A Global Contagion: The Sub-Lending Crisis and the Burst of the Housing Bubble
Sharon L. Secor
October 30, 2007
The sub-prime lending crisis has become quite a scandal for the United States mortgage industry, shedding light on the development of a pattern of reckless and sometimes predatory lending practices in many areas of the home loan market. While much of the press on this issue has been centered around the burst of the housing bubble and the sub-prime meltdown in the U.S., other countries have experienced similar disruptions in the housing market and lending industry, as well as in the general economy, largely due to weakening in mortgage backed securities.
During the inflationary period of the housing bubble, as home prices skyrocketed to astounding heights, the extreme profitability of mortgage lending resulted in an increase of sub-prime lenders in the market, adding a new level of competition to a market that had traditionally been dominated by banking institutions. This proliferation of sub-prime lenders and mortgage brokers brought with them looser lending standards than were seen in the market previously, making it much easier for low income consumers or those with shaky credit histories to obtain a mortgage loan. Of course, these loans came with higher risk levels for lenders, most of whom charged consumers accordingly, with steeper fees and interest rates.
As the housing and sub-prime industries soared to ever more profitable heights, lenders became increasingly reckless with the standards for loan approval and the loan products offered to sub-prime borrowers. Adjustable rate mortgages became the predominant style of home loan sold in the sub-prime market, available in an endless array of flavors. Creative financing options, such as interest only loans, low document or no document loans, piggy back loans, and jumbo loans became common. These riskier loan options seemed a fair gamble to many consumers, lenders, and investors as home values continued to soar, causing many to disregard the possibility of severe consequences should the bet prove not as sure as originally thought.
Which, of course, is exactly what happened as market conditions began to change. Interest rate increases caused steeply rising monthly payments in many of those adjustable rate loans, especially those with artificially low teaser rates. A significant portion of homeowners found themselves in financial trouble, struggling to make payments. Default and foreclosure rates rose to unprecedented levels, and are still climbing, with many more loans due to reset to higher rates in the near future. The housing market is flooded with foreclosure properties, causing a record-setting slump in home prices.
Investors who bought into the profitability of the housing boom and the sub-prime lending market through mortgage backed securities suffered huge losses as the bottom fell out of the market, spreading the woes of the foreclosure crisis throughout the economy, both domestic and world wide. Hedge funds and international banks have seen substantial losses, as have private investors and retirement investment accounts.
While this cycle played out in the U.S. market in tremendous proportions, similar patterns were underway in other countries, most on a somewhat less dramatic scale. European lenders in some areas have had looser lending standards that have led to similar credit issues, particularly in the British market. The housing boom was a global one, affecting nearly every developed country, leaving only Japan's housing market untouched. Many economists attribute this trend to the long period of low interest and inflation rates throughout the major economies of the world during the past 10-15 years.
Spain experienced one of the largest housing booms among the European nations, spurred on by interest rates that were often lower than the country's rate of inflation. In 2006, the average Spanish family spent a figure equal to 6 times their annual income to purchase a home, up form the average of 3 ½ time their annual salary in the late 1990's, according to statistics reported by the Bank of Spain. 726,000 new homes were built in Spain during 2006, a number that is greater than new construction statistics in Britain, Germany, and France combined.
However, this year things are changing in Spain, with new housing permits decreasing by more than 20 percent in the months of May and June, and 38 percent in July from the levels reported during the same months of 2005. The credit crunch and housing slump has significantly impacted the Spanish economy, with falling auto sales and lower consumer confidence. Rising interest rates are the cause of great concern among Spanish homeowners, with more than 95 percent of mortgages held of the adjustable rate variety.
Ireland was significantly affected by the housing boom also, with home prices increasing by four times over the last ten years. A large population of new immigrants, low interest rates, and economic growth are among the causes cited for this tremendous rise in the housing market. But, here as well, the boom seems to be on its way out. Home prices are falling in Ireland, a trend which is expected to reduce new construction rates.
Germany and France had a much milder version of the housing boom, causing these countries to be impacted by the housing slump much more lightly than many other countries. In Germany, home of Europe's largest economy, many citizens prefer renting to home ownership, keeping home prices from growing at the rates seen in other European countries. France has government regulations that limit home building, sparing them much of the recent housing exuberance. Fixed rate loans make up the majority of the mortgages in France, protecting homeowners from the impact of rising interest rates. Even so, France has just had its first quarterly home price decline in nearly a decade.
While the effects of the sub-prime meltdown and the burst of the housing bubble may perhaps be seen at it's most extreme in the United States, the hardship has been felt in most developed countries to some degree. Nations that maintain a more conservative approach to credit and lending standards have remained somewhat insulated from the worst of the impact, while those that traveled along the path to easy sub-prime type lending practices have seen more economic damage. However, just how strongly this will affect the overall world economy remains to be seen, as many analyst say this meltdown has just begun.
During the inflationary period of the housing bubble, as home prices skyrocketed to astounding heights, the extreme profitability of mortgage lending resulted in an increase of sub-prime lenders in the market, adding a new level of competition to a market that had traditionally been dominated by banking institutions. This proliferation of sub-prime lenders and mortgage brokers brought with them looser lending standards than were seen in the market previously, making it much easier for low income consumers or those with shaky credit histories to obtain a mortgage loan. Of course, these loans came with higher risk levels for lenders, most of whom charged consumers accordingly, with steeper fees and interest rates.
As the housing and sub-prime industries soared to ever more profitable heights, lenders became increasingly reckless with the standards for loan approval and the loan products offered to sub-prime borrowers. Adjustable rate mortgages became the predominant style of home loan sold in the sub-prime market, available in an endless array of flavors. Creative financing options, such as interest only loans, low document or no document loans, piggy back loans, and jumbo loans became common. These riskier loan options seemed a fair gamble to many consumers, lenders, and investors as home values continued to soar, causing many to disregard the possibility of severe consequences should the bet prove not as sure as originally thought.
Which, of course, is exactly what happened as market conditions began to change. Interest rate increases caused steeply rising monthly payments in many of those adjustable rate loans, especially those with artificially low teaser rates. A significant portion of homeowners found themselves in financial trouble, struggling to make payments. Default and foreclosure rates rose to unprecedented levels, and are still climbing, with many more loans due to reset to higher rates in the near future. The housing market is flooded with foreclosure properties, causing a record-setting slump in home prices.
Investors who bought into the profitability of the housing boom and the sub-prime lending market through mortgage backed securities suffered huge losses as the bottom fell out of the market, spreading the woes of the foreclosure crisis throughout the economy, both domestic and world wide. Hedge funds and international banks have seen substantial losses, as have private investors and retirement investment accounts.
While this cycle played out in the U.S. market in tremendous proportions, similar patterns were underway in other countries, most on a somewhat less dramatic scale. European lenders in some areas have had looser lending standards that have led to similar credit issues, particularly in the British market. The housing boom was a global one, affecting nearly every developed country, leaving only Japan's housing market untouched. Many economists attribute this trend to the long period of low interest and inflation rates throughout the major economies of the world during the past 10-15 years.
Spain experienced one of the largest housing booms among the European nations, spurred on by interest rates that were often lower than the country's rate of inflation. In 2006, the average Spanish family spent a figure equal to 6 times their annual income to purchase a home, up form the average of 3 ½ time their annual salary in the late 1990's, according to statistics reported by the Bank of Spain. 726,000 new homes were built in Spain during 2006, a number that is greater than new construction statistics in Britain, Germany, and France combined.
However, this year things are changing in Spain, with new housing permits decreasing by more than 20 percent in the months of May and June, and 38 percent in July from the levels reported during the same months of 2005. The credit crunch and housing slump has significantly impacted the Spanish economy, with falling auto sales and lower consumer confidence. Rising interest rates are the cause of great concern among Spanish homeowners, with more than 95 percent of mortgages held of the adjustable rate variety.
Ireland was significantly affected by the housing boom also, with home prices increasing by four times over the last ten years. A large population of new immigrants, low interest rates, and economic growth are among the causes cited for this tremendous rise in the housing market. But, here as well, the boom seems to be on its way out. Home prices are falling in Ireland, a trend which is expected to reduce new construction rates.
Germany and France had a much milder version of the housing boom, causing these countries to be impacted by the housing slump much more lightly than many other countries. In Germany, home of Europe's largest economy, many citizens prefer renting to home ownership, keeping home prices from growing at the rates seen in other European countries. France has government regulations that limit home building, sparing them much of the recent housing exuberance. Fixed rate loans make up the majority of the mortgages in France, protecting homeowners from the impact of rising interest rates. Even so, France has just had its first quarterly home price decline in nearly a decade.
While the effects of the sub-prime meltdown and the burst of the housing bubble may perhaps be seen at it's most extreme in the United States, the hardship has been felt in most developed countries to some degree. Nations that maintain a more conservative approach to credit and lending standards have remained somewhat insulated from the worst of the impact, while those that traveled along the path to easy sub-prime type lending practices have seen more economic damage. However, just how strongly this will affect the overall world economy remains to be seen, as many analyst say this meltdown has just begun.
Print
Email
