How U.S. Schools Sparked the Subprime Mortgage Crisis

I’m illiterate, but should an English teacher really fail me? A growing number of Americans say no…

…At least when it’s the banks doing the grading. An informed public keeps the wheels of democracy and capitalism greased. However, financial illiteracy still plagues many in the “middle class.”

Underlining the need for reform in schools, disgruntled and desperate borrowers are turning to the courts for help in an effort which should serve as a warning; and if in doubt, just look south of the border where a wave of socialist reformers have recently been swept into power:

“Across the nation, anger and litigation are growing against the tactics of subprime lenders, who offer easy credit for homes that are turning out to be too expensive for millions of Americans now that mortgage rates are going up.”

The King of Consumption or the Queen of Denial
The recent run up in asset values was largely influenced by the easy money atmosphere which prevailed following the economic downturn in 2001. It’s really just a result of basic supply and demand:

1. Cheap money and loose lending standards flood the housing market with buyers (many of whom were never truly fiscally viable)
2. Multiple bidders compete for limited goods (homes) and prices rise
3. Builders struggle to keep pace, resulting in a supply glut once rates rise and standards tighten

A simple analysis by anyone looking at the loan types these “boom” buyers used, could’ve concluded with confidence just when all this trouble would begin.

Some of the most popular loans during this period were ARM’s. Such mortgages typically have rate adjustments (per terms of the note) based on some index plus prime after a fixed period of time (frequently 2 to 3 years). 2007 is the year during which many homeowners will feel that pinch according to various reports.

Coming to Terms
You could argue that many believed rates would stay low, but this is major folly at best. The simple fact that interest rates were at all-time lows should have given many pause. It wasn’t just laymen who fell into this trap; as the WSJ noted in an article last year; Lenders Try to Keep Mortgage Boom Alive:

“More than $300 billion of ARMs issued to borrowers with good credit will begin resetting over the next two years, according to Lehman Brothers Mortgage Research, with $718 billion more of these loans resetting in 2008 and 2009. An additional $507 billion of ARMs issued to borrowers with poor credit will reset over the next four years.”

This over-exuberance may just be a cultural thing, but the best way for government to impact culture is through our public school system, not with laws and regulations limiting democracy and capitalism.

Back in 2005, it could be argued, that even Greenspan got in on the irrational exuberance:

“Lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately,” he argued at the height of the housing boom.

While Mr. Greenspan may have been right about the ability of lenders, I guess that when a final decision is left to human beings, reason and reality aren’t always the best of friends. It must be said, when enough demand exists for something, you can be sure that some go-getter will be right there looking to make a quick buck; even to the detriment of others.

Strong Minds Break Chains
If you take the loan of your own volition, sign up for the class, the lender has the right and the responsibility to hold you accountable for your financial literacy, or lack thereof. Even with these challenges, we should not be deterred – Demand for things that society agrees are “unhealthy” can be minimized, but only to the extent we successfully use our resources to educate the public. In the end, it’s the responsibility of the individual to make the right choice – it’s society ‘s responsibility to provide access to the tools for making that choice.

“Yet without a well-informed public, our liberty itself is in peril.”
– Thomas Jefferson

Related Resources
– Real Estate Finance In-Depth, a retrospective (.pdf)
– Annenberg Institute for School Reform
– TIME.com: How to Bring Schools Out of the 20th Century
– Federal Reserve | Personal Financial Education
– The Wall Street Journal Classroom Edition
– State of the Nation’s Housing 2006 | Harvard JCHS
– Residential Mortgage Market in 2007 | MBA
– The Fed’s Consumer Handbook on ARMs

[UPDATE – 3.22.07]
Debating government intervention on Kudlow & Company tonight was Robert Reich, former labor secretary under Bill Clinton. The falseness of his heart was abundantly clear; if not outright frightening – especially given the position he held…I suspect this may have had something to do with Hillary’s comments on the mortgage market.

Watch the debate between the Dynamic Duo.