Why is the sub prime mess a problem for the economy?

I need some help here because I must be the only dummy that doesn't understand the problem.

Why are the mortgage companies reporting such huge losses? The mortgages are secured loans that are backed by real estate. Are the property values that low? If it's a matter of conservative accounting rules in valuing the loans, then are we really in a crisis?

I agree that it is a social tragedy if thousands lose their homes to foreclosure, but is that cause for a recession? I would think the glut of cheap homes in foreclosure would stimulate home sales and the economy making it all a wash.

Why is the sub prime mess a problem for the economy?

This is going to take a moment, so hold on.

...

Lets start in 2003. Greenspan lowered the Fed Rate to a ultra historic low of 1%. Economically speaking, this was incredibly stupid! The interest rate is the risk of money. With a 1% rate, that essentially meant that the risk was factored out. When that happens investors and consumers act irresponsibly, and that is exactly what happened.

1) People got into mortgages they NEVER should have been in. Not only did they get into these loans, but with the low introductory rates already associated with ARMs, these people got into houses that were too big for them to ever get into. This is where consumers were acting irresponsibly. Now, maybe some of them figured they would sell the house before the rate readjusted...its irrelavent what they were thinking, they ALL were made aware the adjustment WOULD take place. But with the attention span of a feret, that meant nothing to these people.

2) Another consumer/investor hybrid that was affected and that contributed was the speculators within the housing market, primarily the house flippers. You have a house on the market, a house flipper buys it and flips it and puts it on the market 4 weeks later. Then someone who wants to live in the house buys it and moves in. What happened in this transaction? Well for one house we got two mortgages, and when the monthly MBA Purchase Application report is delivered (Mortgage Bankers Association) to the market and says there were 2 applications made, but mentions nothing about them being for the same house. So, this creates an artificial signal to the market that housing is exploding and for everyone to jump in. So new homes start to be built. As time progresses, this process continues because two signals are being communicated to the consumer: 1) the housing market is on fire and prices are flying through the roof due to the demand. get in while you can and secure a good rate, 2) rates are at a literal all time low, get them while you can.

This whole thing corrects itself when the speculators can't find anyone to buy the home they are not stuck with (The largest segment of the housing economy, in dollar value, that foreclosed are the homes valued over $470K). So these houses start to foreclose first and then the subprimes foreclose en masse. The rates adjusted, and the result was no one could afford to pay for them and they couldn't sell them, so they foreclosed (banks HATE foreclosures).

3) Then there are the Collateriallized Mortgage/Debt Obligations (CMOs/CDOs). So, in order to meet the demand for all of the home loans the financial institutions pooled all of the mortgages into groups; for example's sake we will focus on the subprime group since they were the largest volume wise. These mortgages were pooled together and then sliced up into Debt instruments (just think of a bond) called CMOs or CDOs. They then sold them like as securities, like bonds. So lets say you bought one, as they were usually sold at $25,000 minimums. What happens is you get this note and when the subprime mortgages made their monthly payment, a portion of the percentage was kept by the finance institution and a portion went to the CMO holders as interest payments. So, rather than receiving a annual interest payment like most bonds, you are receiving one every month. The 25K you invested in owning this (the principal) would be due back to you when the note expired, usually at when the mortgage was paid off on its regular schedule. (there is a lot more to this process, but I am sticking to the basics to explain to you what happened in the market and then the economy). that 25K you invested then goes to the bank to be used to make more home loans, and then they make more CMOs or CDOs. As you see, the cycle continues.

Naturally, there is a risk inherent in this process to the investor, which is why it has a minimum amount that is so high and is largely reserved for investors with over a million in assets and Institutional Investors (other banks, mutual funds, hedge funds, etc). Part of this risk is the possibility of foreclosure, and this is where the Credit Rating on the note comes into play (i am not about to go into this, just know that when the system experienced a massive foreclosure rate, and therefore the bonds defaulted on their interest payments, the credit rating system went to crap and NO ONE wanted to issue credit as it was too risky). When the rates adjusted, foreclosures came swarming in. Investors were striffed their interest payments and the banks couldn't liquidate the homes fast enough, and receive a decent value for the homes (typical in a foreclosure, which is why they hate them). The end result, hundreds of billions of dollars lost, and the impact is felt all over the world.

So how does this affect the economy. The biggest loosers was the Financial Sector, which happens to be the largest sector in the economy; roughly 20%. When they dropped, the took the market with them; especially since they weren't issuing credit due to the Credit Rating mess, and many companies were needing to get credit in order to expand, since their respective sectors were fine. So, the spread trickled all over.

This means that property values were dropping as demand was ACTUALLY reseting to its actual levels. Unemployment went up, since the contruction sector, and the industries that feed off of it, dried up. This meant consumer spending went down, which further spread the problem of no money in the market.

The end result, we are facing (if not already in, as we never know we are in a recession until several months after being in it) a recession. The burn is, while the rates are dropping, so too are the home values. Some people aren't able to refinance their home loans because they don't even have enough equity...and the equity they thought they had is now getting lost to the drop in the home's value (due in large part to the glut on the market with homes, but also due to the fact that the inflation in the housing market was 8-10% for a while there, and that is now readjusting). Now, some think this is just the tip of the iceberg. There were a lot of foreclosures last year due to reseting rates, BUT this year, there are scheduled to be $1 Trillion dollars worth or resets. Bush worked with the Finance Sector to post-pone this reset for another five years, but this is not all of them .... and this still doesn't mean mass foreclosure has been post-poned, as a recession could easily cause that problem.

I know its a lot, and I hope I answered it to a point where it was made clear. Your question is not in any way a simple one...in fact, it is an incredibly complex one!!! And I enjoyed the opportunity to discuss it.

Why is the sub prime mess a problem for the economy?

The sub-prime mortage mess is the biggest %26quot;black eye%26quot; for our corrupted and corporate generated overwhelmed, credit induced economy. Unfortunately, the marketing machine called pop-culture and consumerism has fueled the middle class to become dependant on 2 incomes, leaving them more vulnerable to problems if something happens to reduce those two incomes of the household. No one has any money in savings anymore, and if you can maintain good credit - the theory is you don't really need savings, as long as you have access to credit - which most people do, despite their credit score. Sub-prime encouraged people in the middle class especially, to tap into the largest amounts of $$ they had access to, by purchasing a home that they couldn't really afford in cold-hard cash. The families fell for it, moved into their homes that were lovely, and then the fine print came into play in their financial documents. Interest rates changed, banks decided to make balloon payment due, and many people couldn't afford it after the sub-prime honeymoon period was over. Also - it's a horrible product encouraged by banks and corporations to spin our economy even further into threat of recession. Because of these sub-primes, homes that are actually being paid for and appreciating in investments are losing $$ because of the amounts of foreclosures and homes available that people just want to wash their hands from. Awful.

Why is the sub prime mess a problem for the economy?

If I lend you money at a rate of interest and you lose your job and cannot pay then I stand to lose everthing. almost the same with a mortgage except the mortgage company has the house as security so some of the loan can be repaid which in arecession might well not cover the initial loan plus interest.

Why is the sub prime mess a problem for the economy?

because so many people took out home loans based on cheap MOrtgage payments from low interest

when the Fed raised rates people's payments rocketed

and therefore people lost thier homes and investment homes as well. Some people took 3 and 4 morgages out in order to do house flipping and make money when realestate was hot-

people got greedy and they were stupid for taking out a mortgage that had adjustable rates- BAd move

now banks are in crap because they lost so much money in these mortgage deals because people cannot pay

were talking like Millions and millions of dollars

and that has freaked out the economy

and wallstreet

we are not talking about a couple houses either, its thousands and thousands of homes that this happened to-

we will recover and the real estate market will be hotter than it was, but this time it will be with people who have money that will buy up these forclosures

the rich win again

but back to your idea on realestate being a wash-

well for now trhere is to much supply and not enough demand

and when that happens you have weekness

so untill there is demand to overcome the supply we will have to wade this out

people are afraid right now of real estate- its like a rotten egg

Why is the sub prime mess a problem for the economy?

The homes that those loans were taken out on were over-valued in many cases. So when the banks are forced to foreclose on the homes, they are stuck with a house that isn't worth the money the bank gave the homeowner to purchase it. And on top of that, you add the fact that foreclosures are usually sold at auction, which always brings in even more significantly lower numbers for the house being sold... and in total you end up with the banks that backed these loans to the mortgage companies taking an absolute bath financially in total losses over this housing market collapse. And of course the mortgage companies, once a loan goes into default, they are no longer getting paid the interest they were counting on to make a profit, and so they go belly up because they don't turn a profit and their stocks go into the toilet.

Banks make money on real estate loans when people pay the loans back with interest. They don't make money on foreclosures... and so when the industry started really inflating home values a few years ago to be able to give loans to people who weren't going to be able to pay them back responsibly, the whole industry was just setting itself up to burst... just like the Savings and Loan scandal of the mid-1980s.

Why is the sub prime mess a problem for the economy?

This is not a problem of sub prime. But sub prime is one of the starting result of our huge foreign debt and symbol of US recession.

Recession means we face difficulty in buying foreign made goods. Or we will not have enough money to afford made in chana or made in Japan commodites. Our dollar value in the world market go down. And we feel poor in the world. We allready entered in recession.

Today we have only 11% prodution units compared to post WW I I. More imports and less exports developed foreign debt. As on today we have 9 trillion dollars ( 9,000,000,000,000=00) of foreign debt. So our dollar is going down. This is beyond control. Now there is no choice. .

Its easy to understand in the year 2000 we were getting 1.21 euros for dollar. But right now we are getting only 0.68 euros. Means If we have 100 dollars in year 2000 right now that become worth only 56.19 dollars. Means we lost so much wealth already compared to other nations.

.

No one exactly know what will going to happen. Because this is depression of all world driven by US. Countries like China, Japan, Canada, Mexico and German may suffer more next to our country.

now china currency is almost fixed ( pegged) with US $ . If in case china take out the pegging means if their currency keep floating, we start to feel more sever depression. we may not afford to buy made in china goods. We have to start our closed prodution units back. As per me this date may fall in 2008. Because of weak dollar china is loosing a lot. It buy raw material and oil for more money and sell goods to us for less money . Its loosing money to keep their own and US economy running.

Now everything is beyond control. Nobody can control or prevent us from going depression.

We dont have any chance to escape from this. As we are super power the exact impact of depression is getting postponed.

The only way left is to save yourself.

To know the reality please watch following video clips