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Looking for ways out of the subprime mortgage crisis

Story Highlights

• 2 million people with subprime loans are facing foreclosure
• Some economists say the mortgage defaults could spur recession
• Federal Reserve chair says impact likely contained
• Members of Congress contemplating action
By Kristi Keck
CNN
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(CNN) -- The recent wave of defaults in the subprime mortgage sector that sent shocks through Wall Street has caught the attention of Congress.

More than 2 million people with subprime loans are facing foreclosure this year and nearly 20 percent of subprime mortgages issued between 2005 and 2006 are projected to fail, according to a December 2006 study by the Center for Responsible Lending, a nonpartisan research and policy organization.

Foreclosures in the subprime mortgage market are expected to cost American households as much as $164 billion in lost equity from 1998 through 2006, the center reported.

Meanwhile, at least four subprime lenders have filed for bankruptcy since late December and many others closed last year.

Observers of the credit industry place the blame on predatory lenders and borrowers ignorant of the loans' terms and conditions.

Subprime loans are typically granted to people with less than perfect credit. The loans have low interest rates for the first two or three years.

In some cases, the loans are then adjusted to a higher rate every six months to a year, making the monthly interest payment much higher than the borrower may have initially planned for.

Some economists say the mortgage defaults in the subprime sector could push the economy into a recession, because lenders are tightening their standards and making it more difficult for people to get loans.

But Federal Reserve Chairman Ben Bernanke told Congress Wednesday that while the problems in the subprime mortgage sector have caused "severe financial problems for many individuals and families," they may not affect the overall economy.

"At this juncture ... the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained," he said.

'Unconscionable' practices

Senate Banking Committee Chairman Christopher Dodd called the predatory lending practices "unconscionable and deceptive" at a hearing last week to investigate the subprime mortgage crisis.

Dodd, a Democratic presidential hopeful from Connecticut, outlined what he called a "chronology of neglect" by federal regulators.

He said Federal Reserve analysts first noticed eroding lending standards from late 2003 through early 2004. At the same time, Dodd said, the Federal Reserve Board was encouraging lenders to come up with more adjustable rate plans.

Meanwhile, a series of hikes by the Federal Reserve raised interest rates from 1 percent to 5.25 percent, pushing many adjustable rate mortgages beyond the means of borrowers, Dodd said.

"In my view, these actions set the conditions for the 'perfect storm' that is sweeping over millions of American homeowners today," he said.

"Our nation's financial regulators were supposed to be the cops on the beat, protecting hard-working Americans from unscrupulous financial actors," he said. "Yet they were spectators for far too long."

Deregulation of the lending industry -- especially during the housing boom of the early parts of this decade -- also contributed to the problem, according to Robert Manning, director of the Center for Consumer Financial Service at the Rochester Institute of Technology and author of the book "Credit Card Nation."

During that period, many homeowners were encouraged to consolidate their high-interest and revolving credit card debt into their lower-cost mortgages with hopes that it would help them save money, Manning said.

Consequently, mortgage debt levels more than doubled from about $6 trillion in 1999 to nearly $13 trillion today, according to Manning's testimony before the Senate Banking Committee this year.

As lender fees got higher and the number of adjustable rate mortgages rose, the hoped-for consumer savings were either reduced or failed to materialize. Suddenly, many of those loans were at risk of default.

"The subprime sector is simply the leading edge and it's the most volatile," Manning said. "It's those people that are least able to adjust to fluctuations in their abilities to pay for higher debt levels."

Looking ahead

Dodd wants to end abusive lending practices and help homeowners who may face foreclosure.

"We cannot simply sit back and watch as up to 2.2 million families lose their homes and, with them, their financial futures," Dodd said.

Dodd told CNNMoney.com this week there was "enough on the books" to help borrowers avoid losing their homes and that new regulation may be unnecessary.

Massachusetts Rep. Barney Frank, the Democrat who leads the House Financial Services Committee, said there wasn't much that could be done for borrowers in trouble.

"It is very hard to go back and undo this," he said in a telephone interview. "What we can do is pass legislation that makes it less likely that these kinds of loans will be given in the future."

Frank did not offer specifics on possible legislation.

"We know what the problem is, we have some general ideas about how to solve it, but there's nothing to be gained by speculating how," he said.

CNN's Manav Tanneeru contributed to this story.



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Nearly 1 in 5 subprime mortgages issued between 2005 and 2006 are projected to fail, according to a recent study.

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