Center for Business and Economic Research - Ball State University


CBER Data Center
Projects and PublicationsEconomic IndicatorsWeekly CommentaryCommunity Asset InventoryManufacturing Scorecard

About

Commentaries are published weekly and distributed through the Indianapolis Business Journal and many other print and online publications. Disclaimer

RSS Feed

Disclaimer

The views expressed in these commentaries do not reflect those of Ball State University or the Center for Business and Economic Research.

Recent

Trump’s Tariff Recession Is HereMy new forecast, completed in late April, predicts a national recession began as early as March in reaction to Trump’s tarriffs.

Two Key Economic Lessons in One BillHoosiers face trade-offs and opportunity costs in the wake of SEA1.

Time to Fix Economic Development PolicyAllocating tax dollars to land development won’t cause economic growth.

The Unanticipated Effects of SB1Businesses, governments and households may all feel the effects.

View archives

Top Tags

jobs and employment 261
economics 202
state and local government 188
education 186
indiana 172
economic development 171
budget and spending 145
taxes 145
law and public policy 143
workforce and human capital 139
Browse all tags
Reporter / Admin Login

October 6, 2008

Subprime Loans Add to Wall Street Chaos

Underlying the current financial turmoil is a significantly dreary problem in housing markets. It is a bit easier to understand, but understanding will almost certainly lead to anger and frustration. 

The 1995 revisions to the Community Reinvestment Act specifically permitted sub-prime loans. The intent was laudable enough, to provide lower income Americans a chance to buy homes and force financing to local businesses. The former worked quite well, but in a 2004 academic paper I reported minimal effect of lending on rural businesses. I should note that the first version of the paper was met with a very angry response by an editor whose life’s work focused on microfinance to rural areas. In retrospect it wasn’t the failure of the CRA that caused problems, but rather its success. 

Subprime loans are those made to individuals who wouldn’t qualify for traditional loans at market rates. The chief impediments to loans for these folks are available down payment, income, or a history of bad credit. These are folks who would not have received a home mortgage in years past or who took advantage of some special characteristic of the loan. Making a subprime loan to someone locally offered the chance to easily meet the requirements of the Community Reinvestment Act. This is a clarion call for less, rather than more regulation of financial markets. 

In Indiana about a quarter of mortgage loans over the past few years were subprime. An unknown, but significant proportion of these loans had adjustable rate mortgages. This means the mortgage payment rises as the interest rate rises. This is risky.

The good news is that less than 7 percent of all mortgages are subprime adjustable rate mortgages. The bad news is that these loans represent about half the foreclosures. The ugly news is that these mortgages were sold into financial instruments that now pollute the financial system. The question that remains is what to do about it? 

First we cannot forget the borrower. The mathematics of mortgages are covered by about 8thgrade. Cries of predatory lending should be muted. Lenders who have made the loans are suffering enormous financial difficulties, as well they should. Sympathy is not the emotion of the day for either group. 

As an economist I am loath to give business leaders advice on their operations. But my reticence fades in the face of the sluggish response by so many lenders. Banks holding subprime ARM’s should have been re-setting these mortgages no later than last winter. Failure to reset these mortgages has compounded the problems on Wall Street.

In all fairness, most commercial banks have worked hard to reset loans and avoid foreclosure. I suspect that the larger lending institutions are too large and unwieldy to handle the task. They have insufficient loan officers and too little information about local markets to do the work. As a result more than half of all the growth in foreclosures over the past two years has been from subprime ARM’s. That’s just bad business.

Link to this commentary: https://commentaries.cberdata.org/93/subprime-loans-add-to-wall-street-chaos

Tags: finance


About the Author

Michael Hicks cberdirector@bsu.edu

Michael J. Hicks, PhD, is the director of the Center for Business and Economic Research and the George and Frances Ball distinguished professor of economics in the Miller College of Business at Ball State University. Note: The views expressed here are solely those of the author, and do not represent those of funders, associations, any entity of Ball State University, or its governing body.

© Center for Business and Economic Research, Ball State University

About Ball State CBER Data Center

Ball State CBER Data Center is one-stop shop for economic data including demographics, education, health, and social capital. Our easy-to-use, visual web tools offer data collection and analysis for grant writers, economic developers, policy makers, and the general public.

Ball State CBER Data Center (cberdata.org) is a product of the Center for Business and Economic Research at Ball State University. CBER's mission is to conduct relevant and timely public policy research on a wide range of economic issues affecting the state and nation. Learn more.

Terms of Service

Center for Business and Economic Research

Ball State University • Whitinger Business Building, room 149
2000 W. University Ave.
Muncie, IN 47306-0360
Phone:
765-285-5926
Email:
cber@bsu.edu
Website:
www.bsu.edu/cber
Facebook:
www.facebook.com/BallStateCBER
Twitter:
www.twitter.com/BallStateCBER
Close