Skip to main content

Learning about the Subprime Mortgage Industry

Yuliya Demyanyk as a senior research analyst works for the Federal Reserve in Cleveland. She has documented the rise and fall of the subprime mortgage industry. A subprime mortgage is a mortgage given to a individual whose credit rating is dubious. Often suprime mortgages were adjustable-rate mortgages; that is, the interest rates were not fixed but could increase given the terms of the loans.

This definition of a subprime mortgage is simplistic. Demyanyk pointed out that lenders sometimes labeled a mortgage subprime, even if the borrower had a good credit rating if the loan was unusual such as a fixed rate mortgage changing into an adjustable rate mortgage after a certain number of years. Demyanyk considers this one of many myths about the subprime mortgage industry during the collapse.

The subprime mortgage industry was only 16 percent of all U.S. mortgage debt in 2008. Why then did the suprime mortgage collapse play such a major role in an international financial crisis? Demyanyk states that the complexity of the subprime mortgage industry lent itself to creating leverage problems in the financial institutions. Subprime mortgages were packaged into securities that were repackaged into complex financial instruments called derivatives.

The financial institutions split these derivatives into tranches and sold them to customers such as pension systems. Thje financial institutions became highly leveraged as they bought more and more of these securities to sell them. The credit rating agencies which received fees from the financial institutions helped the boom by rating 80% of these securities as triple AAA. When enough of these mortgages starting defaulting, the securities lost their value and the financial institutions were threatened. They were threatened not only because they had gone into so much debt buying these securities but because of the complexity, no one could figure out what any of the tranches were worth. Hence, the government bailout commenced. Greed makes individuals stupid.

PS. If you would like to read more about Demyanyk’s research, click on the link.


Popular posts from this blog

Free Trade?

What is free trade? Free trade means that nations agree to trade goods and services without government interference – no tariffs, no underlying government regulation. The concept of free trade is supported by mainstream economics (neoclassical) which assumes that there is a level playing field worldwide; that free trade means governments do not help the private sector.

However, we know that is not the case. China’s government has put enormous investment in certain of its industries. One example is solar energy. China’s government has invested in this industry with the result that China now leads the world in the production of solar panels. There are dozens of examples of governments investing in private companies to help them in the tough worldwide competition that has developed.

America companies who put their manufacturing plants in China benefit enormous. It is called the “free rider.”  American companies with manufacturing plants keep reaping all the rewards of selling…

Mayor de Blasio admits homelessness cannot be eliminated immediately.

After three years of blaming his predecessor, Mayor Bloomberg, for moving so slowly on housing the homeless, Mayor de Blasio finally admitted that it will take years to house so many homeless people. Perhaps it isn't all Mayor Bloomberg's fault.
   To add a different perspective, let us take a look at New York State and its inability to commit resources to the city's problem. During the Bloomberg administration, the state cut funding to the homeless from $164 million in FY2002 to $110 million in FY2012, a 33 percent cut.  In addition, the state cut the funding to one of the few programs to permanently house the homeless, the Advantage Program. Not only did the state cut the program, but the state also passed legislation that the city could not use other state funds for the program.
   Then of course there is the federal government that has cut millions of dollars out of the public housing budget that houses so many of people in poverty. Thanks to the federal government, t…