Economic Upheaval: The Mortgage Mess

from the September 11, 2007 eNews issue

What do you get when you combine predatory lending practices and uninformed consumers? Simply put, you get what some financial experts are describing as "the perfect storm." More specifically, you get a nationwide housing crisis in which about one out of every 100 mortgages are expected to end in foreclosure.

From 2001 to 2005 many areas of the country experienced a "housing bubble" in which property values increased dramatically – fueled in part by low interest rates and poor (subprime) lending standards. When the increase reached unsustainable levels the bubble inevitably burst. In 2006 the housing market began to correct itself, and over the past 9 months home sales and prices have continued to fall (the drop in existing-home sales is the steepest since 1989). Because of rising interest rates, many homeowners with adjustable rate mortgages have been unable to meet their financial commitments. At the same time the decline of property values has left lenders without a means to recoup their losses.

This "perfect storm" has resulted in the collapse of the subprime mortgage industry. Since 2004 about 20 percent of all mortgages in the US have been subprime. Subprime lending is essentially the practice of making loans to borrowers with poor credit histories - usually at higher-than-average interest rates and sometimes on less than scrupulous terms. Subprime lending is considered risky, and such lenders have been accused of engaging in fraudulent and predatory lending practices - leaving many borrowers in over their heads and in danger of losing their homes.

The past two years have seen a dramatic spike in the number of homeowners facing foreclosure. The mortgage delinquency rate (the number of borrowers who are falling behind in their payments) has doubled in the last year and is expected to continue to rise. So far this year more than 355,000 homes have been repossessed nationwide and there are more than 730,000 currently facing foreclosure (some sources put this number even higher). That means well over a million homeowners will lose their homes before the year is out.

The mortgage disaster has forced many lenders and investors to tighten their belts - already tens of thousands of jobs have been cut throughout the housing industry. The country's largest mortgage lender, Countrywide Financial, announced it would cut as many as 12,000 jobs. In addition, some companies, like American Home Mortgage and New Century Financial, have filed for bankruptcy. These are just a few examples, according to BusinessWeek: "At least 25 subprime lenders, which issue mortgages to borrowers with poor credit histories, have exited the business, declared bankruptcy, announced significant losses, or put themselves up for sale. And that's just in the past few months."

The fallout from the mortgage crisis has also hit a number of commercial banks and hedge funds. Warren Spector, co-president of the Bear Stearns investment bank, was forced to resign last month following the collapse of two of the company's hedge funds. Some experts believe that this is just the beginning, one mortgage industry insider described the crisis as a "meltdown of unparalleled proportions" that would result in the loss of billions of dollars. Countrywide Financial has warned that home prices are falling "almost like never before, with the exception of the Great Depression" and that the market probably won't begin to recover until 2009.

So where does that leave us? If the United States is indeed facing a financial crisis, what should we do about it? How can we prepare for times of economic uncertainty? Chuck tackles these tough questions in his new briefing titled The Vortex Strategy (see description above).

This is the second installment in a three part series on the state of our economy. Next week we will conclude this series by examining the problem of consumer debt in America.