The US sub-prime crisis in graphics - Part 1

The US sub-prime mortgage crisis has lead to plunging property prices, a slowdown in the US economy, and billions in losses by banks. It stems from a fundamental change in the way mortgages are funded. There seems to be no end to this and with the collapse of the investment banking giant Bear Stearn last week, it is believed more is to come.

It is inevitable the there is going to be a global economic crisis unlike the 1997 crash which started in the stock market, this has started in the core of the economy - Housing. In no time it will see our shores and our new cabinet has to be ready to face it. This two part article is to give us Malaysians a better understanding of this crisis preempt our government.

How it went wrong!

THE NEW MODEL OF MORTGAGE LENDING



Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do.
In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing, but it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue.

THE RISE OF THE MORTGAGE BOND MARKET

In the past five years, the private sector has dramatically expanded its role in the mortgage bond market, which had previously been dominated by government-sponsored agencies like Freddie Mac.

They specialised in new types of mortgages, such as sub-prime lending to borrowers with poor credit histories and weak documentation of income, who were shunned by the "prime" lenders like Freddie Mac.

They also included "jumbo" mortgages for properties over Freddie Mac's $417,000 (£202,000) mortgage limit.
The business proved extremely profitable for the banks, which earned a fee for each mortgage they sold on.

They urged mortgage brokers to sell more and more of these mortgages. Now the mortgage bond market is worth $6 trillion, and is the largest single part of the whole $27 trillion US bond market, bigger even than Treasury bonds.

HOW SUB-PRIME LENDING AFFECTED ONE CITY

For many years, Cleveland was the sub-prime capital of America. It was a poor, working class city, hit hard by the decline of manufacturing and sharply divided along racial lines.

Mortgage brokers focused their efforts by selling sub-prime mortgages in working class black areas where many people had achieved home ownership.

They told them that they could get cash by refinancing their homes, but often neglected to properly explain that the new sub-prime mortgages would "reset" after 2 years at double the interest rate.

The result was a wave of repossessions that blighted neighbourhoods across the city and the inner suburbs. By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting on behalf of bondholders, was the largest property owner in the city.

THE CRISIS GOES NATIONWIDE

Sub-prime lending had spread from inner-city areas right across America by 2005. By then, one in five mortgages were sub-prime, and they were particularly popular among recent immigrants trying to buy a home for the first time in the "hot" housing markets of Southern California, Arizona, Nevada, and the suburbs of Washington, DC and New York City.

House prices were high, and it was difficult to become an owner-occupier without moving to the very edge of the metropolitan area. But these mortgages had a much higher rate of repossession than conventional mortgages because they were adjustable rate mortgages (ARMs).

The payments were fixed for two years, and then became both higher and dependent on the level of Fed interest rates, which also rose substantially. Consequently, a wave of repossessions is sweeping America as many of these mortgages reset to higher rates in the next two years. And it is likely that as many as two million families will be evicted from their homes as their cases make their way through the courts.

The Bush administration is pushing the industry to renegotiate rather than repossess where possible, but mortgage companies are being overwhelmed by a tidal wave of cases.

NEXT: THE HOUSING PRICE CRASH