| EU Commission on the Reasons of the Subprime Crisis: Irresponsible Borrowing and Intransparent MBS Markets |
In its FinFocus Infoletter No 4 2007 addressed especially to a broad audience and issued on December 2007 the European Commission gives its view of the subprime mortgage crisis.
FIN-FOCUS Newsletter
"US sub-prime mortgage crisis – does it affect Europe?
How did the crisis start?
The sub-prime mortgage financial crisis began in the United States in 2006. Loans were made to borrowers with weaker credit histories, who would not normally qualify for a standard mortgage. Unfortunately a fall in US house prices meant that many home owners were now unable to meet their financial commitments, and as such, there was a sharp increase in the number of foreclosures in the sub-prime mortgage market. These circumstances led to several major subprime mortgage lenders to either close or file for bankruptcy."
COMMENT
From the Chairman of the Federal Reserve Board in our previous news we learned that the crisis did start much earlier than 2006. It was the effect of irresponsible lending practices in which consumers were pressured into variable rate credit which promised low instalments in the first years. This made them vulnerable to sudden increase in interest rates.
A drop in house prices alone is no explanation. Lower prices for those who buy houses mean they would need less credit and less credit means lower instalments and lower instalment more ability to pay. Not the consumer but the banks were affected by the drop in house prices but were able to shift the problem to the consumer side. The banks lost security in their loans and then pressured consumers to pay higher interest to compensate for the increased risk. In one NPL fund cited by Sueddeutsche Zeitung today less than 1% equity existed in the loans.
Have borrowers been overcommitted and did they take up too much credit? The increase in homeownership in the US was only 4% in the last years while the default rates in usurious credit products has skyrocket to about 11%. It were consumers who had already financed their homes long ago who became victim to the crisis.
Predatory lending creates risky assets. This is why the FED does not want to cure it with measures to reduce lending but improve the quality of the credit products.
The EU should take this as an example and reflect how well they used the chance given by the reform of the Consumer Credit Directive to attack the problems of predatory lending which are visible in this crisis. We experienced just the other way round: deregulated consumer credit markets are said to cure all problems: lower prices and better access. What we presently face it the opposite: higher prices and less access if the regulator does not limit the way how credit is extended.
"WHY DOES THIS EFFECT US IN EUROPE?
Different from the FED the EU-Commission does not like to tell that the creation of markets for securitised non-performing-loans by speculators has not only caused a drain to create more bad credit but also hinders to rearrange credit relations in default.
Instead the Commission explains the problems of this market with lack of information and globalisation. It writes:
"The answer lies in the extent to which the global financial markets are inter-connected.
Traditionally the risk of someone defaulting on a home loan, the credit risk, was held by the company who issued the loan – traditionally a bank. However, through securitisation, the credit risk associated with these sub-prime mortgages was transferred to the wider financial markets, including to European investors. Once there were foreclosures on sub-prime mortgages in the US, there were no longer mortgage repayments to cover these loans, which made the sub-prime mortgage backed securities lose value. A further problem was that nobody actually knew where the asset-backed securities were located in the market, only that the investors were spread across the globe. This uncertainty made the global financial markets highly volatile and cautious. As a result, credit became more difficult to obtain. The US-specific sub-prime mortgage crisis had now become a world-wide financial crisis."
COMMENT
We doubt that securitization is the cause of the crisis. In the US nearly the mortgage market is securitized for at last 50 years. This did not cause problems. It was the unholy triangle of loan sharks and financial speculators together with a neo-liberal regulator which created bad loans.
CONCLUSION
There is only one solution to the problem and this is a long term sustainable solution: create better credit at the lowest level. Frame the market for mortgages and consumer credit by legislation that forbids usury, exploitation, gambling with consumers’ income etc. Rate ceilings, regulation of rate caps for variable interest rates and minimum standards against luring consumers into risky debt.
Where usurious credit is allowed it creates not only adverse social consequences for the consumers but for all in society worldwide.
Information and transparency comes too late after such credit has been created. |
| ID: |
40725 |
| Author(s): |
UR |
| Publication date: |
20/12/07 |
|
|
|
|
| | |
Created: 21/12/07. Last changed: 14/05/08.
Information concerning property and copy right of the content will be given by the Institut For Financial Services (IFF) on demand. A lack of explicit information on this web site does not imply any right for free usage of any content. |
