TBT: When the Banks Crumbled
In a Piece from 2008, I Look at the Impact of the Banking Crisis on Small Banks
This is the first of what I plan to be a regular feature in which I republish some of my past work, with links to the original news site. This is from Central Jersey, where I spent 20 years covering local news and editing local newspapers. it is from my weekly Dispatches column that ran through October 2010.
Dispatches: Choppy Economic Waters
Driving down Georges Road in Dayton, it is difficult not to notice the new bank building going up at the corner of Route 522.
The red-brick Amboy Bank, a very stable community bank that is expected to open its new branch by the end of the year, is a reminder that the crisis roiling the economic waters has less to do with borrowers and everything to do with the big, out-of-control investment banks that saw easy money in the subprime mortgage market. Community banks, after all, have not been affected by the meltdown.
As the McClatchy News Service reported on Sunday, lending by investment banks and non-bank lenders operating with little federal oversight were the main culprits, taking advantage of lower-income borrowers.
Subprime loans generally went to “persons with blemished or limited credit histories” and “carry a higher rate of interest than prime loans to compensate for increased credit risk,” according the federal Department of Housing and Urban Development.</p>
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Higher interest rates, when combined with skyrocketing housing prices, meant more money for lenders — which is why investment firms and large banks had been so willing to hand out loans in recent years, offering a buffet of loan options designed to ease the worries of unsuspecting borrowers.The problem, as others have reported, is that the mortgages often included huge balloon payments after two or three years, which turned what had been affordable loans into unaffordable burdens that, for many, resulted in foreclosure.
The growing number of foreclosures created a drag on the overall housing market, at first slowing what had been an unsustainable increase in housing prices and then reversing that growth. With the drop in housing prices came a massive liquidation of home equity, leading to more foreclosures, which drives housing prices down further.
And as all this bad debt has piled up, the lenders — or the companies who purchased the debt — have found themselves holding what are being described as “toxic assets,” or loans that exceed the value of the properties to which they are attached.
Community banks like Amboy, Magyar, First Constitution, Roma and others limited their exposure to the subprime market, according to the New Jersey League of Community Bankers.
”Community banks for the most part have not offered subprime mortgages and those that do have utilized proper loan underwriting to qualify borrowers,” League President James R. Silkensen wrote in the organization’s 2008 annual report.
The operative phrase appears to be “proper loan underwriting,” as the McClatchy piece also makes clear, quoting a Friday report from the President’s Working Group on Financial Markets.
”(T)urmoil in financial markets clearly was triggered by a dramatic weakening of underwriting standards for U.S. subprime mortgages, beginning in late 2004 and extending into 2007.”
While subprime mortgages were at the center of the storm, other factors are equally to blame, as the economist Dean Baker explains.
He says the crisis “is really a larger problem of bad mortgage debt.”
”Subprime loans are over-represented because by definition these were the most risky loans to the most vulnerable segment of the population,” he writes on the Comment is Free America blog at The Guardian (U.K.) newspaper site.
“However, the default and foreclosure rate on all housing loans has soared far beyond the normal range.”
These include the various refinancing and equity loans that The Los Angeles Times in 2005 said allowed homeowners — with banks’ encouragement — to turn their equity into “a seemingly magical ATM enabling the owner to live it up or just live.”
Consider Washington Mutual, which was taken over by J.P. Morgan in federally brokered deal last month. As The New York Times reported at the time of the takeover, the bank had grown from a “sleepy Seattle thrift into the ‘Wal-Mart of Banking,’” catering “to lower- and middle-class consumers that other banks deemed too risky” by providing “complex mortgages and credit cards whose terms made it easy for the least creditworthy borrowers to get financing.”
The bank, like nearly every other large lender, then packaged the loans as mortgage-backed securities and sold them on what is called the secondary mortgage market.
It was a very lucrative, and unregulated, business — that is, until the housing bubble burst taking a good chunk of the economy with it.Washington Mutual, of course, was not a rogue player; on the contrary, the bank was doing what nearly every large institution had done over the last decade — take advantage of skyrocketing home prices.
As the McClatchy story points out, the fast-inflating housing bubble “fueled demand for mortgage-backed securities,” especially among private investment banks.
Those banks — “unregulated players” that “weakened lending standards” — saw their share of the secondary mortgage market jump from 52 percent to 76 percent between 2004 and 2006.
Many of those banks, McClatchy reports, “have gone bankrupt or are now in deep trouble.”
As we all are, given the economy’s reliance on credit to keep humming along.
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