Subprime Crisis to Cost U.S. $2.3 Trillion

The report, The Subprime Lending Crisis: The Economic Impact on Wealth, Property Values and Tax Revenues, and How We Got Here, was released today by U.S. Senator Charles E. Schumer, (D-N.Y.,). The report claims to be the first of its kind to project economic costs by state.

“We are headed for billions in lost wealth, property values, and tax revenues,” Schumer said in an announcement.

The subprime mortgage crisis was the result of unregulated mortgage companies that weren’t subject to the Home Owners’ Equity Protection Act or the Community Reinvestment Act; the “slicing and dicing” enabled through mortgage securitizations; and the “perverse incentives” such as yield spread premiums and lack of accountability when loans went bad for mortgage brokers, which originated nearly two-thirds of subprime loans in 2006, according to the study. Also criticized were hybrid programs such as 2/28 and 3/27 adjustable-rate mortgages — which accounted for 72 percent of subprime ARMs originated in 2005, the targeting of vulnerable borrowers and the rise in no documentation programs.

Borrowers had been able to refinance hybrid ARMs during times of rising home values, such as the period between 1997 and 2006 — when home price appreciation was 85 percent, the study indicated. California and Florida were among the states with the highest appreciation.

“A significant increase in lax (and often predatory) subprime lending during a period of rapid housing price appreciation put risky adjustable-rate mortgages in the hands of vulnerable borrowers who are now facing substantial payment shocks and risk foreclosure when their loans reset this year and next,” the report said. “Although underwriting standards in the subprime lending market began to decline after 2001, the effects of this decline were, until recently, mitigated by house price appreciation.”

As many of an estimated 3 million outstanding subprime ARMs will reset during the rest of this year and in 2008, 1.7 million foreclosures are projected by 2009 in addition to the roughly 0.3 million that have already occurred this year. The “tsunami” of foreclosures is expected to directly and indirectly reduce U.S. residential property values by $106 billion.

Schumer, along with three other senators, cited a study on Philadelphia home prices that suggested properties located within 150 feet of foreclosed properties declined by an average of 10 percent while those within 450 feet fell an average of 5 percent.

The resulting lower values will reduce property tax revenues by $917 million, while overall economic losses attributable to the foreclosures are projected at $2.3 trillion, the report said.

“The ten states with the greatest number of estimated foreclosures, in descending order, are California, Florida, Ohio, New York, Michigan, Texas, Illinois, Arizona, Pennsylvania and Indiana,” the study stated. “There are, unfortunately, several others that are close behind in the rankings.”

Among solutions outlined were a boost in funding for foreclosure prevention counseling services, an increase in portfolio limits for Fannie Mae and Freddie Mac, and an expansion of the Federal Housing Administration’s ability to refinance subprime borrowers. The report also called for an amendment to the bankruptcy code that would enable judges to lower the amount of a mortgage to the fire sale value of the security and an amendment to the tax code that considers deficiency balances on foreclosed mortgages as taxable income.

The senators also recommended an increase in loan modifications as well as stepping up predatory lending regulations. Among anti-predatory lending actions suggested were the mandatory escrowing of taxes and insurance on all loans, the elimination of prepayment penalties and increased oversight of mortgage brokers. In addition, federal laws need to replace the patchwork of state laws that were “all-too-easily evaded by subprime mortgage brokers and lenders.”

“State by state, the economic costs from the subprime debacle are shockingly high,” Schumer said in the announcement.

“In the world of subprime lending, the chickens have come home to roost,” Senator Amy Klobuchar, (D-N.Y.,) stated.

Sam Garcia worked in mortgage lending for twenty years prior to becoming publisher of MortgageDaily.com.

e-mail: mtgsam@aol.com