Lay Down Your ARMs: Disarming America of Killer Mortgages
Richard Cole Fay
Submitted in Partial Fulfillment of Graduation Requirements for Trinity Classical Academy
Mr. Weichbrodt
12th Rhetoric
25 February 2017
Exordium:
Since America was conceived, it has progressed at a frantic pace, leading Americans to use simple words like “darn” as a negative interjection opposed to a day to day chore. For those who are unaware, Webster defines “darn” as “mending clothing by weaving yarn across a hole”. For centuries, this was the only use of the word darn. Then the disposable nature of clothing made its technical use obsolete.
Until the early 20th century, socks were made entirely by hand. When they began to wear out, they’d be mended for years until there was nothing left to mend. Going to the store to pick up a pack of socks because they had worn out was entirely unheard of. Darning was a common practice until after World War II, when the U.S. began importing cotton and nylon socks from China. From then on, clothing became more and more disposable. Now, machinery and materials are exploited in order to expedite the production process, rendering it entirely impersonal. In many aspects, the history of housing is not much different.
Until the early 20th century, soliciting a construction company to build a home was an option only considered by the wealthy. From the Pilgrims landing at Plymouth Rock till the late 1800s, nearly all low to mid-upper class homes were hand built by their future inhabitants. Home ownership was a matter of personal pride and a mark of accomplishment until the early part of the twentieth century.
As odd as it might sound, Sears played a key role in this transition due to their introduction of prefabricated houses. They released 340 different models in 1908, quickly selling 75,000 homes ranging in price from $482 to $2,909. The kit included all necessary materials and furnishings to construct a completed home. This allowed anyone to pick their plot of land, their preferred model, and have their chosen kit shipped directly to them by rail car. These easily accessible kits were regularly purchased then handed over to private contractors for quick and proper assembly. These kits seeded the idea of immediate fulfillment in the daily lives of Americans. They ignited a national revolution to the American housing experience, in which residence contractors rose to play an active role in the development of communities, and grew what we today recognize as the housing market.
The progressive changes in the 1900s directly influences the way that current housing construction is conducted. Companies such as Lennar and KB Homes deliver preorganized kits of specific models to the purchased land and put entire communities up in a year’s time. The primary difference between now and a century ago is distinct: instant gratification.
The instant gratification of our society has entirely depleted the beauty of what a home once was. It is all too common to “window shop” homes now a days. As petty as it may seem, the labor and pride that went into homes until the 20th century kept patience and hard work at the helm of a homeowner’s success. It is the absence of this patience that permitted the rise of on-demand housing. This, in turn, directly resulted in a need for compensation for such housing. Instead of working and saving, anyone with a credit score and a pulse could go and buy a home all but instantly. As with a pair of socks.
The medium for this evolution was the home loan, or as we affectionately know it, the mortgage. Mortgages began as 30 year payment process for owning a property which you would leave to your children. The idea of agreeing to 30 years of debt for something one will sell in 10 years should be a red flag for anyone. Instant gratification created a multi-trillion dollar loan industry for the millions of Americans who simply could not afford a home. Lending agencies have come to rule the housing market and they dictate who can live where, and for how much. That being said, they have had to continuously come up with new and more complicated ways to sell a borrower a home for which they do not have the liquidity. The method in particular to be evaluated, is that of the adjustable rate mortgage (ARM).
Narratio:
Any introduction to the discussion of ARMs requires first a brief overview of the American home loan enterprise, as this industry is the setting for the greatest shifts within our societal struggle with traditional expectations and the march of progress. Prior to the Great Depression, home mortgage loans were entirely privatized. However, following the loss of millions of homes and life savings, the government took up the responsibility of regulating and overseeing the housing market. It was the laissez faire approach to the market that directly resulted in economic downpour. The decade following the 1929 crash proved to be a lasting consequence of privatized markets which created a desperation for government intervention. In 1938, Franklin Delano Roosevelt put his “New Deal” through congress. This reform was intended to jumpstart the economy by initiating government programs such as social security, public education, public works, etc… As an amendment to the National Housing Act, a subsection of the New Deal, a division called the Federal National Mortgage Association known as Fannie Mae was assembled. Its main aim was to help repair the 25% of mortgages in default at the time, a term that Webster defines as the “failure to pay debts”.(Webster) Fannie Mae’s purpose was to boost up the secondary mortgage market by compiling mortgage loans (a practice called ‘scrutinizing’) into investable mortgage-backed securities (MBSs). In 1950, Fannie Mae became a Government-sponsored enterprise (GSE), meaning that it was privatized but the government had a say in their monetary and business decisions. GSEs also have a direct feed from the U.S. Treasury due to their alliance with the Federal Reserve. Rajan Raghuram, financial professor and author of the book Fault Lines, said:
Financing for mortgages dried up. To compensate, the government tried to bring more direct financing capacity into the market by splitting Fannie Mae into two in 1968- creating a Government National Mortgage Association (GNMA or Ginnie Mae) to continue insuring, packaging, securitizing mortgages, and a new, privatized Fannie Mae that would finance mortgages by issuing bonds or securitized claims to the public. (Raghuram 33)
Even after the economy had fully recovered from the Great Depression, the systems established during the crisis continued to play an active role in the housing markets. In 1970, the government founded the Federal Home Loan Mortgage Corporation (known as Freddie Mac) in direct competition with Fannie Mae. They sought to recreate what Fannie Mae once was, prior to it being revived as a GSE. Freddie Mac’s sole purpose was for the government to regain a hold of the housing market.
It was not until 1978 that Fannie Mae decided to issue their first mortgage backed security. At this point it is helpful to iterate how MBSs work with relation to the housing market. An MBS is a type of investment that the GSEs like Fannie Mae and Freddie Mac compiled in order to allow for secondary investing in the housing market. They are comprised of thousands of mortgage loans that are similarly rated (AAA, AA, A, BBB, BB, B, etc.) by rating agencies. The rating refers to a specific borrower’s credit score and risk assessment. When referring to a security, it is the overall average rating of the mortgage loans compiled together. Investors can then invest in the individual securities. Generally, the higher the rating, the stronger the investment. A well-rated MBS typically implies slow but sure growth whereas a poorly rated security would likely fluctuate dramatically. A high quality MBS generally has mostly “A”s and “AAA”s mixed in with a few “B”s for diversity. A poor quality security would be the inverse of that. The concept of these securities is fairly harmless on paper.
The housing market was relatively stable from the conception of Fannie Mae until the early 2000s, until the end of the Clinton Administration, when President Bill Clinton commented,
This past year, I directed HUD [Department of Housing and Urban Development] secretary Henry G. Cisneros […] to develop a plan to boost homeownership in America to an all-time high by the end of this century […] Expanding Homeownership will strengthen our nation’s families and communities, strengthen our economy, and expand the country’s great middle class. (Wachter 38)
Raghuram interprets Clinton’s request, saying:
Simply put, the Clinton administration was arguing that the financial sector should find creative ways of getting people who could not afford homes into them, and the government would help push wherever they can. (Raghuram 36)
This announcement began the massive housing push of the early 2000s. According to chapter 6 of Susan Wachter’s American Mortgage System: Crisis and Reform, the government and big banks both were incentivized to put unsophisticated borrowers (young adults fresh out of college with amassed school loans, or minorities who could not be approved for a 30 year fixed rate mortgage due to their credit score or risk assessment) into homes. . In chapter 9, she tells us that a “big bank” is any bank that holds over one billion dollars in assets. (Wachter)
These particular loan holders are considered “subprime borrowers”. A subprime borrower is a person who is considered a higher-than-normal credit risk. They typically have a below-average credit score and are penalized for their poor credit with higher interest rates. The financial information website Investopedia says,
A credit score is a statistical number that depicts a person's creditworthiness. Lenders use a credit score to evaluate the probability that a person repays his debts. Companies generate a credit score for each person with a Social Security number using data from the person's previous credit history. A credit score is a three-digit number ranging from 300 to 850, with 850 as the highest score that a borrower can achieve. The higher the score, the more financially trustworthy a person is considered to be. (Investopedia)
These credit scores are used by just about every bank and lending agency, including credit card companies, in order to assess personal risk history for loan approval.
In order to get all of the low-income borrowers into homes, lenders had to quite literally figure out how to give them money. While, at first, the idea of lenders needing to figure out a way to lend money might seem redundant, the complication of lending to normally unqualified borrowers inspired unprecedented actions from the big banks. The solution was a marginal boost in variable rate mortgages. This meant that after a typical teaser period at which the interest was fixed at an unusually low and attractive rate, the interest would fluctuate based on the Federal Reserve as often as every six months. Four to six percent increases were not uncommon. The danger lay in the fact that the interest rates to most of those particular loans were set to go up as high as was allowed within the loans regulations (based on the borrower’s qualification) at the end of the teaser period. Jane White, an economic researcher and author, said in her article, “ARMed and Dangerous”, that 75% of all low-income loans given to subprime borrowers (i.e. subprime loans) were adjustable rate by 2005 and an estimated 75% of those with ARMs were unclear what their interest rates would be after the introductory rate expired. (White) In essence, the majority of all home loans were inevitably going to default.
Following President Clinton’s push for lower-income housing, subprime lending started to boom. Michael Lewis, financial journalist and author of New York Times Bestseller The Big Short, pointed out that:
Thirty billion dollars was a big year for subprime lending in the mid 1990s. In 2000 there had been $130 billion in subprime mortgage lending, and 55 billion dollars’ worth of those loans had been repackaged as mortgage bonds. In 2005 there would be $625 billion in subprime mortgage loans, $507 billion of which found its way into mortgage bonds. Half a trillion dollars of subprime mortgage-backed bonds in a single year. (Lewis 23)
Susan Wachter said, “In 2002, observers noticed a decline in the lending standards and an increase in non-standard mortgages, especially to unsophisticated consumers.” (Wachter 108) A lender in 2005 was acting entirely out of his own self interest when giving away his firm's money. He was offered lofty commissions and bonuses by the firm for reasons that did not concern him; all that he saw was commission. The problem trickled down from the upper management of the bank or lending agency.
According to Rajan Raghuram, as of 2005, 56% of all home loans were considered low-income and subprime. That resulted in $2.7 trillion dollars worth of very high-risk loans. Not only was this number unprecedented, it was about triple what it had been during the Great Depression factoring inflation. This amount of money being designated to people who could only afford to pay it back via adjustable rate mortgages was the foundation for financial downpour.
Starting in 2004, the major banks and lending agencies became incrementally more flippant with their lending standards. A large factor in this was the practices of Fannie Mae and Freddie Mac. The lending standards were largely relaxed due to something called a loan resell. Thomas Sowell, professor of finance at Stanford University and author of Housing Boom and Bust explained how a loan resell works. Essentially, Fannie Mae and Freddie Mac, with the help of the Federal Reserve and the National Treasury, would purchase about two thirds of all mortgages (56% of which were subprime), believing that they were upholding President Clinton’s and President Bush’s push to put low income families in homes. Unfortunately, it did not end in 2004. By 2006, Fannie Mae owned $1.275 trillion in subprime ARM loans alone. All this to say, the banks knew that they could approve just about anyone for an adjustable rate mortgage and the GSEs would reimburse them. This, combined with the consistent stream of high interest rates charged to subprime borrowers, ensured that the banks made money no matter the circumstances.
This level of fiscal security assured that the banks and lending agencies would eliminate almost all risk for the establishment, allowing them to make money easily and in such a way that incentivized greed, through targeting previously unqualified borrowers, a practice commonly known as predatory lending. Bill Fay, who has extensive experience advising corporate clients and financial institutions says, “Predatory lending is any lending practice that imposes unfair or abusive loan terms on a borrower.”(What is Predatory Lending) He then expands on this by saying “Predatory lending benefits the lender and ignores or hinders the borrower’s ability to repay the debt.” (ibid) This is essential to look at when considering the predatory nature that adjustable rate mortgages are susceptible to.
Overall, adjustable rate mortgages and their success are based entirely on eligibility for a loan combined with the credibility of the agency borrowed from. Those who are less eligible are likely to be approved for a 3/1 ARM meaning that after a 3 year fixed rate period, the interest could fluctuate as often as every six months. A 13-15% interest rate was not unheard of on such loans.
As though the mass low-income lending boom wasn’t enough of a threat to the market stability, as this practice spread a new factor introduced itself: people started betting on the success and failure of these investments. What had begun as an effort to stabilize the economy and the housing market had morphed into the setting for an new and unforeseen threat to both. Fannie Mae, far from being the solution to unsecured loans, figuratively provided a blank check for banks and investors to exploit the home loan market. These securities were packed together for investment and were widely accepted as very low risk profitable ones. Consumers of MBSs based their investments on the ratings of the securities in order to calibrate their gains or possible losses. This may seem trivial and unrelated, but the subprime MBS did one thing that was unprecedented: it brought trusting investors of any and all classes into what is now obviously a flawed system.
That brings us to the final level of this house of cards; the subprime MBS. Whether someone had an adjustable rate mortgage, a fixed rate mortgage, or was invested in secondary stock, they were involved in a market that was interconnected with the now dangerously compromised fluctuation of interest rates. This reality of the market is rarely understood, but it is perhaps the most troubling aspect of the reckless practices from the banks, because no matter the form of inclusion, nearly all property in the United States economy is affected by the housing market. For instance, fixed rate mortgage holders run the risk of their home’s value defaulting and losing their equity. Essentially, people were unknowingly betting that those who had credit scores below 600 and were in hundreds of thousands of dollars of debt each were going to pay their mortgages once the interest rates went up.
Partitio:
Although Adjustable Rate Mortgages (ARMs) appear advantageous by making seemingly affordable loans available to the masses, in reality they damage the national economy and leave millions of people in debt. Dishonest and irresponsible lenders monopolize the housing market and in turn the investments of millions by providing unpredictable mortgages to irresponsible consumers who inevitably cannot afford the fluctuating interest rates. Historically, America has used legislation to restrict individual, private actions for the sake of the general welfare. Similarly, the government has previously restricted predatory lending to protect certain susceptible demographics. Abolition of the ARM would be consistent with such legal action. Because of the harm brought specifically to borrowers but also to everyone associated with the housing market, the mal-lending practice in the form of Adjustable Rate Mortgages must be legalized in the United States of America.
Confirmatio:
As previously mentioned, in the early 2000s, President Clinton and President Bush Jr. encouraged low-income housing at an unprecedented level. This pushed mortgage brokers to approve subprime borrowers with poor credit. Susan Wachter insists in chapter 3 of American Mortgage System: Crisis and Reform that the key factor was the big banks intentionally devaluing the risk of credit deficient mortgage loan applicants. (Wachter)
While the housing market has historically been a reliant and unfaltering facet of the national economy, in 2007-2008 a massive weakness in the invincibility of mortgage loans and investments made itself known in the form of mortgages reliant on mortgage backed securities. According to Chapter 7 of Fault Lines: How Hidden Fractures Still Threaten a World Economy, when these securities were falsely rated as AAA, meaning that the mortgages in the security were falsely rated by the rating agency as being the most stable possible, investors bought into them, thinking that they were putting their money into something considered to be a sure thing. (Raghuram) unfortunately the false rating of these securities was all too common. Rajan Raghuram said that “The MBSs were AAA-rated securities that had more risk associated with them than their rating let on.”(Raghuram 135) When the teaser period on the ARMs expired and the interest rates spiked, homeowners could not pay their mortgages, which caused the securities to default. The use of mortgage backed securities (MBSs) in relation to adjustable rate mortgages proved to be a toxic combination.
The housing crisis of 2008 left millions in debt. The credit risk associated with subprime lenders caused massive instability in the market that spread to those who were almost entirely uninvolved. The housing scare caused by the security investments going bad devalued the personal equity of those who remained uninvested and put them in more debt due to their houses being worth less. Thomas Sowell in chapter 3 of Housing Boom and Bust showed that in just one year, between 2007 and 2008, in metropolitan areas across the U.S., home appraisals dropped by an average of 30%. This meant that they were unable to sell their homes and move for any reason without losing possibly hundreds of thousands of dollars. In Atlanta, Georgia, home values dropped 38% by 2009. For perspective, consider a $500,000 home in 2006. Fast forward two years and that same home in the same condition inhabited by the same owners is only worth $310,000. Continuing with this example, picture that this family purchased the home in 2006. They lost $190,000- their equity and more- in a matter of months. Due to the plummeting housing values, only a select few could safely sell their house or purchase a new one. This was largely thanks to the negligent and impatient investments of both subprime borrowers taking on loans that they were uneducated on, and banks buying into mortgage backed securities. New buyers with home fever notably bought houses far outside of their means because these mortgages made it possible. While common sense and reading the fine print are both factors, when considering the economic downpour, if ARMs were not a factor, we would not be referencing any kind of “housing bubble” today.
A pinnacle reason that ARMs are considered a problem is because of mal-lending practices. Contrary to common misconception, banks are privatized businesses that seek profit like any other enterprise. Lending money with attached interest rates is largely how private banks and lenders generate profit. There is nothing inherently malicious about this practice. Intentional predatory lending, though, is entirely immoral.
Dave Ramsey of Financial Peace University writes that the “very purpose of a mortgage with an adjustable percentage is to favor the bank. They want to get as much money out of you as they can”. (Ramsey) Why is an adjustable rate mortgage bad? They directly benefit the institution that operates with the intent to make its monthly quota of loans written instead of helping people achieve the American dream of homeownership. Because homeownership is considered by many to be a wealth building vehicle, subprime borrowers are lured into subprime loans. When looking at ARMs, the number of 3/1s greatly outweigh the number of 5/1s and 7/1s in the market right now. This means that the ARM is, primarily, a subprime mortgage. For this reason, the nature of adjustable rate mortgages and the purpose they serve the lender versus the borrower makes ARMs entirely immoral by the Bible’s standards.
“Whoever walks in integrity walks securely, but he who makes his ways crooked will be found out.” (Proverbs 10:9) God calls us to be honest and moral people, which should naturally be implemented in every aspect of our lives, including in the workplace. The problem with ARM lending is that by 2005, 74% of all ARMs were subprime. (Lewis 23) Proverbs tells us that it is vicious to prey on those who are less aware or equipped to fend for themselves as far finances are concerned. Lenders must be gracious and honest in their pursuit for profits.
These mortgage loan brokers are acting very dishonestly to both their clients and to those who invest in their mortgage backed securities. It has, in a sense, become a bit of an epidemic. To put it simply, per Michael Lewis, lenders are lying, or at the very least steeply exaggerating to borrowers about their eligibility.(Lewis 162) While it is not inherently the lender’s problem, the morally right thing to do would be to approve the borrower for a loan that the bank knows they have the means to pay off in a timely manner and without struggle. Instead, they use any means, no matter how justifiable, in order to get the most from the uninformed subprime borrowers. The lending brokers answer to the owners of their firms who are motivated by lofty federal incentives in the form of loan resells. Though the specific person filing the loan may not have malicious intent, his firm certainly does. Therefore, the only benefit to an ARM goes to the lender who knows that the borrower will inevitably be over their heads in debt and they will profit regardless.
Banks are more than eager to find subprime borrowers who are ignorant enough to fall for their bait and switch. Thomas Sowell explained in The Housing Boom and Bust, that “banks do not necessarily care if the loan defaults because Fannie Mae or Freddie Mac (depending on which GSE purchases the loan) will have already wholly reimbursed the lender.”(Sowell 168) Subprime lenders have very little accountability, knowing that they will always get their money back and then some.
This kind of lending is far more than negligent. It is devious and intentional. Dr. Rajan Raghuram in his book Fault Lines spoke on this topic and used the example of the East Coast company, New Century. New Century went from $3 million in annual lending to over $60 million only a few years later due to their loan approval process that had unusually low standards, and use of private individual freelance brokers who could spread out across the country. This generated more profit faster which, in turn, made them able to simplify the process, making qualification much more fluent. The major problem with this was that its brokers would approve just about anyone. Raghuram describes an example of an elderly lady with a $1,000 monthly income who was convinced to refinance into an ARM that initially was affordable, but after the teaser period, her mortgage spiked to $2.2k a month. The end result was that her mortgage was more than double her earning potential. For this reason, New Century would write someone a loan and a year later be foreclosing on that same home. This was an all too regular occurrence. It was not until the end of 2007 that the company put restrictions on the brokers regarding who they could lend to, and even then it was only in cooperation with the ECOA. New Century vastly abused the teaser interest rates based on steadily increasing housing costs. (Raghuram 130)
What can be done about ARMs? The United States of America has historically used legislation to regulate and often prohibit personal private actions that have a profound effect on the general public. For instance, on May 4th, 2016, California Governor Jerry Brown signed a bill that officially raised the legal age for tobacco use to 21. California lawmakers are effectively giving up a projected 12% of cigarette sale taxes that were associated with adults age 18-21. The state of California profits an average of $860 Million in much needed cigarette sales tax annually, $105 million of which comes from the 18-21 year old demographic. Keep in mind also that this number is only for cigarette sales and not for the many other tobacco media. That being said, legislation was still passed due to an incredible amount of negative research on smoking and California attempting to preserve the health of its residents.
Some may think that the state regulating what one person puts into his body would prove to be a waste of resources and an imposition on our given freedoms. However, when considering tobacco use, the second hand smoke raises proven health risks to second hand inhalers. To the same point, taxpayer dollars compensate for hospital bills that smokers with emphysema or lung cancer are unable to afford. For a point of reference, according to Minnesota for a Smoke Free Generation, 3.1 billion taxpayer dollars go to cigarette related hospital payments every year in Minnesota alone.(Yoder) This legislation aims to protect individual people from hurting themselves with regards to first hand smoke, but primarily, protects those around them from suffering harm due to others’ actions.
Regulations on cigarette sales and usage are analogous to the regulation of lending and borrowing through adjustable rate mortgages. Both cigarettes and ARMs are consumed by an individual. Cigarettes make their consumers susceptible to lung cancer just as an ARM holder is susceptible to rising interest rates. Cigarette smoke has proven to cause health risks which would inevitably place said smokers in hospitals and on medications they cannot afford. This causes taxpayers to cover the costs. Similarly, ARMs have proven to put all investors and homeowners at risk of their investments and equity worth defaulting due to one particular faction’s faulty loan. The government has put bans and regulations on the cigarette sales market and would therefore be justified in illegalizing the adjustable rate mortgage.
It would be useful to note too that the U.S. government has taken previous legal action on lending practices. The Equal Credit Opportunity Act (ECOA) was put in place in October of 1978, disabling lenders from allowing physical characteristics to impact a loan approval decision. The ECOA effectively protects one from being discriminated against based on race, age, religion, sex, marital status, color, and national origin when seeking a mortgage loan. A lender cannot deny a loan, target specifically, or alter lending qualifications to anyone on the aforementioned grounds. The aim of this act is to greatly suppress, if not eliminate, predatory lending. So too for these reasons, it would not be unprecedented to impose new regulations on mortgage lending.
While the lenders pose an inherent threat, adjustable rate consumers bear much of the fault at hand. A more conservative mindset places significant blame on the borrower. These people should have the patience and wisdom necessary to make big financial decisions. Reading the fine print is a common life skill that one must possess in order to thrive as a citizen. We live in a country where our natural freedoms are to be respected but, with that in mind, there need to be regulations in place to protect the general welfare. A ban on adjustable rate mortgages benefits everyone by taking the vulnerability of our national economy out of the hands of financially struggling young adults and minorities. While it would be fitting to cut these ignorant borrowers lose and let them fail for themselves, the government knows that suppression to certain freedoms is necessary for the prosperity of the nation as a whole. In this specific case, allowing inexperienced borrowers to fail would negatively impact the rest of the economy to such a caliber that imposing on capitalism is a necessary and beneficial step.
Refutatio:
The adjustable rate mortgage has been highly revered as a necessary and helpful facet to the United States housing market by the government and consumers alike. In fact, most would disagree with the abolition of such loans. Their argument is founded on an opposition to excess government regulation, especially on private enterprises. They are justified in this argument, as the American government is based on minimalistic government intervention, and only where necessary, to ensure the freedom and safety of all.
That being said, a refuter argues that it is not in the government's standing to prohibit a citizen from making private investments with a lending firm. Should the magnitude of one’s personal debt not be entirely up to the individual? It is to the borrower's discretion as to how much they can afford to pay towards a mortgage each month. It is also the responsibility of the borrower to read the fine print when hundreds of thousands of dollars are on the table. If a mortgage applicant is not insightful enough to investigate what they are signing for, then the debt and hardships to follow are to be a lesson learned. This is the most elementary form of natural consequence. One must suffer the the said natural consequences both for his own personal development and as an example for others not to follow.
While this may hold truth, the argument being made against ARMs discredits the aforementioned refutation. In essence, why should the credit affluent, successful, and honest mortgage-paying citizens have their investments threatened by these people. By subprime borrowers being allowed to “learn their lesson”, they drag down those who were wise enough not to partake in such loans. Natural consequences are beneficial in gaining life experience. But at what cost are the wise Americans supposed to be negatively affected for the learning purpose of subprime borrowers?
To an entirely different yet equally important point, some argue that adjustable rate mortgages make homes more readily accessible to those who would not otherwise be able to afford them, thanks to lesser lending standards. By the lending firms offering appealingly low teaser rates and variable interest, young up and coming families who are struggling financially are able to house themselves. Many of these people are fiscally responsible and financially stable to the extent to they benefit from ARMs. Purchasing a home is a large and vital part of growing up, maturing, and being fiscally responsible.
The question to be asked with regards to the previous argument is this: are said up-and-coming adults really who should dictate the strength of the U.S. housing market? The answer is “no”. Trillions of U.S. dollars cannot be left at the hands of inexperienced borrowers. According to chapter 3 of Sowell’s Housing Boom and Bust, in 2001, 33% of the average family income went towards housing. (Sowell) Americans place a huge stake in their homes which cannot be jeopardized by the enthusiastic negligence of uninformed twenty-somethings
A variable rate mortgage has far fewer initial stipulations attached and is much more accessible to a much more varied demographic. This particular demographic as essential to the construction and eminent success of our housing market. A pinnacle point to mention too is that only 56% of all mortgages are considered subprime according to Michael Lewis. That being said, the other 44% deserve to reap the honest benefits that an ARM has to offer. Therefore, there should be stricter evaluations of would-be borrowers as to eliminate some of the potential danger, but also allow those deserving to benefit from what an ARM has to offer.
Pro-ARM arguments also would state that ARMs pose no threat by themselves, but with the over regulation of the government that already exists, they become toxic. The very reason that ARMs are troublesome stems from the Federal Reserve’s and the GSE’s over-involvement in the loan industry. Multiple arguments lie in this statement alone. Most importantly, Clinton and Bush pushed for an advance in low-income housing. This in turn caused ARMs to be abused and stretched. They were conformed to anyone and everyone’s situation. If a potential subprime borrower had no money for a down payment, they would be given a 3/1 ARM. Why? Because the president of the United States requested that even those who could not afford a standard ARM be loaned the money for a home.
Lastly, ARMs are commonly used for short-term housing. Certain employment often has families moving around the country. Following work can mean a new city and a new house every couple of years. For these people in particular, the ARM allows them to have little to no interest on their short term mortgages. The biggest problem with this though, is that the banks that lend to these people are essentially giving away an extended stay in their property with no overhead. In other words, the banks cannot make any profit off of the loan and are therefore losing money by owning compensated-for property. The danger in this is that a bank, on principal, will not lose revenue. This leads to the conclusion that the financial weight of the previous owners (who did not pay interest because they moved before the teaser period expired) would fall on the next inhabitants in the form of either stricter loan conditions or higher initial interest rates.
Peroratio:
Like a crystal clear glass of spring water, 47% of ARM consumers are without flaw or concern. Like a single lethal drop of poison, the other 53% are subprime and pose a 75% chance of defaulting. When these two ingredients are blended together, the end result, no matter how pure, is not fit to drink. This combination of ARMs has proven to be a fatal dose.
It is not a matter of whether some can handle the responsibility of fluctuating interest, it is the fact that the abuse of interest-strapped loans devalued the American housing market, henceforth devaluing the property of millions of unexpecting citizens. To those who lost their life’s savings in equity. To those who lost their jobs. To those who lost their homes, rendering their families homeless. Because of millions of evidently careless bets, you may have lost, and can lose, financial security and livelihood in a way that can shake a family to its core. Because the detriments of an ARM outweigh the benefits, the government ought to do their country the service of taking legislative action on the legality of the adjustable rate mortgage.
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