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Subprime mortgage crisis

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The financial crisis otherwise known as the subprime mortgage crisis began in July of 2008. Over 3.1 million foreclosures were filed during this period and hundreds of banks were bailed out due to faulty practices. Although many date the crisis as beginning in July of 2008, the determining conditions of the crash truly took form years earlier when mortgage lenders relaxed the qualifications needed by an individual to obtain loans from banks to pay for home mortgages. After the financial crisis of 2008 many rules and regulations were set in place in order to prevent this catastrophic event from happening again.
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The Dodd-Frank act set in place by president Obama was among one of these rules and regulations. This allowed society to better understand the cost of a mortgage and the responsibility they were taking on when obtaining these loans in a concise document. The relaxation of qualifications, the impact on members of society, and the roles of the banks during this economic downturn help put into perspective the magnitude of this crisis and the impact it had on societies financial well being.
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The lenders justified this relaxation of qualification to obtain these subprime loans (also known by the names of near prime, non-prime, or second chance loans) by setting higher interest rates for the more "risky" customer according to John V. Duca, the Vice President and Associate Director of Research at the Federal Reserve. The subprime loans were PMBS loans or Probated- label Mortgage back securities, meaning they do not have government backing and were no longer considered "safe".
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This allowed for those who once did not meet the guidelines to obtain loans from these mortgage lenders to now have that accessibility and become homeowners. Banking firms, however, profited from the extending these dubious loans by selling these toxic assets that would be meaningless to the buyer. The planet money team of NPR (national public radio) purchased one of these toxic assets and tracked its process. The planet money team tracked the process by region, time period, and the delinquent and foreclosure rates of this period.
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The lending process implemented by the lenders did not harm any of the lenders at first because the housing market was on the rise. If an individual did not pay back the interest and loan payment because they financially were not able to then the firm that issued that loan would foreclose the house and now sell the house at fair market value allowing the firm to gain a profit from the selling of this house as well as the previous payments made on the house.
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The rise in the housing market allowed for these profits to be made and can be attributed to the housing bubble of this period. "The Housing bubble is a run-up in housing prices fueled by demand, speculation and the belief that recent history is an infallible forecast of the future. Housing bubbles usually start with an increase in demand (a shift to the right in the demand curve), in the face of limited supply which takes a relatively long period of time to replenish and increase" according to a well acclaimed financial analysis site, Investopedia.
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Leading up to what we call subprime loans, many events in history took place, one of the most notable being the great depression. During this period roughly 1/10 of all home faced foreclosure. In the 1970s the Federal Home Loan Mortgage Corporation took form and encouraged home ownership. This lead to arise in home ownership but with this rise came the more risky loans being issued due to the reliance on the market to keep steadily increasing.
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The subprime loans were of these risky loans that were obtained. In order to be compensated for this higher risk that is taken on when granting these loans higher interest rates were set on these loans. Those that do not have the financial standing that others have (lower income customers vs. higher income customers) have to take on these greater interest rates in order to obtain these loans. The riskier customers may have a more difficult time following the repayment schedule, which warrants the higher interest rates, but not how the banks orchestrated these efforts.
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Banks such as Wells Fargo, Goldman Sachs Group, Bank of America, JP Morgan Chase, as well as others were among the offenders. These banks took advantage of society by encouraging subprime mortgages in order to earn these higher interest rates knowing the market would cover the firms if these loans were unable to be repaid.
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Florida: An Illustrative Case Study
This crisis affected many people across America. States such as Florida, Nevada, California, and Arizona are the ones dramatically affected by the foreclosure rates that occurred when the financial crisis began. In the beginning of 2008 the foreclosure rates rose a drastic 81% according to John V. Duca. These foreclosure rates were especially pronounced in Florida where, in Fort Meyers, 1 in every 84 houses received a foreclosure filing. This is 6.7 times the national average. It was devastating for all neighborhoods. If a house within any particular neighborhood foreclosed, the market value for all of the houses in that neighborhood declined.
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Once one house foreclosed in a neighborhood a ripple affect occurred dropping the value of all houses in the neighborhood. Herd Immunity and the reliance of community members to make housing payments in order to keep the neighborhood's housing value up is an important concept that Eula Biss's talks about in her book "On Immunity". In order for the community to prosper it all members need to in this case stay up on their payments and keep the foreclosures in neighborhoods low.
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Unfortunately with the practices of the banks and such high interest rates paired with a declining market this was hard to maintain. Houses began to foreclose and advanced the decline in the market value of houses. The decline in market value of homes lead to a greater number of Floridians owing more on their houses than the market value of those houses. Homeowner's loans going "underwater" lead to many people either failing or refusing to pay their mortgage payments because they lost a significant amount already. Other homebuyers came in and tried taking over these homes, but banks were under investigation and were very hesitant on making any loans.
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George Packer's New Yorker article "The Ponzi State" he recounts, "Liquidity dried up and the market was in a holding pattern." Projects were stopped in the middle of progress with no one to pay to finish them. George Packer also states that, "A loss of confidence became ingrained in homeowners and the industry itself. City skylines filled with unfinished condo high rises. The "see-through" buildings became emblems, monuments to the financial decay that had set in."
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As Packer suggests, in addition to the crisis affecting homeowners who remained trapped in depreciating properties, it likewise affected the construction industry, in particular, construction workers and contractors who built these homes. People began to be laid off and work started to diminish. With no homes being built and foreclosure starting to rise this declined the value of the housing market.
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With this decline the once safe guarded lenders who were selling houses at a premium to cover the risky lending process no longer were protected and began to lose money rapidly. This hit the banks and financial corporations giving out these loans extremely hard as they were losing money at an extreme pace.
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The Federal Reserve history shows that many banks and financial corporations filed for bankruptcy after this crisis hit one of these being New Century Corporation. In 2007 "New Century Financial Corp., a leading subprime mortgage lender, filed for bankruptcy. Shortly thereafter, large numbers of PMBS and PMBS-backed securities were downgraded to high risk, and several subprime lenders closed. " PMBS stands for Private-label Mortgage backed securities. This meaning they do not have government backing which in turn makes these securities obtain a much higher risk than normal or "safe" mortgage back securities by individuals who have the financial standing to pay off these loans obtained.
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TARP and the Bank Bailout:
When the financial crisis hit the government decided to take action and bail out the big banks that filed for bankruptcy. The law that was set in place was the emergency stabilization act of 2008. This act supplied around 700 billion dollars to banks in trade for these mortgage back securities in order to bail out these banks from the bankruptcy that they faced.
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On October 28th of 2008 multiple big named banks were bailed out including: Wells Fargo (25 billion dollars), State Street Corp (2 billion), Bank of America (20 billion), JP Morgan Chase & Co. (25 billion), Citi Group (25 billion), Goldman Sachs Group Inc. (10 billion), Morgan Stanley (10 billion), along with many others according to Matthew Ericson and Amy Schoenfeld of the New York Times. Many of these big banks have paid back these treasuries, but Wells Fargo and Citi Group are among banks that have not fully paid back these treasuries yet.
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Wells Fargo and other firms were criticized and sued for encouraging loan officers to target the city of Baltimore Maryland and forced upon them these subprime mortgages that they knew were unlikely to be paid back. Ms. Jacobson, a subprime loan officer at Wells Fargo said that the firm saw this as a "fertile ground for subprime mortgages". Loan officers took advantage of this predominately African American city in Maryland.
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In an article written by Michael Powell on the targeting of this Baltimore community he illustrates, "Wells Fargo mortgage had an emerging-markets unit that specifically targeted black churches, because it figured church leaders had a lot of influence and could convince congregants to take out subprime loans" (Powell). After leaving the company Ms. Jacobson provided the first details into racial steering orchestrated by Wells Fargo towards this section of Maryland.
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A Wells Fargo spokesperson refuted these remarks and went on to say that only "one percent of the cities 33 thousand foreclosures have come from Wells Fargo mortgages" (Powell). They do not view this issue as targeting but rather focusing their efforts on African American borrowers in order to make homeownership possible for those of that ethnic background that strive for this goal. This issue branches beyond Wells Fargo though, "the N.A.A.C.P has filed a class-action lawsuit charging systematic racial discrimination by more than a dozen banks."
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The New York Times released an analysis on this issue and the results were black households that collectively made around 68,000 dollars were five times as likely to hold high interest subprime mortgages as those of the same financial positioning and sometimes even lower financial positioning that were predominantly white. Mr. Paschal a black loan officer at Wells Fargo offers his input on this topic and the strategy taken by Wells Fargo. "In 2001 he states in his affidavit, Wells Fargo created a unit in the mid-Atlantic region to push expensive refinancing loans on black customers, particularly those living in Baltimore, southeast Washington and Prince George's County, Maryland."
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The loans made in these locations were referred to as "ghetto loans" and the people receiving these loans were minority customers, "those people have bad credit", "those people don't pay their bills" and "mud people" was what Mr. Paschal stated in his affidavit. Ghetto loans are paired with the red lining practices during this time. Red lining is a practice of denying people of certain ethnic backgrounds such as Latino and Black citizens from obtaining home loans in particular areas that are concentrated with those ethnic backgrounds.
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An African American marketing group at Wells Fargo was hired to call predominantly African American churches on the topic of these loans because they believed that church leaders had a higher influence or impact on the community than cold calling them might. This shows the corrupt nature of these banks and the direct action they were pursuing on the community.
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Incentives were received notes Paschal when loan officers pressured subprime mortgages on the people of this community. Bonuses were in fact distributed for loan officers who referred barrowers from the prime division to that of the subprime division. Ms. Jacobson states that in one year alone she received upwards 700 thousand dollars for these referrals. Methods other than the one mentioned were used to direct personnel towards subprime loans. This was done by falsely telling the underwriting department that a lack of documentation on the income was provided by the client even if they were in good financial standing. This in turn switched what would have been a prime loan to that of a subprime loan.
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A figure was used in this article to express the impact of this change from prime to a subprime loan. "For a homeowner taking out a 165 thousand dollar mortgage, a difference of three percentage points in the loan rate- a typical spread between conventional and subprime loans- adds more than 100 thousand dollars in interest payments." This puts interest rates in perspective and shows how what seems to be a slight increase in the percentage points in the loan rate can have a tremendous impact on the overall payment of this subprime mortgage package. City Solicitor George Nilson states the obvious, "this behavior was explicit" they intentionally did this as an act of self-interest. It is sad to see how profound affect this had on many Americans because of the selfish acts of individuals at banks like Wells Fargo. The discriminatory acts of Wells Fargo lead to a court case hearing in June of 2009 between the City of Baltimore Maryland and Wells Fargo. The verdict was a settlement of 175 million dollars "recognizing discrimination by effect as well as intent" reported Luke Broadwater, journalist for The Baltimore Sun.
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City Solicitor George Nilson states the obvious, "this behavior was explicit" they intentionally did this as an act of self-interest. It is sad to see how profound affect this had on many Americans because of the selfish acts of individuals at banks like Wells Fargo. The discriminatory acts of Wells Fargo lead to a court case hearing in June of 2009 between the City of Baltimore Maryland and Wells Fargo. The verdict was a settlement of 175 million dollars "recognizing discrimination by effect as well as intent" reported Luke Broadwater, journalist for The Baltimore Sun.
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Changes need to be made in order to better illustrate the loans that were being taken on by the lower income individuals. One of the changes that was erected was they Dodd-Frank act. This act is set in place to prevent risk taking. Taxpayers are now not responsible for the actions of the firms and will not be responsible to bail them out, but rather Wall Street and these firms will be held accountable.
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The Consumer Financial Protection Bureau was created to better protect people from these bad practices that took place leading up to the 2008 financial crisis. Not all people know what they will be encountering when obtaining these loans so rules and regulations should be continually added to the financial lending system in order to set guidelines for which lenders must follow while offering loans to all classes of people.
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This will allow the bureau to protect the individuals from these bad practices and gives them the knowledge necessary before diving head first into a loan agreement. The Know Before you Owe program has been implemented by the CFPB to condense the overwhelming stack of papers received when acquiring a mortgage into a simpler document that explains the cost and risks of a loan in a more concise and clear manor.
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Knowledge is the key to many issues in society and if society can gain knowledge before issues such as the subprime mortgage occur this will limit economic downturns of society such as this one. Recognizing these issues and trying to implement strategies for the future, which will deter problems like the subprime mortgage crisis from repeating themselves in years to come.
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