Subprime loans contribute to slump in U.S. housing market

PETER VIGLIETTA
News Editor

Private lenders, financial institutions and the federal government have begun to take action to moderate what The Wall Street Journal has called the worst housing slump in 40 years. A number of factors have contributed to an excess supply of housing and an increase in mortgage foreclosures.

"There is definitely an excess supply of housing, even around here. People just don't have the disposable income that they used to have," said Mike Pucci, a landlord who owns seven houses and apartments in Fredonia that he rents out to college students.

"When the banks' interest rates go up, that means insurance rates go up and eventually rates for the apartments go up."

Amar Parai, chair of the economics department at Fredonia, said a large factor contributing to the nationwide housing slump is the subprime loan business, which makes up for 21 percent of the housing market. Not to be confused with prime interest rates, subprime loans are loans given to individuals with low income and poor credit histories.

Parai said the concept of a prime or subprime borrower is similar to the concept of a credit rating. Mortgage lenders such as CountryWide and Century Financial do not market themselves as subprime lenders.

They are better known for offering mortgages to individuals who are not able to afford a mortgage due to low income, which has lead to high rates of foreclosure and an excess supply of housing.

While there are varying definitions of ‘subprime,' Parai said that anyone with a credit score of 650 or less would most likely qualify as subprime. A large factor contributing to the problem is the use of adjustable interest rates. When a customer takes out a mortgage, Parai said, the banks start with a flat interest rate and then start adjusting it after two years. For the remaining 28 years of the mortgage, the interest rate can be adjusted by more than 10 percent.

Customers often cannot keep up with spiked interest rates and have no choice but to foreclose, or pull out of the mortgage agreement.

Customers falsely overstating their income when applying for a mortgage has been another trend contributing to the slump, Parai said.

"They are overstating their income and understating their other liabilities such as credit cards and other loans in order to look better on paper," Parai said. "The problem is not only with the customers, it's with the lenders too. When they are very eager to do business aren't very vigilant and become careless in reviewing their customer's financial history."

Economic analysts such as Robert Kuttner of The American Prospect, a distinctly left-wing publication, have called for federal legislation to regulate the subprime industry. In a March 19 article from Prospect.org, Kuttner called the $1.3 trillion subprime lending business "a textbook case of why financial institutions need to be regulated to protect both consumers and the solvency of the larger economy."

An Oct. 4 article from The Hill, a publication exclusively dedicated to covering Congressional sessions, Democrats such as House Speaker Nancy Pelosi (D-CA) and Senate Majority Leader Harry Reid (D-NV) criticized the Bush administration for not implementing federal standards on the housing market in response to the housing crisis.

"If we do not act, subprime lending could end up eliminating more homeowners than it created and the number of Americans foreclosed out of their homes could exceed the number of Americans from the Gulf Coast forced out of their homes by Hurricane Katrina," Reid said. "This is unacceptable and Democrats are leading the way to do something about it."

In response to growing panic in the housing market the Federal Reserve Bank (or "the Fed") cut its interest rates .5 percent in September. This allows smaller banks to lower their interest rates, providing some cushion for mortgage lenders such as Bank of America, who issue loans to mortgage lenders like Century Financial, who in turn lend mortgages to individual consumers.

"The Fed has two major goals- [to] control inflation and to stop financial panic," said Li Feng, an economics professor at Fredonia. "I think the Fed made the right decision in lowering the interest rate because the stock market rose as soon as they did it."

Feng said that while the housing economy has shown an overall decrease, there are always pockets of isolated growth in certain parts of the country.

Laine Stewart, a local realtor in Fredonia, said that while there has been a 2.8 percent decrease in house sales in Chautauqua county since last October, the market in Fredonia itself has remained healthy.

"It all depends on the businesses in the area," Stewart says. "In Fredonia the college is the main employer, so you know that there are going to be so many new people hired every year."

Non-profit public agencies such as the Neighborhood Housing Services of America work to stabilize the housing market and revitalize communities by offering credit counseling to moderate-income homebuyers.

"If you look at the U.S. economy, the most important sector is housing," Parai said. "When a house is built, think about how many different industries go into building it and then all the things that you buy once you buy a house- furniture, TVs, cars. It is the backbone of our economy."