The subprime mortgage crisis is an ongoing financial crisis triggered by a dramatic rise in

mortgage delinquencies and foreclosures in the United States, with major adverse consequences
for banks and financial markets around the globe. The crisis, which has its roots in the closing
years of the 20th century, became apparent in 2007 and has exposed pervasive weaknesses in
financial industry regulation and the global financial system.
Many USA mortgages issued in recent years were made to subprime borrowers, defined as those
with lesser ability to repay the loan based on various criteria.[1] When USA house prices began to
decline in 2006-07, mortgage delinquencies soared, and securities backed with subprime
mortgages, widely held by financial firms, lost most of their value. The result has been a large
decline in the capital of many banks and USA government sponsored enterprises, tightening
credit around the world.
Background

Factors Contributing to Housing Bubble – Diagram 1 of 2

Domino Effect As Housing Prices Declined – Diagram 2 of 2

The crisis began with the bursting of the United States housing bubble[2][3] and high default rates
on "subprime" and adjustable rate mortgages (ARM), beginning in approximately 2005–2006.
Government policies and competitive pressures for several years prior to the crisis encouraged
higher risk lending practices.[4][5] Further, an increase in loan incentives such as easy initial terms
and a long-term trend of rising housing prices had encouraged borrowers to assume difficult
mortgages in the belief they would be able to quickly refinance at more favorable terms.
However, once interest rates began to rise and housing prices started to drop moderately in
2006–2007 in many parts of the U.S., refinancing became more difficult. Defaults and
foreclosure activity increased dramatically as easy initial terms expired, home prices failed to go
up as anticipated, and ARM interest rates reset higher. Foreclosures accelerated in the United
States in late 2006 and triggered a global financial crisis through 2007 and 2008. During 2007,
nearly 1.3 million U.S. housing properties were subject to foreclosure activity, up 79% from
2006.[6]
Financial products called mortgage-backed securities (MBS), which derive their value from
mortgage payments and housing prices, had enabled financial institutions and investors around
the world to invest in the U.S. housing market. Major banks and financial institutions had
borrowed and invested heavily in MBS and reported losses of approximately US$435 billion as
of 17 July 2008.[7][8] The liquidity and solvency concerns regarding key financial institutions
drove central banks to take action to provide funds to banks to encourage lending to worthy
borrowers and to restore faith in the commercial paper markets, which are integral to funding
business operations. Governments also bailed out key financial institutions, assuming significant
additional financial commitments.
The risks to the broader economy created by the housing market downturn and subsequent
financial market crisis were primary factors in several decisions by central banks around the
world to cut interest rates and governments to implement economic stimulus packages. These
actions were designed to stimulate economic growth and inspire confidence in the financial
markets. Effects on global stock markets due to the crisis have been dramatic. Between 1 January
and 11 October 2008, owners of stocks in U.S. corporations had suffered about $8 trillion in
losses, as their holdings declined in value from $20 trillion to $12 trillion. Losses in other
countries have averaged about 40%.[9] Losses in the stock markets and housing value declines
place further downward pressure on consumer spending, a key economic engine.[10] Leaders of
the larger developed and emerging nations met in November 2008 to formulate strategies for
addressing the crisis.[11]
[edit] The mortgage market
Main articles: Subprime crisis background information and Subprime crisis impact
timeline

Number of U.S. household properties subject to foreclosure actions by quarter.

Subprime lending is the practice of lending, mainly in the form of mortgages for the purchase of
residences, to borrowers who do not meet the usual criteria for borrowing at the lowest
prevailing market interest rate. These criteria pertain to the borrower's credit score, credit history
and other factors.[12] If a borrower is delinquent in making timely mortgage payments to the loan
servicer (a bank or other financial firm), the lender can take possession of the residence acquired
using the proceeds from the mortgage, in a process called foreclosure.
The value of USA subprime mortgages was estimated at $1.3 trillion as of March 2007, [13] with
over 7.5 million first-lien subprime mortgages outstanding.[14] Between 2004-2006 the share of
subprime mortgages relative to total originations ranged from 18%-21%, versus less than 10% in
2001-2003 and during 2007.[15][16] In the third quarter of 2007, subprime ARMs making up only
6.8% of USA mortgages outstanding also accounted for 43% of the foreclosures begun during
that quarter.[17] By October 2007, approximately 16% of subprime adjustable rate mortgages
(ARM) were either 90-days delinquent or the lender had begun foreclosure proceedings, roughly
triple the rate of 2005.[18] By January 2008, the delinquency rate had risen to 21%.[19] and by May
2008 it was 25%.[20]
The value of all outstanding residential mortgages, owed by USA households to purchase
residences housing at most four families, was US$9.9 trillion as of year-end 2006, and US$10.6
trillion as of midyear 2008.[21] During 2007, lenders had begun foreclosure proceedings on nearly
1.3 million properties, a 79% increase over 2006.[22] As of August 2008, 9.2% of all mortgages
outstanding were either delinquent or in foreclosure.[23] 936,439 USA residences completed
foreclosure between August 2007 and October 2008.[24]
[edit] Credit risk

Understanding financial leverage.

Credit risk arises because a borrower has the option of defaulting on the loan he owes.
Traditionally, lenders (who were primarily thrifts) bore the credit risk on the mortgages they
issued. Over the past 60 years, a variety of financial innovations have gradually made it possible
for lenders to sell the right to receive the payments on the mortgages they issue, through a
process called securitization. The resulting securities are called mortgage backed securities
(MBS) and collateralized debt obligations (CDO). Most American mortgages are now held by
mortgage pools, the generic term for MBS and CDOs. Of the $10.6 trillion of USA residential
mortgages outstanding as of midyear 2008, $6.6 trillion were held by mortgage pools, and $3.4
trillion by traditional depository institutions. [25]
This "originate to distribute" model means that investors holding MBS and CDOs also bear
several types of risks, and this has a variety of consequences. There are four primary types of
risk:[26][27]
1. Credit risk - the risk that the homeowner or borrower will be unable or unwilling to pay
back the loan;
2. Asset price risk - the risk that assets (MBS in this case) will depreciate in value, resulting
in financial losses, markdowns and possibly margin calls;
3. Liquidity risk - the risk that a business entity will be unable to obtain financing, such as
from the commercial paper market; and
4. Counterparty risk - the risk that a party to a contract will be unable or unwilling to uphold
their obligations.
The aggregate effect of these and other risks has recently been called systemic risk, which refers
to when formerly uncorrelated risks shift and become highly correlated, damaging the entire
financial system.[28]
When homeowners default, the payments received by MBS and CDO investors decline and the
perceived credit risk rises. This has had a significant adverse effect on investors and the entire
mortgage industry. The effect is magnified by the high debt levels (financial leverage)
households and businesses have incurred in recent years. Finally, the risks associated with
American mortgage lending have global impacts, because a major consequence of MBS and
CDOs is a closer integration of the USA housing and mortgage markets with global financial
markets.
Investors in MBS and CDOs can insure against credit risk by buying credit defaults swaps
(CDS). As mortgage defaults rose, the likelihood that the issuers of CDS would have to pay their
counterparties increased. This created uncertainty across the system, as investors wondered if
CDS issuers would honor their commitments.
[edit] Causes
The reasons proposed for this crisis are varied[29][30] and complex.[31] The crisis can be attributed
to a number of factors pervasive in both housing and credit markets, factors which emerged over
a number of years. Causes proposed include the inability of homeowners to make their mortgage
payments, poor judgment by borrowers and/or lenders, speculation and overbuilding during the
boom period, risky mortgage products, high personal and corporate debt levels, financial
products that distributed and perhaps concealed the risk of mortgage default, monetary policy,
and government regulation (or the lack thereof).[32] Utimately, though, moral hazard lay at the
core of many of the causes.[33]
In its "Declaration of the Summit on Financial Markets and the World Economy," dated 15
November 2008, leaders of the Group of 20 cited the following causes:

"During a period of strong global growth, growing capital flows, and prolonged stability
“ earlier this decade, market participants sought higher yields without an adequate
appreciation of the risks and failed to exercise proper due diligence. At the same time,
weak underwriting standards, unsound risk management practices, increasingly complex
and opaque financial products, and consequent excessive leverage combined to create
vulnerabilities in the system. Policy-makers, regulators and supervisors, in some
advanced countries, did not adequately appreciate and address the risks building up in
financial markets, keep pace with financial innovation, or take into account the systemic
ramifications of domestic regulatory actions."[34] ”
[edit] Boom and bust in the housing market
Main articles: United States housing bubble and United States housing market correction
Existing homes sales, inventory, and months supply, by quarter.

Common indexes used for adjustable rate mortgages (1996–2006).

Vicious Cycles in the Housing & Financial Markets

A culture of consumerism is a factor "in an economy based on immediate gratification."[35]
Starting in 2005, American households have spent more than 99.5% of their disposable personal
income on consumption or interest payments.[36] If imputations mostly pertaining to owner-
occupied housing are removed from these calculations, American households have spent more
than their disposable personal income in every year starting in 1999.[37]
Low interest rates and large inflows of foreign funds created easy credit conditions for a number
of years prior to the crisis.[38] The USA home ownership rate increased from 64% in 1994 (about
where it had been since 1980) to an all-time high of 69.2% in 2004.[39] Subprime lending was a
major contributor to this increase in home ownership rates and in the overall demand for
housing.
This rise in demand fueled rising house prices and consumer spending.[40] Between 1997 and
2006, the price of the typical American house increased by 124%.[41] During the two decades
ending in 2001, the national median home price ranged from 2.9 to 3.1 times median household
income. This ratio rose to 4.0 in 2004, and 4.6 in 2006.[42] This housing bubble resulted in quite a
few homeowners refinancing their homes at lower interest rates, or financing consumer spending
by taking out second mortgages secured by the price appreciation. USA household debt as a
percentage of annual disposable personal income was 127% at the end of 2007, versus 77% in
1990.[43]
Household debt grew from $705 billion at year-end 1974, 60% of disposable personal income, to
$7.4 trillion at yearend 2000, and finally to $14.5 trillion in midyear 2008, 134% of disposable
personal income.[44] During 2008, the typical USA household owned 13 credit cards, with 40% of
households carrying a balance, up from 6% in 1970.[45]
This credit and house price explosion led to a building boom and a surplus of unsold homes.
Easy credit, and a belief that house prices would continue to appreciate, encouraged many
subprime borrowers to obtain adjustable-rate mortgages. These mortgages enticed borrowers
with a below market interest rate for some predetermined period, followed by market interest
rates for the remainder of the mortgage's term. Borrowers who could not make the higher
payments once the initial grace period ended would try to refinance their mortgages. Refinancing
became more difficult, once house prices began to decline in many parts of the USA. Borrowers
who found themselves unable to escape higher monthly payments by refinancing began to
default.
By September 2008, average U.S. housing prices had declined by over 20% from their mid-2006
peak.[46][47] This major and unexpected decline in house prices means that many borrowers have
zero or negative equity in their homes, meaning their homes were worth less than their
mortgages. As of March 2008, an estimated 8.8 million borrowers — 10.8% of all homeowners
— had negative equity in their homes, a number that is believed to have risen to 12 million by
November 2008. Borrowers in this situation have an incentive to "walk away" from their
mortgages and abandon their homes, even though doing so will damage their credit rating for a
number of years.[48] The reason is that unlike what is the case in most other countries, American
residential mortgages are non-recourse loans; once the creditor has regained the property
purchased with a mortgage in default, he has no further claim against the defaulting borrower's
income or assets. As more borrowers stop paying their mortgage payments, foreclosures and the
supply of homes for sale increase. This places downward pressure on housing prices, which
further lowers homeowners' equity. The decline in mortgage payments also reduces the value of
mortgage-backed securities, which erodes the net worth and financial health of banks. This
vicious cycle is at the heart of the crisis.[49]
Increasing foreclosure rates increases the inventory of houses offered for sale. The number of
new homes sold in 2007 was 26.4% less than in the preceding year. By January 2008, the
inventory of unsold new homes was 9.8 times the December 2007 sales volume, the highest
value of this ratio since 1981.[50] Furthermore, nearly four million existing homes were for
sale,[51] of which almost 2.9 million were vacant.[52] This overhang of unsold homes lowered
house prices. As prices declined, more homeowners were at risk of default or foreclosure. House
prices are expected to continue declining until this inventory of unsold homes (an instance of
excess supply) declines to normal levels.
Economist Nouriel Roubini wrote in January 2009 that subprime mortgage defaults triggered the
broader global credit crisis, but were just one symptom of multiple debt bubble collapses: "This
crisis is not merely the result of the U.S. housing bubble’s bursting or the collapse of the United
States’ subprime mortgage sector. The credit excesses that created this disaster were global.
There were many bubbles, and they extended beyond housing in many countries to commercial
real estate mortgages and loans, to credit cards, auto loans, and student loans. There were
bubbles for the securitized products that converted these loans and mortgages into complex,
toxic, and destructive financial instruments. And there were still more bubbles for local
government borrowing, leveraged buyouts, hedge funds, commercial and industrial loans,
corporate bonds, commodities, and credit-default swaps." It is the bursting of the many bubbles
that he believes are causing this crisis to spread globally and magnify its impact.[53]
[edit] Speculation
Speculation in residential real estate has been a contributing factor. During 2006, 22% of homes
purchased (1.65 million units) were for investment purposes, with an additional 14% (1.07
million units) purchased as vacation homes. During 2005, these figures were 28% and 12%,
respectively. In other words, a record level of nearly 40% of homes purchases were not intended
as primary residences. David Lereah, NAR's chief economist at the time, stated that the 2006
decline in investment buying was expected: "Speculators left the market in 2006, which caused
investment sales to fall much faster than the primary market."[54]
While homes had not traditionally been treated as investments, this behavior changed during the
housing boom. For example, one company estimated that as many as 85% of condominium
properties purchased in Miami were for investment purposes. Media widely reported
condominiums being purchased while under construction, then being "flipped" (sold) for a profit
without the seller ever having lived in them.[55] Some mortgage companies identified risks
inherent in this activity as early as 2005, after identifying investors assuming highly leveraged
positions in multiple properties.[56]
Economist Robert Shiller argues that speculative bubbles are fueled by "contagious optimism,
seemingly impervious to facts, that often takes hold when prices are rising. Bubbles are primarily
social phenomena; until we understand and address the psychology that fuels them, they're going
to keep forming."[57] Keynesian economist Hyman Minsky described three types of speculative
borrowing that contribute to rising debt and an eventual collapse of asset values:[58][59]
• The "hedge borrower," who expects to make debt payments from cash flows from other
investments;
• The "speculative borrower," who borrows believing that he can service the interest on his
loan, but who must continually roll over the principal into new investments;
• The "Ponzi borrower," who relies on the appreciation of the value of his assets to
refinance or pay off his debt, while being unable to repay the original loan.
Speculative borrowing has been cited as a contributing factor to the subprime mortgage crisis.[60]
[edit] High-risk mortgage loans and lending/borrowing practices
Lenders began to offer more and more loans to higher-risk borrowers,[61] including illegal
immigrants.[62] Subprime mortgages amounted to $35 billion (5% of total originations) in
1994,[63] 9% in 1996,[64] $160 billion (13%) in 1999,[63] and $600 billion (20%) in 2006.[64][65][66] A
study by the Federal Reserve found that the average difference between subprime and prime
mortgage interest rates (the "subprime markup") declined from 280 basis points in 2001, to 130
basis points in 2007. In other words, the risk premium required by lenders to offer a subprime
loan declined. This occurred even though the credit ratings of subprime borrowers, and the
characteristics of subprime loans, both declined during the 2001–2006 period, which should have
had the opposite effect. The combination of declining risk premia and credit standards is
common to classic boom and bust credit cycles.[67]
In addition to considering higher-risk borrowers, lenders have offered increasingly risky loan
options and borrowing incentives. In 2005, the median down payment for first-time home buyers
was 2%, with 43% of those buyers making no down payment whatsoever.[68] By comparison,
China has down payment requirements that exceed 20%, with higher amounts for non-primary
residences.[69]

Growth in mortgage loan fraud based upon US Department of the Treasury Suspicious Activity
Report Analysis.
One high-risk option was the "No Income, No Job and no Assets" loans, sometimes referred to as
Ninja loans. Another example is the interest-only adjustable-rate mortgage (ARM), which allows
the homeowner to pay just the interest (not principal) during an initial period. Still another is a
"payment option" loan, in which the homeowner can pay a variable amount, but any interest not
paid is added to the principal. An estimated one-third of ARMs originated between 2004 and
2006 had "teaser" rates below 4%, which then increased significantly after some initial period, as
much as doubling the monthly payment.[70]
Mortgage underwriting practices have also been criticized, including automated loan approvals
that critics argued were not subjected to appropriate review and documentation.[71] In 2007, 40%
of all subprime loans resulted from automated underwriting.[72][73] The chairman of the Mortgage
Bankers Association claimed that mortgage brokers, while profiting from the home loan boom,
did not do enough to examine whether borrowers could repay.[74] Mortgage fraud by borrowers
increased. [75]
[edit] Securitization practices

Borrowing under a securitization structure.

Securitization, a form of structured finance, involves the pooling of financial assets, especially
those for which there is no ready secondary market, such as mortgages, credit card receivables,
student loans. The pooled assets serve as collateral for new financial assets issued by the entity
(mostly GSEs and investment banks) owning the underlying assets.[76] The diagram at right
shows how there are many parties involved.
Securitization, combined with investor appetite for mortgage-backed securities (MBS), and the
high ratings formerly granted to MBSs by rating agencies, meant that mortgages with a high risk
of default could be originated almost at will, with the risk shifted from the mortgage issuer to
investors at large. Securitization meant that issuers could repeatedly relend a given sum, greatly
increasing their fee income. Since issuers no longer carried any default risk, they had every
incentive to lower their underwriting standards to increase their loan volume and total profit.
The traditional mortgage model involved a bank originating a loan to the borrower/homeowner
and retaining the credit (default) risk. With the advent of securitization, the traditional model has
given way to the "originate to distribute" model, in which the credit risk is transferred
(distributed) to investors through MBS and CDOs. Securitization created a secondary market for
mortgages, and meant that those issuing mortgages were no longer required to hold them to
maturity.
Asset securitization began with the creation of private mortgage pools in the 1970s.[77]
Securitization accelerated in the mid-1990s. The total amount of mortgage-backed securities
issued almost tripled between 1996 and 2007, to $7.3 trillion. The securitized share of subprime
mortgages (i.e., those passed to third-party investors via MBS) increased from 54% in 2001, to
75% in 2006.[67] Alan Greenspan has stated that the current global credit crisis cannot be blamed
on mortgages being issued to households with poor credit, but rather on the securitization of such
mortgages.[78]
Investment banks sometimes placed the MBS they originated or purchased into off-balance sheet
entities called structured investment vehicles or special purpose entities. Moving the debt "off the
books" enabled large financial institutions to circumvent capital requirements, thereby increasing
profits but augmenting risk.[79] Investment banks and off-balance sheet financing vehicles are
sometimes referred to as the shadow banking system and are not subject to the same capital
requirements and central bank support as depository banks.[80]
Some believe that mortgage standards became lax because securitization gave rise to a form of
moral hazard, whereby each link in the mortgage chain made a profit while passing any
associated credit risk to the next link in the chain.[81][82] At the same time, some financial firms
retained significant amounts of the MBS they originated, thereby retaining significant amounts
of credit risk and so were less guilty of moral hazard. Some argue this was not a flaw in the
securitization concept per se, but in its implementation.[26]
According to Nobel laureate Dr. A. Michael Spence, "systemic risk escalates in the financial
system when formerly uncorrelated risks shift and become highly correlated. When that happens,
then insurance and diversification models fail. There are two striking aspects of the current crisis
and its origins. One is that systemic risk built steadily in the system. The second is that this
buildup went either unnoticed or was not acted upon. That means that it was not perceived by the
majority of participants until it was too late. Financial innovation, intended to redistribute and
reduce risk, appears mainly to have hidden it from view. An important challenge going forward
is to better understand these dynamics as the analytical underpinning of an early warning system
with respect to financial instability." [83]
In 1995, the Community Reinvestment Act (CRA) was revised to allow CRA mortgages to be
securitized. In 1997, Bear Sterns was the first to take advantage of this law.[84] Under the CRA
guidelines, a mortgage issuer receives credit for originating subprime mortgages, or buying
mortgages on a whole loan basis, but not holding subprime mortgages. This rewarded issuers for
originating subprime mortgages, then selling them to others who would securitize them. Thus
any credit risk in subprime mortgages was passed from the issuer to others, including financial
firms and investors around the globe.
[edit] Inaccurate credit ratings
Main article: Credit rating agencies and the subprime crisis

MBS credit rating downgrades, by quarter.

Credit rating agencies are now under scrutiny for having given investment-grade ratings to
CDOs and MBSs based on subprime mortgage loans. These high ratings were believed justified
because of risk reducing practices, including over-collateralization (pledging collateral in excess
of debt issued), credit default insurance, and equity investors willing to bear the first losses.
However, there are also indications that some involved in rating subprime-related securities
knew at the time that the rating process was faulty. Emails exchanged between employees of
rating agencies, dated before credit markets deteriorated and put in the public domain by USA
Congressional investigators, suggest that some rating agency employees suspected that lax
standards for rating structured credit products would result in major problems.[85] For example,
one 2006 internal Email from Standard & Poor's stated that "Rating agencies continue to create
and [sic] even bigger monster—the CDO market. Let's hope we are all wealthy and retired by the
time this house of cards falters."[86]
High ratings encouraged investors to buy securities backed by subprime mortgages, helping
finance the housing boom. The reliance on agency ratings and the way ratings were used to
justify investments led many investors to treat securitized products — some based on subprime
mortgages — as equivalent to higher quality securities. This was exacerbated by the SEC's
removal of regulatory barriers and its reduction of disclosure requirements, all in the wake of the
Enron scandal.[87]
Critics allege that the rating agencies suffered from conflicts of interest, as they were paid by
investment banks and other firms that organize and sell structured securities to investors.[88] On
11 June 2008, the SEC proposed rules designed to mitigate perceived conflicts of interest
between rating agencies and issuers of structured securities.[89] On 3 December 2008, the SEC
approved measures to strengthen oversight of credit rating agencies, following a ten-month
investigation that found "significant weaknesses in ratings practices," including conflicts of
interest.[90]
Between Q3 2007 and Q2 2008, rating agencies lowered the credit ratings on $1.9 trillion in
mortgage backed securities. Financial institutions felt they had to lower the value of their MBS
and acquire additional capital so as to maintain capital ratios. If this involved the sale of new
shares of stock, the value of the existing shares was reduced. Thus ratings downgrades lowered
the stock prices of many financial firms.[91]
In December 2008 economist Arnold Kling testified at congressional hearings on the collapse of
Freddie Mac and Fannie Mae. Kling said that a high-risk loan could be “laundered” by Wall
Street and return to the banking system as a highly rated security for sale to investors, obscuring
its true risks and avoiding capital reserve requirements.[92]
[edit] Government policies
Main article: Government policies and the subprime mortgage crisis
Both government action and inaction have contributed to the crisis. Some are of the opinion that
the current American regulatory framework is outdated. President George W. Bush stated in
September 2008: "Once this crisis is resolved, there will be time to update our financial
regulatory structures. Our 21st century global economy remains regulated largely by outdated
20th century laws."[93] The Securities and Exchange Commission (SEC) has conceded that self-
regulation of investment banks contributed to the crisis.[94][95]
Increasing home ownership was a goal of the Clinton and Bush administrations.[96][97][98] There is
evidence that the Federal government leaned on the mortgage industry, including Fannie Mae
and Freddie Mac (the GSE), to lower lending standards.[99][100][101] Also, the U.S. Department of
Housing and Urban Development's (HUD) mortgage policies fueled the trend towards issuing
risky loans.[102][103]
In 1995, the GSE began receiving government incentive payments for purchasing mortgage
backed securities which included loans to low income borrowers. Thus began the involvement of
the GSE with the subprime market.[102] Subprime mortgage originations rose by 25% per year
between 1994 and 2003, resulting in a nearly ten-fold increase in the volume of subprime
mortgages in just nine years.[104] The relatively high yields on these securities, in a time of low
interest rates, were very attractive to Wall Street, and while Fannie and Freddie generally bought
only the least risky subprime mortgages, these purchases encouraged the entire subprime
market.[105] In 1996, HUD directed the GSE that at least 42% of the mortgages they purchased
should have been issued to borrowers whose household income was below the median in their
area. This target was increased to 50% in 2000 and 52% in 2005.[106] From 2002 to 2006 Fannie
Mae and Freddie Mac combined purchases of subprime securities rose from $38 billion to
around $175 billion per year before dropping to $90 billion, thus fulfilling their government
mandate to help make home buying more affordable. During this time, the total market for
subprime securities rose from $172 billion to nearly $500 billion only to fall back down to $450
billion. [107]
By 2008, the GSE owned, either directly or through mortgage pools they sponsored, $5.1 trillion
in residential mortgages, about half the amount outstanding.[108] The GSE have always been
highly leveraged, their net worth as of 30 June 2008 being a mere US$114 billion.[109] When
concerns arose in September 2008 regarding the ability of the GSE to make good on their
guarantees, the Federal government was forced to place the companies into a conservatorship,
effectively nationalizing them at the taxpayers' expense.[110][111]
Liberal economist Robert Kuttner has suggested that the repeal of the Glass-Steagall Act by the
Gramm-Leach-Bliley Act of 1999 may have contributed to the subprime meltdown, but this is
controversial.[112][113] The Federal government bailout of thrifts during the savings and loan crisis
of the late 1980s may have encouraged other lenders to make risky loans, and thus given rise to
moral hazard.[114] [115]
Economists have also debated the possible effects of the Community Reinvestment Act (CRA),
with detractors claiming that the Act encouraged lending to uncreditworthy
borrowers.[116][117][118][119] and defenders claiming a thirty year history of lending without increased
risk.[120][121][122][123] Detractors also claim that amendments to the CRA in the mid-1990s, raised the
amount of mortgages issued to otherwise unqualified low-income borrowers, and also allowed
for the first time the securitization of CRA-regulated mortgages even though some of these were
subprime.[124][125]
[edit] Policies of central banks
Central banks manage monetary policy and may target the rate of inflation. They have some
authority over commercial banks and possibly other financial institutions. They are less
concerned with avoiding asset price bubbles, such as the housing bubble and dot-com bubble.
Central banks have generally chosen to react after such bubbles burst so as to minimize collateral
damage to the economy, rather than trying to prevent or stop the bubble itself. This is because
identifying an asset bubble and determining the proper monetary policy to deflate it are matters
of debate among economists.[126][127]
Some market observers have been concerned that Federal Reserve actions could give rise to
moral hazard.[128] A Government Accountability Office critic said that the Federal Reserve Bank
of New York's rescue of Long-Term Capital Management in 1998 would encourage large
financial institutions to believe that the Federal Reserve would intervene on their behalf if risky
loans went sour because they were “too big to fail.”[129]
A contributing factor to the rise in house prices was the Federal Reserve's lowering of interest
rates early in the decade. From 2000 to 2003, the Federal Reserve lowered the federal funds rate
target from 6.5% to 1.0%.[130] This was done to soften the effects of the collapse of the dot-com
bubble and of the September 2001 terrorist attacks, and to combat the perceived risk of
deflation.[126] The Fed believed that interest rates could be lowered safely primarily because the
rate of inflation was low; it disregarded other important factors. Richard W. Fisher, President and
CEO of the Federal Reserve Bank of Dallas, said that the Fed's interest rate policy during the
early 2000s was misguided, because measured inflation in those years was below true inflation,
which led to a monetary policy that contributed to the housing bubble.[131]
Financial institution debt levels and incentives

Leverage Ratios of Investment Banks Increased Significantly 2003–2007

Many financial institutions, investment banks in particular, issued large amounts of debt during
2004–2007, and invested the proceeds in mortgage-backed securities (MBS), essentially betting
that house prices would continue to rise, and that households would continue to make their
mortgage payments. Borrowing at a lower interest rate and investing the proceeds at a higher
interest rate is a form of financial leverage. This is analogous to an individual taking out a second
mortgage on his residence to invest in the stock market. This strategy proved profitable during
the housing boom, but resulted in large losses when house prices began to decline and mortgages
began to default. Beginning in 2007, financial institutions and individual investors holding MBS
also suffered significant losses from mortgage payment defaults and the resulting decline in the
value of MBS.[27]
A 2004 SEC ruling allowed USA investment banks to issue substantially more debt, which was
then used to purchase MBS. Over 2004-07, the top five US investment banks each significantly
increased their financial leverage (see diagram), which increased their vulnerability to the
declining value of MBSs. These five institutions reported over $4.1 trillion in debt for fiscal year
2007, about 30% of USA nominal GDP for 2007. Further, the percentage of subprime mortgages
originated to total originations increased from below 10% in 2001-2003 to between 18-20% from
2004-2006.[132][133]
Three investment banks either went bankrupt (Lehman Brothers) or were sold at fire sale prices
to other banks (Bear Stearns and Merrill Lynch) during September 2008. The failure of 3 of the 5
large USA investment banks augmented the instability in the global financial system. The
remaining two investment banks, Morgan Stanley and Goldman Sachs, opted to become
commercial banks, thereby subjecting themselves to more stringent regulation.[134]
The New York State Comptroller's Office has said that in 2006, Wall Street executives took home
bonuses totaling $23.9 billion. "Wall Street traders were thinking of the bonus at the end of the
year, not the long-term health of their firm. The whole system—from mortgage brokers to Wall
Street risk managers—seemed tilted toward taking short-term risks while ignoring long-term
obligations. The most damning evidence is that most of the people at the top of the banks didn't
really understand how those [investments] worked."[42]
Investment banker incentive compensation was focused on fees generated from assembling
financial products, rather than the performance of those products and profits generated over time.
Their bonuses were heavily skewed towards cash rather than stock and not subject to "claw-
back" (recovery of the bonus from the employee by the firm) in the event the MBS or CDO
created did not perform. In addition, the increased risk (in the form of financial leverage) taken
by the major investment banks was not adequately factored into the compensation of senior
executives.[135]
[edit] Credit default swaps
Credit defaults swaps (CDS) are financial instruments used as a hedge and protection for
debtholders, in particular MBS investors, from the risk of default. As the net worth of banks and
other financial institutions deteriorated because of losses related to subprime mortgages, the
likelihood increased that those providing the insurance would have to pay their counterparties.
This created uncertainty across the system, as investors wondered which companies would be
required to pay to cover mortgage defaults.
Like all swaps and other financial derivatives, CDS may either be used to hedge risks
(specifically, to insure creditors against default) or to profit from speculation. The volume of
CDS outstanding increased 100-fold from 1998 to 2008, with estimates of the debt covered by
CDS contracts, as of November 2008, ranging from US$33 to $47 trillion. CDS are lightly
regulated. As of 2008, there was no central clearinghouse to honor CDS in the event a party to a
CDS proved unable to perform his obligations under the CDS contract. Required disclosure of
CDS-related obligations has been criticized as inadequate. Insurance companies such as
American International Group (AIG), MBIA, and Ambac faced ratings downgrades because
widespread mortgage defaults increased their potential exposure to CDS losses. These firms had
to obtain additional funds (capital) to offset this exposure. AIG's having CDSs insuring $440
billion of MBS resulted in its seeking and obtaining a Federal government bailout.[136]
Like all swaps and other pure wagers, what one party loses under a CDS, the other party gains;
CDSs merely reallocate existing wealth. Hence the question is which side of the CDS will have
to pay and will it be able to do so. When investment bank Lehman Brothers went bankrupt in
September 2008, there was much uncertainty as to which financial firms would be required to
honor the CDS contracts on its $600 billion of bonds outstanding.[137][138] Merrill Lynch's large
losses in 2008 were attributed in part to the drop in value of its unhedged portfolio of
collateralized debt obligations (CDOs) after AIG ceased offering CDS on Merrill's CDOs. The
loss of confidence of trading partners in Merrill Lynch's solvency and its ability to refinance its
short-term debt led to its acquisition by the Bank of America.[139][140]
Economist Joseph Stiglitz summarized how credit default swaps contributed to the systemic
meltdown: "With this complicated intertwining of bets of great magnitude, no one could be sure
of the financial position of anyone else-or even of one's own position. Not surprisingly, the credit
markets froze."[141]
[edit] Impact
Main articles: Financial crisis of 2007–2008 and Global financial crisis of 2008
[edit] Financial sector downturn
Main article: List of writedowns due to subprime crisis

FDIC Graph - U.S. Bank & Thrift Profitability By Quarter

As of August 2008, financial firms around the globe have written down their holdings of
subprime related securities by US$501 billion.[142] Mortgage defaults and provisions for future
defaults caused profits at the 8533 USA depository institutions insured by the FDIC to decline
from $35.2 billion in 2006 Q4 billion to $646 million in the same quarter a year later, a decline
of 98%. 2007 Q4 saw the worst bank and thrift quarterly performance since 1990. In all of 2007,
insured depository institutions earned approximately $100 billion, down 31% from a record
profit of $145 billion in 2006. Profits declined from $35.6 billion in 2007 Q1 to $19.3 billion in
2008 Q1, a decline of 46%.[143][144]
The crisis began to affect the financial sector in February 2007, when HSBC, the world's largest
(2008) bank, wrote down its holdings of subprime-related MBS by $10.5 billion, the first major
subprime related loss to be reported.[145] During 2007, at least 100 mortgage companies either
shut down, suspended operations or were sold.[146] Top management has not escaped unscathed,
as the CEOs of Merrill Lynch and Citigroup resigned within a week of each other.[147] As the
crisis deepened, more and more financial firms either merged, or announced that they were
negotiating seeking merger partners.[148]
[edit] Market weaknesses, 2007

A MetaView diagram shows the key subprime mortgage stocks as they undergo a chain reaction.
On July 19, 2007, the Dow Jones Industrial Average hit a record high, closing above 14,000 for
the first time.[149]
On August 15, 2007, the Dow dropped below 13,000 and the S&P 500 crossed into negative
territory for that year. Similar drops occurred in virtually every market in the world, with Brazil
and Korea being hard-hit. Through 2008, large daily drops became common, with, for example,
the KOSPI dropping about 7% in one day,[150][dead link] although 2007's largest daily drop by the
S&P 500 in the U.S. was in February, a result of the subprime crisis.
Mortgage lenders[151][dead link][152] and home builders[153][154][dead link] fared terribly, but losses cut across
sectors, with some of the worst-hit industries, such as metals & mining companies, having only
the vaguest connection with lending or mortgages.[155]
Stock indices worldwide trended downward for several months since the first panic in July–
August 2007.
[edit] Market downturns and impacts, 2008

The TED spread – an indicator of credit risk – increased dramatically during September 2008.
The crisis caused panic in financial markets and encouraged investors to take their money out of
risky mortgage bonds and shaky equities and put it into commodities as "stores of value".[156]
Financial speculation in commodity futures following the collapse of the financial derivatives
markets has contributed to the world food price crisis and oil price increases due to a
"commodities super-cycle."[157][158] Financial speculators seeking quick returns have removed
trillions of dollars from equities and mortgage bonds, some of which has been invested into food
and raw materials.[159]
Beginning in mid-2008, all three major stock indices in the United States (the Dow Jones
Industrial Average, NASDAQ, and the S&P 500) entered a bear market. On 15 September 2008,
a slew of financial concerns caused the indices to drop by their sharpest amounts since the 2001
terrorist attacks. That day, the most noteworthy trigger was the declared bankruptcy of
investment bank Lehman Brothers. Additionally, Merrill Lynch was joined with Bank of America
in a forced merger worth $50 billion. Finally, concerns over insurer American International
Group's ability to stay capitalized caused that stock to drop over 60% that day. Poor economic
data on manufacturing contributed to the day's panic, but were eclipsed by the severe
developments of the financial crisis. All of these events culminated into a stock selloff that was
experienced worldwide. Overall, the Dow Jones Industrial plunged 504 points (4.4%) while the
S&P 500 fell 59 points (4.7%). Asian and European markets rendered similarly sharp drops.
The much anticipated passage of the $700 billion bailout plan was struck down by the House of
Representatives in a 228–205 vote on September 29. In the context of recent history, the result
was catastrophic for stocks. The Dow Jones Industrial Average suffered a severe 777 point loss
(7.0%), its worst point loss on record up to that date. The NASDAQ tumbled 9.1% and the S&P
500 fell 8.8%, both of which were the worst losses those indices experienced since the 1987
stock market crash.
Despite congressional passage of historic bailout legislation, which was signed by President
Bush on Saturday, Oct. 4, Dow Jones Index tumbled further when markets resumed trading on
Oct. 6. The Dow fell below 10,000 points for the first time in almost four years, losing 800
points before recovering to settle at -369.88 for the day.[160] Stocks also continued to tumble to
record lows ending one of the worst weeks in the Stock Market since September 11, 2001."[161]
[edit] Indirect economic effects
Main article: Indirect economic effects of the subprime mortgage crisis
The subprime crisis has had a number of actual and likely economic effects. Declining house
prices have reduced household wealth and the collateral for home equity loans, which is placing
downward pressure on consumption.[162] Members of USA minority groups received a
disproportionate number of subprime mortgages, and so have experienced a disproportionate
level of the resulting foreclosures. Minorities have also born the brunt of the dramatic reduction
in subprime lending.[163][164] House-related crimes such as arson have increased.[165] There have
been significant job losses in the financial sector, with over 65,400 jobs lost in the USA as of
September 2008.[166] The unemployment rate rose to its highest level since 1994 in October 2008,
reaching 6.5%.[167]
Many renters became innocent victims, by being evicted from their residences without notice,
because their landlords' property has been foreclosed.[168] In October 2008, Tom Dart, the elected
Sheriff of Cook County, Illinois, criticized mortgage lenders for their actions vis-a-vis tenants,
and announced that he was suspending all foreclosure evictions.[169]
The tightening of credit has caused a major decline in the sale of motor vehicles. Between
October 2007 and October 2008, Ford sales were down 33.8%, General Motors sales were down
15.6%, and Toyota sales had declined 32.3%.[170]This contributed to a global automobile industry
crisis and possible government intervention.
The Impact of the Subprime Mortgage Crisis on the Markets of the Regional Countries
09/27/2007
Dr. Henry Tawfiq Azzam
The Economic Risks associated with the US mortgage crisis recently subsided when the US
Federal Reserve lowered the federal funds rate by 50 basis points. But the impact of this
crisis on global financial markets will remain visible during the coming weeks and months.
The crisis that began in the US soon turned into a financial crisis threatening most global
markets. Housing loans were converted to collateralized debt obligations and sold to
investment institutions in Europe, South America and other parts of the world. This caused
these institutions to incur different losses and get exposed to the risks associated with these
debts.
Arab Financial Institutions
Arab equity markets have remained immune from what is happening in the global markets,
and during the past few weeks have witnessed semi-natural fluctuations. The reason is that
the majority of the players in these markets are individual investors who do not have a
notable presence in the global arena, in addition to the lack of coherence between the Arab
and international markets.
The vulnerability of Arab Banks to the US subprime mortgage crisis and its financial
instruments is limited. Most Arab banks invest little in such tools. But, investors from banks,
institutions and global companies, who invested in real estate covered bonds or in hedge
funds that are invested in real estate covered bonds that were directly affected by the current
financial crisis, would incur losses in the amount of their holdings of such assets.
According to a recent "Standard & Poor’s" opinion poll, the total investments of the [Arab]
regional banks in the real estate mortgage bonds with low credit ratings do not exceed 1% of
the total assets of these banks, since the majority of their investments are focused on
financial instruments and derivatives with a good credit rating of (AAA) or (AA). In general,
the good financial performance of Arab banks in recent years and their strong capital base
and high profitability would enable these banks to absorb any losses that they might be
exposed to, due to this crisis.
Debt Securities and Sukuk
One of the crisis’ negative impacts is the postponement in issuing and marketing debt
securities or sukuk (Islamic bonds) issued in the region or re-pricing these bonds in a way
that reflects a decline in the liquidity in the market and weakness in the domestic and global
demand of these borrowing tools. The contraction that was recorded in the margin of
difference between the interest rate on bonds issued by developing countries and their
companies compared with the interest rates on debt instruments issued by developed nations
is expected to increase again to match the rising risks' rate that the markets have recently
experienced. It is worth mentioning that the interest rates on debt instruments issued by
developed nations had reached its lowest level before the current crisis.
Financing Merger and Acquisition Deals
Direct investment companies operating in the (Arab) region are less dependent on borrowing
for their mergers and acquisitions’ operations compared with those in developed countries.
But these firms have recently experienced a difficulty or a rise in the costs of financing new
acquisition deals. The process of reducing the excessive reliance on borrowing to finance
mergers and acquisitions would also have its impact on the domestic markets. Arab Banks
are now more cautious and selective in providing the required funds for direct investment
firms.
This means that deals of mergers and acquisitions that rely excessively on borrowing from
local or regional sources might be re-priced or canceled, and there will be more focus on
deals that can be financed in large part from cash flow of the targeted companies and from
the bridge loans that the banks offer. More direct investment funds will refer to investment
banks that can provide sophisticated Islamic lending structures to finance these acquisitions.
Investments in Arab Markets
The fluctuations that are taking place in the international capital markets will have some
impact on Arab bourses, especially equity markets, which allow global portfolios to invest in
them. In periods of crisis, investors tend to reduce risk and shift from emerging markets to
more liquid and safer investments such as government bonds. In spite of the small volume of
the global flows of investment portfolios to Arab domestic markets, they did eventually
contribute in determining the orientation of the Arab bourses. It is noteworthy that the largest
regional equity markets in terms of market value, namely the Saudi equity market, only
allows foreigners to hold shares indriectly, through investment funds managed by local banks
[Saudi Arabia has recently lifted remaining restrictions on share trading by Gulf Arab
citizens, as nationals of Kuwait, the UAE, Qatar, Oman and Bahrain can now trade in all
Saudi stocks]; while the UAE, Kuwait, Egypt, Qatar and Jordan markets are experiencing a
rising increase in the volume of foreign investments in their bourses.
The global hedge funds, which have recently become more active in the Arab equity markets,
have sold part of their holdings in these markets in an attempt to support their financial
performance and provide the needed liquidity. Furthermore, the region's equity markets were
negatively affected by the decline in acquisitions by the listed companies with the rise in
borrowing costs for the implementation of such operations.
Economic Slowdown
The biggest risk that may arise from the current financial crisis is the possibility of a global
economic slowdown. The monetary policy makers of the regional countries would feel
obligated to keep up the expansionary monetary policy that the US had recently pursued.
This would lead to a decline in domestic interest rates and exchange rates of the dollar-
pegged Arab currencies and would increase the inflationary pressures that have recently
emerged in a number of countries in the region.
The Way Forward
In conclusion, it can be emphasized again that the current crisis in the global financial
markets is not expected to have any notable effect on the regional financial markets, but its
impact will be greater in the event that it would turn from a financial crisis to an economic
crisis. Even if there is to be a slowdown in global economic growth, oil prices are not
expected to drop to below $60 a barrel from their current record peak. This means that the
economic performance of the GCC countries, which serves as the main engine of the
economies of other regional countries, would remain strongly backed by an expansionary
fiscal and monetary policy. Add to this the implementation of many projects in infrastructure,
and growth and expansion occurring in the private sector by the regional countries.
US subprime mortgage crisis hurts
individuals and whole communities
Tony Favro, US Correspondent

14 April 2007: Homeownership has long been the basis of community revitalization efforts in
American cities. Homeowners bring well-documented stability and investment to neighborhoods.
The recent rise in mortgage foreclosures, fueled by subprime lending, seriously threatens
neighborhood stability and revitalization.
| Growth of lending | Disparities & foreclosures | City responses |

Home purchases in the United States are typically financed by mortgage loans. Home mortgages are
indexed to the prime rate, that is, the interest rate commercial banks charge their most creditworthy
customers.

Mortgages with the lowest interest rates are available to customers whose creditworthiness, or ability to
repay the loan, is so high that there is little risk to the lender. “Subprime” mortgages are offered to
borrowers who don’t meet the credit standards for borrowing in the prime market. These loans are more
expensive for borrowers with rates higher than prevailing prime rates, presumably to compensate lenders
for the additional risks associated with lending to less creditworthy borrowers. Subprime loans are
characterized by low ‘introductory’ interest rates, usually for the first two or three years. These rates
frequently rise rapidly in subsequent years, resulting in payments that can increase hundreds of dollars
each month.

The subprime mortgage market has expanded dramatically in the US, growing at an annual rate of 25 per
cent between 1994 and 2005, a tenfold increase in a decade.

In 2005, the number of homeowners defaulting on their subprime mortgages began to soar. The
Consumer Federation of America, a nonprofit pro-consumer advocacy and research organization,
estimates that as many as 2.2 million of the 69 million homeowners in the US are at risk of defaulting on
their subprime loans and losing their homes.

The subprime mortgage problem in the United States has rattled world financial markets. The US
economy is robust enough to absorb the impact of substantial mortgage foreclosures. The fear among
global investors is that the subprime loan crisis is a symptom of deeper, as yet unknown, problems in the
US economy.

Subprime mortgage foreclosures are not just a problem for world financial markets. They are a serious
problem for American cities. Mortgage foreclosures in the US are geographically concentrated, and much
of that concentration occurs in cities.

In Detroit, 24.6 per cent of all subprime loan payments are in arrears for 60 days or more; in Jackson,
Mississippi, 22.0 per cent; in Boston, 15 per cent; in Sacramento, California, 14 per cent. Cuyahoga
County, Ohio – which includes Cleveland and 58 suburban cities – had 13,000 foreclosures in 2006, up
from 2,500 in 1995, according to The New York Times.

A home is generally an individual’s or a family’s largest investment and greatest asset. Therefore, the loss
of a home can be a shattering personal tragedy. It is also a neighborhood tragedy. Concentrations of
foreclosures can lead to vacant, shuttered properties, which in turn can lead to criminal activity,
neighborhood blight, and declining real estate values.

An estimated 10,000 of Cleveland’s 84,000 single-family homes are vacant. In the city’s Slavic Village
neighborhood, over 900 homes were abandoned in the past four years. “Our neighborhoods are
becoming ghost towns,” said Inez Killingsworth, a neighborhood activist. “You can’t get out. You can’t sell
your house. The value keeps decreasing.”

A 2007 study by the Woodstock Institute, a nonprofit community development research group, shows that
even a single foreclosure has a negative impact on a neighborhood. Houses within an eighth mile of that
foreclosure immediately lose one per cent or more of their value.

The report also notes “a clustering of foreclosures around low-income and minority communities,” where
residents often have little job security, little financial savvy, low creditworthiness, and few borrowing
options.

Growth of subprime lending

In 1994, fewer than five percent of mortgages in the US were subprime, but by 2005 nearly 20 percent of
new mortgage loans were subprime. The sharp increase is due primarily to changes in the banking
system.

Fifteen years ago, American communities were served by commercial banks, which offered almost
exclusively fixed-rate, prime-market mortgages. Few alternative mortgage products were available to
consumers.

Today, commercial banks are no longer the leading originators or holders of residential mortgages.
Changes in federal laws now allow other financial institutions such as insurance companies, stock brokers
– even Wal-Mart – to offer mortgages. Mortgage brokers and mortgage finance companies compete
aggressively with traditional banks to offer new products to consumers. The increased competition has
resulted in a wide variety of mortgage products and choices for prospective homeowners, including
subprime loans.

In 2005, interest rates began to rise in the US after a decade of stable or gradually declining rates. As a
consequence of rising interest rates, demand for homes fell. Home sales began to slow, leading to falling
home prices.

Many homeowners with subprime mortgages were hit with a double blow. They couldn’t cope with
payment increases, nor could they sell their homes or refinance their high-cost mortgages because of the
slow real estate market and price depreciation. In Merced, California, for example, the Wall Street Journal
recently reported that homes were 77 per cent overvalued, the city had the nation’s sixth highest share of
subprime loans (21.6 per cent), and the rate of mortgage foreclosures increased 50 per cent since 2005.

Disparities in lending and foreclosures

Subprime mortgages have helped expand homeownership for all racial and income levels in the US.
Between 1995 and 2006, the homeownership rate increased seven per cent among white households, 13
per cent among African-American households, and 18 per cent among Latino households. In lower-
income urban neighborhoods, the rate of homeownership grew six per cent, versus the four per cent
growth rate in higher-income suburban areas.

Despite recent gains in homeownership rates, minorities are facing foreclosure or losing their houses
disproportionately. A 2007 study by the Center for Responsible Lending, a nonprofit homeownership
research group, concludes that African-Americans and Latinos are more likely than whites to be steered
into high-risk subprime mortgages.

This national study, based on information from the US Federal Reserve and replicated by several smaller
studies, demonstrates that Blacks are 3.2 times more likely to receive a subprime loan than white
borrowers. After adjusting for differences in credit scores, income, and other risk factors between average
Black and white borrowers, the study finds that Blacks are still 1.6 times more likely to get a subprime
loan than whites when purchasing a home.

These findings are not surprising. Minorities in the US have a long history of rejection from prime-rate
lenders. And American city governments – responsible for most of the nation’s poor minorities -- have had
to acquire expertise in loss-mitigation techniques, alternative mortgage financing, and legal issues related
to subprime lending and personal bankruptcy in order to combat mortgage foreclosures.

City responses
While the federal government debates how to better regulate subprime lenders and protect subprime
borrowers, cities are left to deal with foreclosed homes and devastated families.
Urban poor and minority homeowners are particularly vulnerable to foreclosure when they or a family
member experience one or more of the “six D’s: disability, disease, death, divorce, discrimination, and
downsizing (job loss),” according to Bob Barrows, a housing consultant and retired Director of Housing
and Project Development for the City of Rochester, New York.

Rochester has the oldest active mortgage default counseling program in the US. Operating since 1988 in
partnership with the nonprofit Housing Council of Rochester, the widely-publicized program is available to
all city homeowners who meet certain income guidelines. The program offers pre- and post-purchase
counseling in debt-management, family-budgeting, home maintenance, foreclosure-prevention, and
refinancing.

In 2000, Rochester funded a major study of foreclosures in the city. The study led to several innovative
initiatives, including city-funded mortgage relief grants to bring eligible homeowners current on their
mortgages and a partnership with the nonprofit Empire Justice Center to bring lawsuits against predatory
lenders.

The Rochester experience is emblematic of how many US cities now confront foreclosures. Cities are
gaining the requisite financial and legal knowledge. They are partnering with nonprofit organizations to
provide early-delinquency intervention, counseling, and financial assistance; and they are beginning to
pursue subprime lenders in the courts. For example:

The Mortgage Foreclosure and Prevention Program in Minneapolis and St. Paul, Minnesota works with a
network of community-based organizations to provide in-depth counseling on financial and personal
issues, intervention and advocacy with mortgage lenders, and assistance in accessing funds for
homeowners at risk of losing their homes.

Chicago’s well-advertised Home Ownership Preservation Program works directly with subprime lenders to
mitigate foreclosures by working out payment terms for homeowners who fall behind on their loan
payments. The program also provides financial assistance through a multi-million dollar loan program,
and offers homeowner counseling. HOPP is credited with preventing nearly 1500 foreclosures in targeted
Chicago neighborhoods where the foreclosure rate is up to five times the national average.

The Colorado Housing Counseling Coalition is a diverse network of nonprofit organizations which offers a
wide range of services (i.e., debt counseling, financing, home maintenance, etc.) to a broad range of
clients (i.e., elderly, families, disabled, etc.). The Coalition applies whatever resources its member
organizations can offer to homeowners at risk of foreclosure, by referring homeowners to other members
as necessary. The Coalition works in Denver and other Colorado cities.

NeighborWorks of West Vermont works with homeowners in the small town of Rutland, Vermont
(population 17,000) and three rural counties. It provides loans for housing repairs and family emergencies
and offers extensive homebuyer education classes and family counseling. The goal of the program is to
build relationships with homeowners that last beyond the initial purchase and become a long-term
resource for them.

Most foreclosure intervention programs in the US focus on low-income minority neighborhoods that have
seen a dramatic rise in subprime lending over the past two or three years. With great effort, these
programs can help prevent foreclosures. But they can’t stop subprime lending.

Twenty per cent of subprime mortgages originated since 2005 are expected to end in foreclosure,
according to the Center for Responsible Lending. The damage to American cities will therefore continue,
undermining years of neighborhood revitalization efforts.