comprised not only of home mortgage loans, but extends to consumer credit cards, "payday" loans, rent-to-own loans, loans by phone, and loans solicited through the Internet (Bond 2002). As of 2002, the federal and state governments had not clearly defined predatory lending practices, nor determined penalties for engaging in it.
Predatory lending also includes offering subprime loans to individuals who qualify for prime loans. Fannie Mae estimated that up to 50% of the subprime refinanced loans could have been prime loans--saving the borrowers thousands of dollars in fees and interest rates (Christie 2007a, b). Minorities have also been hard hit as evidenced by a government study in an African-American neighborhood showing over 51% of the refinanced mortgages being subprime, compared to only 9% in predominantly white neighborhoods (Bocian et al. 2006).
In the early 2000s, interest rates were low and mortgage money was available, which helped raise real estate values across the country. With values escalating, lenders felt more comfortable making mortgages to customers whose poor credit histories had prevented them from buying homes in the past. As home values, rise borrowers are less likely to default since they can sell their homes and have enough to pay off the mortgage if they face financial hardship. That put more buyers into the market, helping to raise home ownership rates to a record 69% in 2004 (Arnold, May 5, 2008), which pushed housing prices to double digit growth in some areas. …