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Predatory Lending in the US and European Welfare Recipients: US Federal Reserve Board: Predatory Lending is a major Cause for the Subprime Crisis or
Why German Welfare Recipients stabilise the Profit Margins of Predatory Lenders in the US

American subprime lenders sold their high interest portfolios of mortage loans to investors all over the world who like the Saxon German Public Bank (SachsenLB) even borrowed about 20 billion € from other banks to buy these papers with a high yield so that they could pretend profitability. The fantastic dream of country side bankers to become rich by borrowing at a lower rate than the return of the investment has turned into a German nightmare.

Meantime the State of Saxony has sold this bank to the Baden-Wurttemberg public bank not only without any return on the money it spend on this quite new public investment bank but by throwing about 3 billion € in tax payers money after this sale.

This money will be taken from the budget of a German State who was part of the former GDR and has an unemployment rate of still close to 20%. Many people live on welfare and poverty is well known in this area. The 3 Billion abount to about 20% of the total budget. All public spending which is not directly linked to federal law will therefore see a dramatical reduction. This will cut deeply into the chances of welfare recipients and especially children in this part of Germany just as it has been the case after the 7 billion € bailout of the State of Berlin for the Berliner Bankgesellschaft a few years ago. Experts estimate that much more money will be necessary in the future.

This occurs at a time where Germany discusses already for two years whether it can afford the 3 billion € necessary to provide sufficient day care for poor children in Germany while in a few days the same sum is spend for this bank.

Why can this bank not go bankrupt which would not burden the weakest in society with the criminal or just speculative behaviour of the well-off? Some see the reason in the structure of public banks. But this is not true. Since two years thanks to the EU the state is no longer allowed to guarantee his public Landesbanken which always gave them a triple AAA rating regardless how corrupt they acted. This would have allowed a straight bankruptcy procedure for this bank if the State of Saxony just like before the State of Berlin had not made secret contracts in which they still promise such a guarantee. According to insiders the German banking industry was well aware of this responsibility and seemed to have dumped a lot of financial trash into these wholes which rating agencies welcomed as a save haven.

But as the Northern Rock crisis in the UK proves the whole thing has nothing to do with public or private banks. Too big to fail or just "banks never fail" has become a dogma under which states and social budgets have been taken hostage by private investors since the S & L crisis in the US, the Norvegian, Finnish, Japanese or Canadian bank crisis.


Indeed the bankruptcy of banks affects the whole financial system and trust of a country. This is why the ordinary bankruptcy procedures are inadequate and it is easy to show that they are inapplicable. What we need at any rate is a bankruptcy system for banks that punishes those who have caused the collapse of a bank and helps all those who did and still want to do decent business. It should especially spare the State from spending throwing good tax payers' money after the fictious bad money in the books of the bank.


There is a chain reaction from predatory lending to German welfare recipients. The American subprime crisis is not an accident but a well calculated transfer of such money into the pockets of irresponsible lenders.

Predatory lending practices possible in the US due to the very weak standards of its respective consumer protection legislation and the enormous freedom usury gets in this market have created an enormous amount people who through refinancing and extra credit were pushed into variable rate credit often with a three years initial low interest period which then faced bankruptcy. Such lending practices were profitable because the generators of such loans new that they could sell the irresponsible package of loans to equally irresponsible investors who looked only at the promised profit margins hoping to sell the portfolio before it went wrong. A heated circuit of credit sales went around the world.

Small banks all over the world saw a good opportunity to hide their low profitability through this form of gambling. Bank authorities even eased such transactions and the German legislator pushed by the banking industry constantly lowered the standards for such transactions to "remain a part of the global finance circus". The big players all made enormous profits and many managed to sell the risks to others and even households as a pension investment.


We can cite a crown witness the head of the Federal Reserve Board, the US Central Bank, for this analysis. In his speech delivered on May 2007 to bankers in Chicago on the subprime loan crisis he said among others:


"The Recent Problems in the Subprime Mortgage Sector With this background in mind, I turn now to the recent problems in the subprime mortgage sector. In general, mortgage credit quality has been very solid in recent years. However, that statement is no longer true of subprime mortgages with adjustable interest rates, which currently account for about two-thirds of subprime first-lien mortgages or about 9 percent of all first-lien mortgages outstanding. For these mortgages, the rate of serious delinquencies--corresponding to mortgages in foreclosure or with payments ninety days or more overdue--rose sharply during 2006 and recently stood at about 11 percent, about double the recent low seen in mid-2005.3 The rate of serious delinquencies has also risen somewhat among some types of near-prime mortgages, although the rate in that category remains much lower than the rate in the subprime market. The rise in delinquencies has begun to show through to foreclosures. In the fourth quarter of 2006, about 310,000 foreclosure proceedings were initiated, whereas for the preceding two years the quarterly average was roughly 230,000.4 Subprime mortgages accounted for more than half of the foreclosures started in the fourth quarter.


"The practices of some mortgage originators have also contributed to the problems in the subprime sector. As the underlying pace of mortgage originations began to slow, but with investor demand for securities with high yields still strong, some lenders evidently loosened underwriting standards. So-called risk-layering--combining weak borrower credit histories with other risk factors, such as incomplete income documentation or very high cumulative loan-to-value ratios--became more common. These looser standards were likely an important source of the pronounced rise in "early payment defaults"--defaults occurring within a few months of origination--among subprime ARMs, especially those originated in 2006."


"Although the development of the secondary market has had great benefits for mortgage-market participants, as I noted earlier, in this episode the practice of selling mortgages to investors may have contributed to the weakening of underwriting standards. Depending on the terms of the sale, when an originator sells a loan and its servicing rights, the risks (including, of course, any risks associated with poor underwriting) are largely passed on to the investors rather than being borne primarily by the company that originated the loan. In addition, incentive structures that tied originator revenue to the number of loans closed made increasing loan volume, rather than ensuring quality, the objective of some lenders. Investors normally have the right to put early-payment-default loans back to the originator, and one might expect such provisions to exert some discipline on the underwriting process."


Chairman Ben S. Bernanke proposes four ways how to cope with this crisis which are not only part of the seven principles of responsible credit as promoted by ECRC but even address the necessity to have such principles.

Bernanke enumerates these ways as follows:

Broadly speaking, financial regulators have four types of tools to protect consumers and to promote safe and sound underwriting practices.

First, they can require disclosures by lenders that help consumers make informed choices.

Second, they can prohibit clearly abusive practices through appropriate rules.

Third, they can offer principles-based guidance combined with supervisory oversight.

Finally, regulators can take less formal steps, such as working with industry participants to establish and encourage best practices or supporting counseling and financial education for potential borrowers."

We should add that his first idea "working with industry" only seems a bit strange of a representative of the public good. It was the industry who developed the subprime market. Why does he not reflect about the chances to speak with those who represent the victims of this system: the American home owners, the poor and the welfare recipients of Saxony in Germany. Our Global Fair Finance Initiative could also be a valuable interlocutor.

ID: 40708
Author(s): UR
Publication date: 28/01/08

Chairman Ben S. Bernanke on the Subprime Mortgage Market

Created: 20/12/07. Last changed: 06/02/08.
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