Preserving the Dream Understanding and Addressing the Subprime Mortgage Crisis

July, 2008 | Preserving the Dream Understanding and Addressing the Subprime Mortgage Crisis. This briefing paper explores how this crisis developed, highlight strategies that some communities are using to mitigate its negative impacts, review recent federal proposals to address the situation and discuss possible intervention strategies that foundations can pursue to address the crisis.

Executive Summary

Throughout the past 15 years, the United States has experienced a revolution in mortgage finance. Our mortgage markets have changed dramatically and become much more complex. These changes have had many positive aspects but also some serious negative consequences.

On the positive side, many new technological innovations were implemented in the financial services industry such as credit scoring, expanded mortgage securitization and automated underwriting. These innovations, combined with policy changes and a period of historically low-interest rates, created unprecedented access to credit for many Americans—allowing them to purchase homes and tap their home equity, providing liquidity to many low- and moderate-income families.

However, this era of easy credit came with many challenges. The complexity of the new mortgage market came with an array of new players, options, and products that thoroughly confused most consumers—leading many of them to choose inferior and risky products. Subprime lending also exploded during the last decade with its aggressive marketing techniques and its mortgage broker sales channel. Overall, an under-regulated lending market produced risky, costly and exotic mortgages that eventually produced a system-wide crisis that challenges the basic safety and soundness of the nation’s mortgage lending industry.

This leads us to the current situation: the nation has 54 million mortgage borrowers and 7.1 million hold subprime mortgages (more than 13 percent of all loans).1 These risky subprime mortgages have been defaulting at rates up to 20 times higher than the rates of prime mortgages.2 As of the fourth quarter 2007, 1.2 million foreclosures are in process while another 1.8 million loans are seriously delinquent.3 All told, more than two million foreclosures totaling up to $3 trillion in value are expected in 2008-2009.4 The damage has spread from subprime to prime mortgage markets which are now experiencing record levels of default, as well. Researchers have also noted this contagion effect spreading internationally, with housing bubbles now bursting in Ireland, Spain, England, and other countries.5

With housing values declining in many U.S. markets, an estimated 8.8 million homeowners now have mortgages worth more than the value of their homes, leaving them in risky situations and unable to refinance their mortgages for the immediate future.6 If price declines continue to accelerate, this number could double in the next year. The negative impacts of declining home values and rising defaults affect not only the families involved, but also their neighbors, the larger community and the nation as a whole. "This downward spiral of lost confidence and credit contraction threatens to touch off the worst recession and most serious social crisis of the post-World War II era," says Eugene A. Ludwig, comptroller of the currency from 1993-1998.

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