How the Mortgage Crisis Is Affecting School Budgets

By Charles K. Trainor

August 2007 marked the beginning of the seemingly never-ending saga of the sub-prime mortgage debacle. Multibillion dollar losses have been reported in world-class banking institutions, large U.S. mortgage banking operations, prestigious brokerage houses, and major investment firms. Wall Street firms alone have lost more than $100 billion. Some of the most respected names in international commerce and banking have fallen victim to the unwinding of the sub-prime mortgage market as well.

How did this crisis develop?

Sub-prime mortgages are loans provided to individuals with poor (sub-prime) credit ratings. The borrower receives money needed to buy a home, and a mortgage loan is created. Sometimes little or no down payment is needed. At the start of the loan, interest rates are very low but, in a year or so, the rates are reset to a much higher level.

Lenders believed that housing prices would continue to rise; therefore, they could take additional risk without fear of losing the value of these loans. In other words, if the borrower defaulted the lenders would merely have to sell the house for a higher sum than the original purchase price. Some lenders only wanted the origination fees associated with making the loans, intending to sell them to another institution.

Once loans were made, they were sold to a bank or brokerage firm that bundled them with similar loans to create a large dollar amount investment security. These securities were sold as investments to large domestic banks, corporations, pension funds, state and county managed investment funds, and international investors. The securities became popular because of the high fees paid to the originators and those packaging the securities. And, of course, higher interest rates were attractive to the ultimate investors. It seemed everyone was a winner. 

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