Amid rising home foreclosures and growing delinquencies on subprime home mortgages extended to less creditworthy borrowers across the country, a key Senate Banking Committee panel today examines how a huge but little understood secondary marketplace in home mortgages helped fuel the great American housing boom over the past decade.
The decision by the Senate Banking Subcommittee on Securities, Insurance and Investment to hold hearings Tuesday on the securitization and sale of home mortgages to institutional investors worldwide comes just as the Federal Reserve Board summons a number of Wall Street executives to Washington to discuss this same topic. In addition, other federal banking regulators are signaling to lenders that they should consider refinancing options for some subprime borrowers—even if those subprime loans were sold to other investors in the secondary market.
This focus on the role of securitization in the boom in mortgages over the past few years should help policymakers and regulators to understand the forces that fueled the growth of the subprime market and the irresponsible terms upon which some mortgages were originated.
Our nation’s sophisticated financial markets—including secondary markets that provide liquidity and assign risk to those market participants best able to bear it —are a boon to mortgage borrowers and lenders alike. Packaging mortgages into tradeable securities to sell to institutional investors worldwide helps build homeownership in the United States.
The creation of a sophisticated secondary market for subprime loans was a welcome development to those who long advocated expanding access to credit to more low- and moderate-income families and to first-time homebuyers, giving them the potential for wealth accumulation and economic mobility others have long enjoyed.
Problems arose in the subprime mortgage marketplace, however, when overeager mortgage brokers and lenders extended new home loans to some borrowers on predatory terms. At times, borrowers were enticed to borrow money when it was clear they had no capacity to repay. Many of these subprime loans required no underlying income documentation. Many more boast adjustable interest rates that could jump sharply to levels that the borrowers could not repay.
Some of these loans were extended on predatory terms by mortgage brokers and lenders who knew they could package and sell these mortgages into the secondary marketplace to institutional investors looking for higher returns on more risky securities. What’s worse, some of these predatory loans included unnecessary and exploitive fees and other costs that borrowers bear even when they can afford to make their loan payments.
Congress needs to ensure such predatory lending is no longer possible in American mortgage markets. New consumer protection legislation for borrowers is urgently needed.
But Congress’ first order of business ought to be even more critical legislation to help some of the existing homeowners caught in subprime loans destined for foreclosures. Last year saw a 42 percent increase in the number of foreclosure filings, and in the subprime market alone 2.2 million families are currently in danger of losing their homes.
With spending on new homes and home improvements also seeing its sharpest decline in 15 years, the housing market is in danger of further downturn if an influx of foreclosed homes floods the market. This downturn could hurt lower- and middle-income homeowners who need to relocate for new jobs, or retirees who need to buy smaller homes to cope with other daily costs, and could hit less affluent communities particularly hard given the higher level of subprime mortgages in these neighborhoods.
This is why Congress needs to act immediately by passing legislation that would help state and local authorities help some of these homeowners in danger of losing their homes. While we cannot avoid the personal and broader economic consequences of unsustainable loans already on the books, we can help prevent some foreclosures, help communities to deal with the impact of concentrated defaults, and ensure credit continues to flow to impacted communities.
The Center for American Progress earlier this year released a report that outlines effective avenues for policy action, including:
- Providing federal grants to expand and enhance current mortgage assistance and foreclosure prevention programs and low-interest mortgage assistance to eligible borrowers.
- Allotting federal funds to target key cities and states facing the highest risk of mass foreclosure.
- Including provisions to ensure federal agencies assess the effectiveness of each program every three years.
- Strengthening programs that aid families while their mortgage contracts are renegotiated or the property is sold on the market so that the homeowners’ credit ratings are salvaged, allowing for the possibility of future homeownership.
Finally, Congress should also consider whether the Federal Housing Administration, which has been marginalized by its outmoded programs and limited capacity, should be revitalized to play an important countercyclical role in maintaining the flow of credit to communities worst hit by foreclosures. As Congress prepares to help homeowners in danger of losing their homes, ensures credit continues to flow, and prevents further predatory lending, senators and representatives also should take some time to better understand how secondary markets in home mortgages worked in practice over the past several years. These are very sophisticated markets with sophisticated investors.
A good question to ask is why investors were willing to purchase mortgage-backed securities backed by loans—a portion of which were (on their face) not sustainable. Why didn’t market signals prevent these originations? What incentives exist in the system to overwhelm any reasonable limitations lenders might have considered?
Congressional policymakers and financial regulators need to understand how the dynamics of these critical marketplaces affect homeownership in America. Many lower- and moderate-income families, hampered by low-wage growth and rising personal debt, never fully shared in the benefits of economic growth over the past few years. But many did achieve the dream of homeownership. Without action from Congress and regulators, the American dream for some of these homeowners could be lost and remain forever out of reach.
For more information on the Center for American Progress’ take on the housing market, see:
- From Boom to Bust: Helping Families Prepare for the Rise in Subprime Mortgage Foreclosures, by Almas Sayeed
- The End of the Great American Housing Boom, by Christian E. Weller
- Subprime Market—Isolated or a Tipping Point? by Gene Sperling
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