Is Subprime Lending to Blame For America's Economic Mess?
Beginning in late 2006, Americans began to hear news of a weakening real estate market and the expected collapse of the sub-prime lending market. More currently the news is reporting that the American economy in general is in trouble and we are headed for a recession. Most of the reports on the American economy go back to the sub-prime lending market and the increase in sub-prime delinquencies and foreclosures as the reason for the decline in our economy. Many say that, as a result of the collapse of the sub-prime market, companies have been forced into bankruptcy, the housing market has collapsed, and the American economy has suffered. But can this one market be blamed for the
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Borrowers who could not qualify for a prime loan with a traditional lender were offered many different risk-based mortgage products based upon their credit history and down payment availability. These products included fixed rate mortgages with a higher overall interest rate, mortgages with no down payment, interest only mortgages, and adjustable rate mortgages with an initially low interest rate and corresponding low monthly payment, but over time the interest rate increases to a rate well above prime. The needs for sub-prime products grew as the American housing market grew. From 1998 through 2005, home prices in certain areas of the country increased significantly. Prior to 1998, home prices had increased proportionally with the overall rate of inflation. But through 2005, home prices increased 60 percentage points greater than inflation. During the increase in the housing market, everyone was trying to get a piece of the mortgage market. Not only were some buyers able to purchase for the first time, but existing homeowners saw the value of their homes increase dramatically, spurring them to refinance to take equity out, or flip homes to make quick money.
The reason the housing market was so attractive to many the Federal Reserve kept the federal funds rate below 3 percent from 2001 through mid-2005 in order to keep the U.S. economy on an upswing. The low interest rate encouraged borrowers to take