With the foreclosure crisis still in full swing, sending new ripples through the economy with every cycle of ARM resets, defaults, and foreclosures, the true effects of this giant market correction are yet to be seen. Therefore, it seems that the only sure bet these days is that the economic woe that began with the sub-prime lending meltdown will trickle down to affect the financial circumstances of virtually every consumer, with even those who are in no direct danger of foreclosure feeling the pinch as home values continue to decline and credit markets tighten.
While many everyday consumers who have financed their homes with stable and affordable fixed rate loans may feel insulated from the current foreclosure crisis, the fact is that all consumers will be in the line of fire in one way or another. Trouble in one sector of the economy often spreads, especially in today’s heavily leveraged financial markets. Debt based economic structures and policies amplify the effects of disruptions in the credit markets, as demonstrated by the progression of the current crisis.
Debt has become a hot commodity in the financial world in recent years, wrapped into neat investment packages. Essentially, investors purchasing consumer debt are gambling that this debt will be honored, with the interest rates earned on these investments the reward for the risk of default. Of course, the incentive for these investors is profit, so as long as returns are good and risk is manageable, funds will flow into the credit markets.
The debt incurred by the homeowners who are now facing default has in most cases been packaged and sold to investors as mortgage backed securities. The sale of these mortgage notes gives lenders the working capital necessary to originate more loans, which are than sold, continuing the cycle. This system depends upon investors to provide the liquidity necessary to keep the mortgage loan funding flowing steadily. As real estate and mortgage lending markets boomed in recent years, mortgage backed investments were very profitable, encouraging more investors to enter the market. More investors resulted in growing liquidity in the mortgage markets, spurring more growth.
As profits soared, adding incentive for lenders to sell loans and investors to buy them, the balance in the mortgage industry began to shift. Sub-prime lenders gained market share against more traditional mortgage lenders, making an ever-rising percentage of new mortgage loans. As the number of sub prime and other non-traditional loans included in mortgage backed securities investment packages rose, so too did the level of risk. Loose lending standards became common as many brokers and lenders began to become more reckless in pursuing those rising profit margins, elevating the risk to mortgage backed securities investors.
The foreclosure crisis has been the source of heavy losses for many of these investors, with figures in the billions of dollars and still climbing fast cash advance. These investments are spread throughout the financial world, held by a wide variety of investors that include banks, hedge funds, and retirement funds. As investors are hit with these losses, or anticipate possible devaluation in securities they own and can no longer unload, economic slowdown is an inevitable result, as cash is held in reserve to balance the books. In this manner, the liquidity crisis from the mortgage industry has spread throughout the economy, the contagion carried by the variety of institutions and corporations that hold mortgage related investments.
For the average consumer, the most obvious consequence will be seen in the continued withering away of credit availability, as financial institutions lose their capital to the crisis or even fail. Credit card companies are very likely to feel the pinch, as financially distressed homeowners declare bankruptcy in the wake of foreclosure, and will surely pass their losses on to customers in higher interest rates. Consumers who would take second mortgages or home equity loans to pay higher interest debt may find that sinking home values and stricter lending standards reduce such options significantly.
Retirement accounts could be affected, especially if the crisis drives the economy into recession, a possibility that is quite real according to many experts. An October survey conducted by The Financial Services Forum found that Wall Street chief executives are predicting a 37% chance for a U.S. recession in the next 12 months, and predictions made in December 5th testimony before the House Budget committee was even more pessimistic, with experts stating that chances for a recession stand at 50 percent.
Thousands of everyday Americans employed in financial and mortgage related fields have lost jobs to the sub-prime meltdown, and more are sure to come. Job losses in many other sectors could rise should the economy fall into a recession, another way in which ordinary Americans could be squeezed by the nation’s economic woes.
So, the fact of the matter is that the mortgage meltdown fiasco and the resulting chaos in the financial markets will affect the working class citizen over the days and years to come. It seems that none are immune from the fallout, except, perhaps, the wizards of high finance that instigated it, should the government save them from the consequences of their latest scheme with yet another bailout plan.
For further information on how to manage personal finances effectively during economically challenging times, more of Sharon Secor’s work can be read at Lenders Mark and Direct Lending Solutions.