Back! And looking for questions...

Hi everyone! After a break from politics and book events, I'm back to talk about the book and answer your questions on everything that's happened in the last few months -- and I'll post some more excerpts in the coming weeks.

(Speaking of the book, if you don't have it yet, here's your chance!)

A few things that have been on my mind lately...

What happened to the economy? Some of the causes of the collapse were visible a year ago when I was finishing the book; some of them came almost out of nowhere.

What do you think about the bailout and the stimulus? Are we doing the right thing? What should we do? If you could give President Obama one suggestion, what would it be?

Is it baseball yet? I can't wait for Opening Day. And if Lowell and Papi are healthy this year, then the Sox are going to be good. Like really good. I hope.

So what's on your mind? Email me at questions@jessamynconrad.com!

Excerpt - The Subprime Mortgage Crisis

Starting today, I'll be posting a series of entries with excerpts from the book that relevant to current headlines. And remember, if you have anything you're particularly curious about, send in a question to jessamynconradpolitics@gmail.com.

Our first topic will be the one on everyone's minds -- the subprime mortgage crisis, which is covered in Chapter 3: The Economy. I've also added a bit of material from recent weeks, as the crisis has become much worse since the book went to press in June.

In 2007 a slowdown in the once-fiery housing market turned talking heads, and the words "subprime mortgage crisis" fell from pundits' lips like so many economic pie crumbs. Mortgages are loans for real estate that take the property itself for collateral (the asset used to guarantee the loan). Subprime loans cost more than normal loans because they are particularly risky, or more likely to go into foreclosure. Foreclosures happen when people cannot pay their mortgage and the property they have bought with the loan is taken by the lending agency. Banks lost billions on bad loans as families across the country fell into foreclosure. Though the media generally blamed a cooling market for the troubles, the mortgage crisis had complex -- and instructive -- roots. In fact, understanding just what happened gets you to the heart of America's monetary policy.

It all started when the government decided to deregulate the banking industry. Deregulation occurred over a period of fifteen years, beginning in 1980. Before then, strict laws controlled how banks could market mortgages, what interest rates they could charge, and even under what criteria people could take out a loan. People who couldn't afford mortgages weren't given them; this led to a basic understanding that when you applied for a mortgage, a lender would give you only an amount you were likely able to repay. That expectation proved disastrous for many Americans.

To entice people into taking out mortgages, many lenders offered teaser rates, very low interest mortgages that required either no down payment or a very small one, usually attached to a variable rate mortgage. Variable rate mortgages [or adjustable rate mortgages, or ARMs] are loans whose interest rates can change, while normal mortgages are fixed rate loans whose rate doesn't change. Variable rate mortgages seem attractive when interest rates are low, but they are risky because if interest rates go up, loan payments can rise significantly overnight. If you have no financial cushion, that can be devastating -- and people who bought these loans were by definition subprime borrowers, people with less than sterling credit ratings who didn't have extra money.

Variable rate mortgages were popular when the real estate market was very hot and people were buying property to make a quick buck by flipping, meaning that they only held the variable rate mortgage for a short time, thus minimizing their financial risk. But if there's a downturn in the housing market and your house doesn't sell and you have a variable rate mortgage with an increasing rate, you could have a big problem. In addition to dealing with higher payments from rising interest rates, if you put down no or only a little money, you aren't actually paying down the debt on the house; you're mostly paying interest. If you put down $100,000 on a $500,000 house, you already own 20 percent of it. If you put down nothing, you don't own anything, and your mortgage payments will mostly be interest on the loan -- you'll be buying the house at a very slow rate.

Other kinds of deregulation also spurred the growth in subprime mortgages. Key laws passed in 1986 and 1999 allowed for what's called increased securitization. This is pretty complicated, but the upshot is that the new laws created incentives for the finance industry to invest in mortgages by betting on the risk of the loans. These new financial tools were so complex, however, that investors couldn't accurately assess the risks of the investments they were buying.

Unfortunately, they were ultimately betting on people's ability to pay back questionable loans. When increasing numbers of Americans couldn't make their payments, the value of these securities dropped precipitously, sending many large and imprudent banks into a tailspin. A more serious crisis was averted when a big Main Street bank, Bank of America, bought a big Wall Street mortgage lender, Countrywide, bailing it out from near ruin. [But recent events have deepened the crisis, as Wall Street fixtures Lehman Brothers and Bear Stearns collapsed under the weight of the bad debt; the federal government stepped in to take over American International Group; and the giant Main Street bank Washington Mutual fell -- the largest bank failure in American history.] So there were really two pieces to the mortgage crisis: one, there were the people who took out loans they couldn't afford and the lenders who pushed and sold those loans; and two, there were banks investing in those loans in new and risky ways. Both were products of deregulation.

Many Democrats feel that the lending industry hoodwinked gullible consumers into taking out mortgages they couldn't afford. Pro-business Republicans and some Democrats stress personal responsibility and point out that if people make bad financial decisions, it's their own fault. They weren't forced to take out risky loans; they did it of their own free will. Most Democrats respond that it's only natural that low-income people wanted to buy a house -- a staple American dream -- the second it looked feasible. They argue that many just assumed a bank would not extend a risky mortgage. Before deregulation, that was a reasonable assumption.

Both Democrats and Republicans are right. Of course people want to buy a house, of course many are ignorant when it comes to money, and of course it's fundamentally our own responsibility to read the fine print. The real question is who should assume responsibility now that the housing market has failed on the weakness of bad loans. Should we force the lending agencies to be less harsh? Should we freeze interest rates so fewer people lose property? Are the other effects of freezing interest rates too detrimental to the economy? Should we let banks operate independently?

Copyright © 2008 by Jessamyn Conrad

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