Tuesday, August 11, 2009

Was There A Subprime Created Crisis?

Yes, there is a mortgage crisis. Many homeowners have mortgages they cannot afford. Many have homes worth less than the mortgage. Many borrowers are defaulting on their loans. Many homes were foreclosed upon or are in foreclosure proceedings.

But was this a subprime created crisis? We know that mortgages are categorized as prime, Alt-A and subprime, with the lowest risk for prime, then Alt-A and the highest risk for subprime.

If we answer yes, then preventing a recurrence requires new regulations and industry structure that limits subprime mortgages and expanding home ownership was a mistaken goal.

If we recognize that subprimes did not cause the crisis, but instead they were just the most vulnerable that were first to feel the early effects of the recession that eventually reached the Alt-A and prime mortgages, then they were just an early warning system, a canary in a mine, and not in any way a cause of any of the housing or economy problems.

At this point, we know that this is one of the worst recessions in a very long time. The economy declined and unemployment increased much more than we expected would happen in a recession. We also know that many homeowners with low risk prime mortgages, in addition to Alt-A and subprime, are defaulting on their mortgages and are in foreclosure or were foreclosed.

Given the severity of this recession and the amount of unemployment, if subprime loans were not made, we would still have an increase in mortgage defaults and foreclosures in prime and Alt-A mortgages.

If the difference in this recession between subprime and prime is just how soon they used up their resources and started defaulting on their mortgages, then subprimes were an early warning and a not a cause of or contributor to the crisis.

Then we should not restrict subprime loans or have a consumer financial protection agency for mortgages. We should recognize that the banks did not lend unscrupulously to poor credit risks, and that expanding home ownership was not a problematic goal. Instead, the severity of the recession hit all mortgage borrowers hard. In fact, our mistake was not understanding the early signs of the subprime crisis and next time, if anything like this happens again, we will see subprimes as an early warning of further economic problems. Having outstanding subprime loans would be a valuable resource and an early economic indicator.

Why should we disable an early warning system? As renters as opposed to homeowners or as prime borrowers instead of subprime, these individuals would still lose their jobs and be unable to meet their expenses, such as rent. Unemployment would still be high and we would still be in a recession.

Instead of restricting home ownership and subprime mortgages and instead of criticizing the banks for making poor loans, let us plan for the next subprime crisis and recognize subprime loans as canaries in mines that will warn us of the next severe downturn in the economy.

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