Houston, TX

The financial markets were in turmoil last week, and the experts blame the credit-ratings firms and subprime lending practices of mortgage lending companies.

Robert Siegel of NPR interviewed Bethany McLean, Editor-at-Large for Fortune magazine, on Monday. Local NPR-affiliate KUHF carried the story about credit-ratings firms and how their “ratings for hire” and amortization of high-risk ventures across stable lending have created a mortgage-backed security monster.

McLean detailed the dangers of investing in subprime debt—which is lending money to people with poor credit ratings and history—and explained how credit-rating firms are involved in the subprime-lending crisis to Siegel. She also detailed this in an article for Fortune magazine in April.

Because ratings firms graded—through complicated recombinations of debt—subprime debt as investment-worthy, people who simply took these trusted agencies at their words invested heavily.

Unfortunately, now, trust in ratings has decreased. This has created some market instability and puts many who invested at risk for major losses if the housing market continues to slide.

McLean explains

All this has real-world implications. If the rating agencies do downgrade some of this paper, investors who can’t own non-investment-grade debt would be forced to sell in droves. The losses could affect the bottom line of an untold number of companies, including insurers and possibly even mutual funds.

And if CDOs stop purchasing mortgage paper, then a major source of liquidity will evaporate. That tightening of credit could affect the demand for homes, thereby turning the virtuous circle of recent years into a vicious one of falling home prices. That, say Rosner and Mason, creates the “potential for prolonged economic difficulties that also interfere with home ownership in the U.S.” And who will take credit for that?

In July, new home sales fell 6.6 percent for a grand total of a 22 percent drop from last year (25% in Houston). In Houston, although pricey homes are still selling briskly, homes in the $80,000 to $130,000 price are most affected.

This drop is directly related to tighter mortgage lending standards, with a dramatic decrease in subprime lending, and a large number of defaults on subprime mortgages.

Subprime lending hit a record high of $1.3 trillion, taking advantage of the good interest rates and people’s desire to buy into the housing market for the first time. Now that this bubble has popped, it’s starter and first time home buyers most affected.

Lawmakers are on their usual August hiatus, but when they return, Democrats say they plan to push for stricter control on the practice of subprime lending to protect consumers, investors and the market from recent volatility

House Democrats say stricter lending requirements will not only help consumers but also could provide some future protections for investors in the market for mortgage securities. The market has experienced upheaval as a result of a surge in defaults among borrowers with weak, or subprime, credit.

“We’ve been told by some that if we do this, we’ll ruin the market,” said Rep. Barney Frank, D-Mass., the chairman of the House Financial Services Committee, who plans to introduce a predatory lending bill in September or October. “I think that, if we do this right, we could help the market.”

With slumping sales of starter and existing homes locally, last week’s market volatility, and distrust of ratings due to credit-rating agencies practice of selling good ratings to high bidders, perhaps Democrats are right. Currently the economy is strong, and one piece of evidence of this is the brisk sales of upscale homes. Perhaps the Democrats are wrong to meddle in the market. Is the lending and investment practice “broken” and does it need fixing, as the Democrats say? Or not?

What do you think?

subprime lending, subprime investing, financial market, housing market, Houston housing market, financial market volatility, subprime-lending crisis