Can the Fed rescue the Subprime Market?

In the last meeting of the Federal Reserve, Chairman Ben Bernanke and colleagues chose not to lower the interest rates. However, not too long after that meeting on August 17, Bernanke chose to cut its discount rate, the interest rate on loans made directly to banks by the Federal Reserve. This has led to a tumultuous time for Wall Street.

Since the start of trouble in the subprime mortgage loan sector at the beginning of this year, lenders and homeowners alike have been tossed back and forth by the winds of change and uncertainty. The equity markets have suffered some of their worst losses in the last half century with hedge funds being hit the hardest. This coupled with the rise in oil prices and stagnating domestic growth, all eyes are now turning to the the Federal Reserve to do something to stem the tide. Many of those calling for action, remember the hands on approach by Bernankes' predecessor Alan Greenspan. During the tenor of Greenspan, immediately after the tragic September 11th crisis and the "Internet Bubble" meltdown, the Fed Chief lowered the interest rates multiple times in an effort to stem the time of a looming recession. A hands on approach that many believe was a precursor to our current mortgage woes.

While this is a positive approach that will aid in the salvation of mortgage lenders, hedge funds and wealthy investors who are tied closely to the money supply issues, how will lowering the interest rates assist the everyday homeowner? A lower interest rate is a blessing in the sky to those homeowners who mortgage payments are tied to Adjustable Rate Mortgages or ARMs as they are commonly known. But, is this truly the answer to the homeowners' woes?

I am not sure that lowering the Fed Fund Rate, the rate by which the lenders tie their mortgage rates to will be the answer? The truth to the matter is that when interest rates were at a historic low, many of the lenders at the time dropped the ball. Loans were made to available to the subprime market at an astounding rate. The borrowers were a gigantic overall risk, but because of the loose money supply spurred on by lower interest rates, lenders saw an opportunity to grow their portfolios. This resulted in loans being made to individuals who ordinarily did not qualify. Not to mention the growing segment of the mortgage borrowers who fit into a class of loans known as "Alt A". These were borrowers who possessed marginal credit that were not all together disqualified under normal terms, but did not possess credit that met the industry standard. Many of the "exotic" loans such as "interest only" loans and "no doc" loans were a product of this group.

Whatever the Federal Reserve and Ben Bernanke choose to do over the next few days, it is apparent that a call for swift action is needed. Homeowners are falling by the wayside. In the face of an oncoming tide of continued credit woes, the subprime meltdown is looming threat that must be taken seriously.

Subprime Headache??

This weekend I read an excellent article in Bloomberg magazine which encapsulated the entire Subprime mess that is weakening the Stock Market.

One portion of the article in the magazine which caught my attention was how the high flyers of 2004-2005 were feeling the pinch now that the "chickens have come home to roost." Some of the top name in the subprime sector: Countrywide Financial, Ameriquest, Option One, Freemont, First Franklin are hemorrhaging. First Franklin has been sold. Freemont is on the way out. Ameriquest, with its myriad of problems, shut down all of its retail offices! Others are selling off their portfolios and closing their doors never to be seen again. This here is akin to the Dot Com Bubble of 2000-2001.

Now the Federal Reserve and Fed Chairman Ben Bernanke late last week pumped $3.2 Billion dollars into the system to provide liquidity to the various banks that are suffering. This was don't to shore of the markets and hopefully provide some stability.

Something tells me that this is in the end to the subprime woes.

Subprime Mortgage Loans

The recent slide in the equity markets on Wall Street can be directly tied to the mess that was created in the subprime mortgage industry. What has resulted is a meltdown of the entire industry.

How did the mortgage industry get to this situation and what exactly is a subprime mortgage loan? Subprime mortgage loans are loans made to borrowers who possess a low credit score or a poor financial background. Over the last past decade, the subprime mortgage market has grown at an amazing rate. This has allowed individuals who may have not normally been able to obtain a mortgage loan the opportunity to do so.

After the slowing down of the economy between 2002-04, the Federal Reserve lowered Interest Rates to historically low levels. During this period, homeowners refinanced their homes to take advantage of the rate drops. Serving as a mortgage loan officer, I personally witnessed borrowers who refinanced their homes at least THREE times in the space of less than 3 years! This is unprecedented in the area of personal finance and home ownership.

Seeing an opportunity, mortgage lenders used the availability of cheap money to make available loans to anyone and everyone. While providing loans to as many borrowers as possible is never bad; the requirements and the type of loans were what was suspect.

The mortgage industry began to add new terms to their lexicons with loans as "no doc" or "interest only loans". This is where the problems erupted. These "exotic" loans were new to the industry and wisely or unwisely took advantage of the market. Subprime loans were being offered to individuals of dubious credit knowledge that teased them with very low starter interest rates or payments. Usually, at a period of 24-36 months these rates would increase to the current interest rate. Many borrowers had the mindset that they would just refinance their mortgage at the time of the recalibration of the loan in order to get a better and more stable interest rate.

As you can see, this has not been the case with many homeowners. An overall slowdown in the real estate market has been a nail in the coffin for many borrowers who are now experiencing foreclosure notices. We can only wonder what is in store for the equity markets continue to suffer.