For almost a year the chief concern for the global economy has been the much-publicised meltdown in the US sub-prime mortgage market. In short, a sub-prime loan is a term that refers to a loan made to borrowers who do not qualify for market interest rates because of problems with their credit history.
The story began in late 2006, when the amount of sub-prime mortgage foreclosures rose sharply (said to be currently 11%!). The answer to the question of who was to blame for the “meltdown” was, in true economist form, different for each person asked.
Generally, it is accepted that the meltdown was due to a number of factors:
- predatory practices of sub-prime lenders
- appraisers inflating housing values to cash in on the housing bubble, and
- naïve borrowers. By March 2007, over 20 separate sub-prime mortgage lenders had failed or filed for bankruptcy.
Considered by most to be the main driver behind the recent slowdown in the US economy, the real question is to what extent the sub-prime mortgage meltdown will “spillover” into the rest of the economy. The answer, according to US Fed chief Ben Bernanke, is not at all.
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In a speech made at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition, in Chicago, Bernanke was still positive about the benefits that the sub-prime mortgage lenders had brought to the economy:
Credit market innovations have expanded opportunities for many households. Markets can overshoot, but, ultimately, market forces also work to rein in excesses. For some, the self-correcting pullback may seem too late and too severe. But I believe that, in the long run, markets are better than regulators at allocating credit.
Bernanke was also optimistic that a spillover will not occur:
We have spent a bit of time evaluating the financial implications of the sub-prime issues, tried to assess the magnitude of losses, and tried to determine how concentrated they are … the financial system will absorb the losses from the sub-prime mortgage problems without serious problems.
Effectively, Bernanke is arguing “Sure, people got bad mortgages. But others were able to finally buy a home”.
While Henry would not disagree with such a noted guru, he is not without his opponents. Predatory lending opponents the Centre for Responsible Lending assert that sub-prime lending has been a net drain on home ownership.
The CRL argue that the reason for this net loss is that from 1998-2006, only 9% of sub-prime loans went to first-time home buyers, but over 15% of sub-prime loans ended (or will end) with borrowers losing their homes through foreclosure.
While it is still unclear the impact that the sub-prime mortgage will have on the macro level, with delinquencies currently running at 11%, there has been obvious significant pain on the micro level, which is made even more noteworthy due to the fact those suffering are the people who can least afford it.
Read more at Henry Thornton.