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Are subprime home-loans risky investments?

Article 5197 - July 09, 2007

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Last month, two hedging funds operated by the investment bank Bear Stearns almost collapsed under debt. They had borrowed billions of dollars from lenders and invested in securities tied to subprime mortgages. Bear Stearns agreed to offer over one and one-half billion dollars to save one of the funds. Investors in the new could suffer everything.

The problem at Bear Stearns is an instance of the risks involved with mortgage-backed securities. These investments have helped push house possession rates in the United States to almost seventy percentage. But as stake rates have risen, some homeowners now discover it difficult to repay their mortgages, and hold their homes. Americans normally need a mortgage loan to purchase a home. Subprime borrowers are folk without powerful recognition histories. Lenders can accuse them more because there is a greater opportunity they will not be capable to repay backwards the loan.

Subprime lenders often depend on credit to make the loans. Once processed, the loan is usually sold to an investment bank. Loans with similar levels of risk are grouped together and then sold to investors worldwide as mortgage-backed securities. The higher the risk, the higher the return.

The Government National Mortgage Association, known as Ginnie Mae, and two other organizations known as Fannie Mae and Freddie Mac produce most mortgage-backed securities. But investment banks have increased their share, led by Lehman Brothers. Last year, it processed more than fifty billion dollars in securities backed by subprime mortgages.

Being able to sell their loans offers mortgage lenders a way to raise money to make new loans. But being able to spread their risk can also be seen as an invitation to make bad loans.

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