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US Sub-Prime Mortgage Market bailed out

 
7 December 2007

The housing market slump which has been a drag on the US economy and financial markets over the last several… … months has been highlighted by the collapse of the sub-prime mortgage market.

With so many financial services companies failing or struggling and many Americans suffering with unmanageable debt, the US Government has examined options to help bail out victims of sub-prime mortgages for several months. The Mortgage Bankers Association today announced that the third quarter (July-September) foreclosure percentage of .78% of homes entering the process broke the prior quarter’s record of .65%. Delinquent mortgage payments continue to escalate, as well.

The Bush administration just finalized an agreement to freeze interest rates on certain types of sub-prime mortgages for five years. President Bush was set deliver the news of the interest rate ‘freeze’ on Thursday (December 6th). Bank regulators, lenders, and mortgage investors agreed to the non-binding deal to freeze interest rates immediately on many mortgages expected to spike in the next couple years as adjustable rates kick in. This controversial move to help offset the large amount of foreclosures linked directly to adjustable interest rate, sub-prime mortgages, has offered hope to many struggling with monthly debt.

Some believe the move is an unfair government intervention in a situation where borrowers made poor financial decisions and found themselves heaped in debt. Many Americans wonder why sub-prime and adjustable rate mortgage (ARM) borrowers deserve special aid while others have suffered through periods of higher conventional loan interest rates without assistance. The bail out is intended to assist struggling home owners, and several restrictions in the agreement are intended to block speculators and second home owners from taking advantage of the plan.

Sub-prime mortgages were developed as a credit alternative for borrowers with a mediocre credit history. The mortgages begin with introductory loan that start around seven to eight percent and after a couple years jump to around nine to eleven percent. Some ARMs see balloon payments as high as 25-30% during some years of the repayment period. Many Americans, tempted by the increased borrowing potential, used the initial rate as justification to buy bigger homes, with the mindset that by the time of the interest jumps, their incomes would increase to match. However, as is typical, many tend to increase spending in other areas as income goes up, and are unprepared for the sharp increases in monthly mortgage payments that come with the interest rate spikes.

In 2006, US foreclosures were around 1.3 million. According to RealtyTrac Inc., there were already 1.8 million foreclosures in 2007, through October. This number is expected to increase again, during 2008, lead by ARM linked foreclosures.

While many conventional loan borrowers, and wealthy Americans with manageable monthly payments, have expressed little sympathy for overwhelmed sub-prime borrowers and lenders, all home owners suffer indirectly from the effects of growing foreclosures on the already slumping housing market. While banks, mortgage investors, and consumer advocates were the catalysts pushing for a rate freeze, the slumping US housing market as a whole should benefit from a reversal of the growing foreclosure trend.

Increased foreclosures have added to an already oversupplied market, which is only beginning to see a turnaround in some areas, in terms of the quantity of existing homes listed for sale. As with any supply and demand based, free enterprise market, the decreases in home value and lack of growth in resale prices during the housing slump are directly attributable to the fact that there are more homes available than buyers looking for them. Thus, while some home owners are not faced with uncontrollable mortgage payments, most home owners should eventually benefit from reductions in foreclosures in the way of appreciated home values, due to less supply of homes on the market.

Proponents of the government intervention suggest the interest rate freeze may allow sub-prime borrowers an opportunity to catch up with payments and eventually refinance to lower rate conventional loans. This development should help jump start the housing market and increase home values nationwide, as well as boost the overall economy and financial markets, which have seen the collapse of many financial services and mortgage companies. While the ‘freeze’ plan will help less credit-risk borrowers who can manage the lower rates on their existing loans, it will not necessarily save homes for Americans with bad credit, who cannot keep up with existing rates.

Market Recap

Strong November jobs and factory order data were the catalysts for a nearly 1.5% jump in the Dow during Monday’s US stock market trading. The upbeat economic news combined with strong hopes for another Fed rate cut sparked hope in investors that the US economy may be able to overcome the ongoing housing market slump. The NASDAQ and S & P were up over 1.5% on the day as well.

In Thursday morning equity trading, mixed retail sales numbers, increased Fed rate cut hopes, and big drops in jobless claims were enough to overcome the announcement of record foreclosure rates in the US during the third quarter of 2007 (July-September). All the major indices saw minor gains in mid-morning trade with the Dow up 22 points around 11AM EST.

Neil Kokemuller is an Associate Professor of Marketing at Des Moines Area Community College in Des Moines, Iowa, USA. He has a MBA from Iowa State University with a specialization in marketing.

Neil Kokemuller
Thursday, December 6th, 2007
11:05 AM EST

Please note: The information provided in this article is intended for informational and entertainment purposes, and not as advice for financial decisions or investments. Actions taken on the basis of the information shared is at the sole risk and discretion of the individual.

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