Background

• The term "subprime lending" refers to the practice of loaning to borrowers who would not otherwise qualify for market interest rates because of poor credit history, income level, employment status, or other factors. Since the risk for lenders is greater in with subprime borrowers, the lender will charge a premium. Higher interest rates most commonly paired with fixed-term loans and mortgages.
• Subprime lending became popular in the U.S. in the mid-1990s, and by 2006, 20% of all mortgages originated that year were considered to be subprime. Before then, banks could only lend the cash their customers deposited. To increase their lending capacity, banks have begun to sell on the mortgages to the bond markets. With every mortgage, the bank produced a profit. Thus, banks had less incentive to vet the wherewithal of their borrowers.
• Additionally, banks were removed from the risk of lowering their lending standards through the process of securitization, the bundling of numerous loans into assets that are sold to investors. As investors began churning a profit in the booming housing market, demand soared for higher-yielding securities. These could only be created with more subprime loans.
• One other component to the housing boom and bust was the credit rating agencies, which evaluate a number of mortgage-related securities. As the subprime mortgage crisis unfolded, it became clear that credit agencies had indicated risk profiles were much lower than they actually were. Since rating agencies are paid by the firms that organize and sell the debt to investors, they made huge profits from the subprime lending trend over the past 10 years (Source: The Economist).
• By 2005, one in five mortgages were sub-prime. In the 1990s and through the mid-2000s, lenders began aggressively promoting Adjustable Rate Mortgages (ARMs) as alternatives to conventional fixed-rate mortgages. ARMs have variable interest rates that that are linked to current prevailing interest rates. The payments are fixed for two years, and then become dependent on the interest rates set by the Fed. Many lenders enticed borrowers by offering low introductory, or “teaser”, rates. Subprime mortgages swelled to record numbers while interest rates rose substantially. Many borrowers began defaulting on their loans and a wave of repossessions swept the country.
• Experts are predicting that as many as two million families will be evicted from their homes.
• The wave of repossessions is causing the first national decline in house prices since the 1930s, at a rate of 4.5%. Four million unsold homes are depressing housing prices and builders have also been forced to lower prices to get rid of unsold properties. Housing prices are expected to fall by at least 10% by 2009 and more in "hot" real estate markets.
• Banks and other lenders are tightening credit by rejecting more credit card applications and loans. Non-traditional mortgages are increasingly difficult to secure as well. Banks have already announced $60bn worth of losses as the value of mortgage bonds backed by sub-prime mortgags have fallen. Most are worth between 20% and 40% of their original value.
• Lending institutions will lose an estimated $220bn to $450bn. Since the credit markets froze, state-backed mortgage lending giants Fannie Mae and Freddie Mac have regained their central role in mortgage finance after losing significant market share to investment banks during the housing boom. Frannie and Freddie have issued the majority of mortgage securities sold since the credit crunch began because investors have lost confidence in big investment banks (Source: NY Times).

legislation

Bush Administration

• In Dec 2007, President Bush and Treasury Secretary Henry Paulson announced a foreclosure relief plan for approximately 1.2 million Americans who have been hit hardest by the crisis. The plan targets those who will be unable to make mortgage payments at higher interest rates and includes a five year freeze on interest rates for certain borrowers with adjustable rate mortgages resetting early in 2008. It excludes individuals who are more than 30 days late at the time the plan is implemented or have been more than 60 days late at any time within the previous 12 months. The plan has been widely criticized for excluding less than hald of the adjustable rate mortgages that are expected to reset over the next two years.(Source: CNN Money)
• The Bush administration previously said it would oppose proposals to help troubled homeowners as long as they shift the burden of the bailout onto tax payers. It has since supported the House and Senate proposals because they found a way to eliminate costs to taxpayers and they contain the tighter regulation of the mortgage finance companies that Bush has sought for years (Source: NY Times).

Frank-Dodd

• Representative Barney Frank (D-Mass.) proposed a bill that would guarantee $300 billion in new, cheaper loans. The legislation allows the government to step in and rescues the two mortgage giants Fannie Mae and Freddie Mac, who own or guarantee about $5.2 trillion of the nation’s $12 trillion in mortgages. (Source: NY Times)

• A similar Senate bill, backed by Senator Chris Dodd (D-Conn) would provide $400 billion in guarantees. The Senate Banking Committee approved legislation to help homeowners refinance loans, thus stabilizing the housing market, without reaching into taxpayers' pockets. Fannie Mae and Freddie Mac would be required to contribute to a fund that the government would use to back troubled loans. (Source: NY Times)

Debate

• House Republicans were split over their support for Frank's bill (which the president endorsed). Republicans said they would not support a bill that puts taxpayer money at risk while potentially bailing out irresponsible borrowers and greedy lenders (Source: NY Times).

• Some have argues that Frank's bill, which serves as a mortgage insurer, could put the government at risk of significant losses if borrowers default on their new, lower debt (Source: NY Times).

• Democrats argue this sweeping legislation is necessary to slow foreclosures, stabilize markets,

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