Rutgers Model Congress 2009
Massachusetts
Senate Committee on Banking, Housing and Urban Affairs
Subprime Mortgage Lending
Rahul Guha (D)
East Brunswick High School
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Over the course of the last two years, the United States has entered a looming recession
after the burst of the housing bubble. What promises to be the greatest financial crisis since the
Great Depression can trace its roots back as far as the late 90s as the subprime mortgage market
began to gain momentum. The financial institutions which only 5 years ago were relishing their
record profits, ensuring their investors of long term security, and expanding at a rapid rate are
now reeling at the colossal debt mounted upon them. However, exuding all of the frustrations of
economic recession onto the financial giants of Wall Street can not be the solution. As Treasury
Secretary Hank Paulson put it, the U.S. can no longer depend on a laisez faire capitalistic society,
and there needs to be greater oversight of business (Barnes 1). To ensure the security of the U.S.
economy, the government needs to focus on stricter regulation as well as a higher standard for
subprime mortgages.
At the his term, the policies advanced by Clinton as well as chairman Greenspan have led
to the inevitable creation and burst of the housing bubble. Creating the idea that every American
should have a home is a step in the right direction; however the means in which it was
implemented provided a great risk to the economy. In the wake of the Great Crash of 1929,
Congress passed the Glass-Steagal Act of 1933 (Heakal 1). Through this legislation, Congress
created a separation of commercial and investment banking to prevent another economic crisis.
Prior to the passage of the act, commercial banks used deposits for high risk trading, and without
insured accounts, millions were lost (1). Sixty six years later, under Clinton, the act was repealed
through the Gramm-Leach-Bliley Act (1).The GLB act would prove to become a nightmare
following the economic recession of 2001. In an attempt to stimulate the economy, the Federal
Reserve reduced the interest rate, thus credit became widely available. With their newfound
ability to posses mortgage backed securities, commercial banks began investing with deposits(1).
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With the low level of interest being offered by the Federal Reserve, banks were able to provide
credit to those who were not qualified for a loan. With adjustable interest rates so low, banks
were able to convince prospective home owners to take out mortgages far beyond their financial
capability. In this time period of low interest rates, millions signed on for adjustable, subprime
mortgages, and found their mortgages soon rising (Barnes 1). To compensate the period of
inflation, the Fed began a period of equable increase in the chief interest rate. No longer able to
afford the homes the banks assured were in their financial means; thousands filed for bankruptcy
and lost their homes to foreclosures. To combat the flurry of foreclosures hitting the market, , the
Fed’s key interest rate has a seen a steady decline. Currently, banks can take loans from their
Reserve bank at a rate anywhere from .25%-0% loans (Isidore 1)
In order to prevent periods of volatility and uncertainty, the government needs to take a
more proactive role in the regulation of business. The problem is businesses are left to operate
with no oversight until a crisis hits. For a short period time thereafter, the government institutes
strict regulations, but within a few years, allows their oversight to be undermined and everything
is back to square one. The government needs to assume control of the agencies which provide
the ratings for financial institutions. Those who argue it is socialism should look back on the last
hundred years, a period of staunch capitalism which has left American reeling from multiple
recessions. Ratings agencies such as Moody and Standard and Poor failed to provide proper
analysis of some of the nations largest banks. Overnight, Moody downgraded AIG from its
highest rating to a very modest level (Serwer and Sloan 1). This sudden downgrade cost
American taxpayers over 15 billion dollars. Since AIG offers its clients insurance on all of its
securities, it had to come up with billions of dollars overnight when it was downgraded (1). To
ensure that enterprise is protected from the inadequate service of credit raters, a government
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agency should be instituted to compile ratings on companies. The private sector has affirmed
they are not capable; their errors have cost the U.S. taxpayer, who should be the number one
priority.
The blunders of the corporate credit raters has indirectly cost the United States billions,
but many Americans feel the direct affects of their own credit rating. The government needs to
be amenable to clearing small blunders on people’s credit history. People did not turn to
subprime mortgages because they believed it was a better option, but it was the only feasible
option. A small mistake person’s credit rating can add thousands of dollars to payments and
interest ( Credit rating system needs overhaul 1). When applying for a mortgage, someone with a
perfect credit score may take a loan with a interest rate of 5.49% ( The importance of credit
rating 1). However, many of those who turned to subprine mortgage were offered rates such as
8.53% due to their lower credit rating. Simply forgetting to pay even a two hundred dollar credit
card bill can amount to paying over $50,000 over the term of a mortgage (1). To prevent
Americans from being forced into taking out subprime mortgages, the government needs to
establish an agency to differentiate between credit blunders. A person with a spotless record who
then forgot one bill should be allowed to clear their credit record after paying the bill as well as a
fee to the government (1). By doing so, homeowners can try and get a fair interest rate when
taking out a mortgage and will not be pressured to take out subprime loans.
Clearly, commercial banks have attributed to the current financial crisis through their
subprime mortgage dealings and their use of deposits in mortgage backed securities (Serwer and
Sloan 1). Although unpopular, legislation should be pushed onto the floor of Congress which
would repeal the Gramm-Leach Bliley Act. With thousands of small businesses and people
dependant on a credit line, banks are vital to the revitalization of the economy. The meltdown of
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subprime mortgages has left banks reeling from the billions of dollars of bad debt incurred (1).
Now, hesitant to provide credit, small businesses are failing, and overall spending is down which
is keeping the economy in the red. To ensure commercial banks will be able to provide a
continuous credit line in the future, commercial banking needs to be simplified. Instead of
involving clients’ money in high risk trading, it should be used to give out loans to qualified
people (Barnes 1). In the short-term, incentives should be given to banks which are continuing to
extend credit to their constituents. A permanent solution can be erected through legislation which
will restrict the practices of commercial banks.
The system of fixed and adjustable mortgages needs to be redesigned to prevent
foreclosures. A federal agency needs to be created which asses the risks involved in the
mortgages banks are providing. If such an agency were erected, the government could monitor
the credit ratings of those applying for loans. Anybody without unfaltering income would be
denied an adjustable rate to prevent banks from incurring debt. The subprime market needs to be
extensively curbed, and the government should provide tax breaks to those buying a new home
with a fixed rate. With incentives for 15 and 30 year fixed mortgage plans, more homeowners
will begin to step away from the dangers of a subprime mortgage (Serwer and Sloan 1). To aid
the Americans who already have signed a adjustable mortgage deal, and those who may need to
turn to an adjustable rate in the future, the government should re-assess the proceedings of the
Federal Reserve. The fluctuation in the interest rates put out by the reserve causes exorbitant
mortgage rates for people who can no longer afford their homes are ultimately condemned to the
street. Eventually, many of these people will end up living off of government aid and costing the
tax payer even more money (1). To ensure the American people an economic crisis will occur in
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the near future, the government needs to reaffirm their position on limiting subprime mortgage
dealing.
To combat the tough economic times ahead, the government needs to take a more
aggressive stance on corporate regulation, and look at the possibility of limiting subprime
mortgages. More and more, people are asking the question, why has the government been
allowing corporations to operate without any oversight? There is no answer, but as this period of
recession passes, the government will have another chance to prevent another crisis in the future
by becoming more proactive in the regulation of the economy. A nationalization of credit raters
needs to take place as well as government oversight of mortgage lending. In the future, the U.S.
will not have to give up its fundamental policies of capitalism. All that is needed is a more
levelheaded, conservative approach to the democratic, free market system which the nation was
founded upon.
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Works Consulted
Barnes, Ryan. “The Fuel that Fed the Subprime Meltdown.” Investopedia. 6 Feb. 2009. Forbes.
5 Apr. 2009 <http://www.investopedia.com/articles/07/subprime-overview.asp>.
“Credit Rating System needs Overhaul.” Investment News. 23 Feb. 2009. 7 Apr. 2009
<http://www.investmentnews.com/apps/pbcs.dll/article?AID=/20090222/REG/
302229990/1003>.
Heakal, Reem. “Investopedia.” What was the Glass-Steagal Act. 12 Apr. 2008. Forbes. 5 Apr.
2009 <http://www.investopedia.com/articles/03/071603.asp>.
“Importance of Credit Rating.” Investopedia. Forbes. 7 Apr. 2009
<http://www.investopedia.com/articles/00/091800.asp>.
Isidore, Chris. “Fed leaves rates near zero.” CNN Money. 28 Jan. 2009. 7 Apr. 2009
<http://money.cnn.com/2009/01/28/news/economy/fed_decision/
index.htm?postversion=2009012816>.
Kennedy, Edward M. Senator Edward M. Kennedy United States Senator for Massachusetts. 4
Apr. 2009. 5 Apr. 2009 <http://kennedy.senate.gov/issues_and_agenda/
legislation.cfm?PageNum_sponsoredLegislation=2&id=106>.
Serwer, Andrew, and Allan Sloan. “How Financial Madness Overtook Wall Street.” Time 18
Sept. 2008. 5 Apr. 2009 <http://www.time.com/time/business/article/0,8599,18421232,00.html>.
“The U.S. Congress Votes Database.” Washington Post. 2 Apr. 2009. 5 Apr. 2009
<http://projects.washingtonpost.com/congress/106/senate/1/votes/354/>.
Woolley, John, and Gerhard Peters. “Political Party Platforms.” American Presidency Project. 25
Aug. 2008. 5 Apr. 2009 <http://www.presidency.ucsb.edu/ws/index.php?pid=78283>.