The Spark

“The emancipation of the working class will only be achieved by the working class itself.” — Karl Marx

United States:
The Subprime Economy

Oct 31, 2007

The housing crisis in the U.S. has continued to worsen. Over two million home foreclosures are expected for this year, and predictions are that next year’s foreclosure numbers will be even worse. The New York Times says this is the worst housing crisis since the Great Depression.

This crisis is said to have started with people holding subprime mortgages, mainly those from the working and lower middle classes, who are usually portrayed as financially irresponsible and poor credit risks. But not only do the people losing their homes have jobs and income, they are often working two or three jobs in order to keep their heads above water.

The High Price of Housing

Their problem is an acute and chronic shortage of affordable housing. On the one hand, rents have been rapidly increasing, and in some places skyrocketing. In Los Angeles, for example, the average rent on a two-bedroom apartment is close to $1,700 per month. Someone has to make at least $24 per hour, what economists call the “housing wage,” in order to afford a two-bedroom apartment. Obviously, most working people don’t make that kind of money. As an alternative, a lot of working people look to buy a home.

Housing prices are even more outrageous. For example, houses in the vast gang-ridden area known as Central Los Angeles can cost $400,000 or even $500,000. The interest alone on such a mortgage costs $25,000 or $30,000 per year, not to speak of the cost of payments on the principal, insurance, taxes and utilities. In other words, home prices are completely out of reach for ordinary working people.

In most big cities housing prices had always been high and there was always a chronic shortage of affordable housing. But over the last decade, the rapid influx of people into many big cities worsened that shortage. Starting in 1996, housing prices, especially in some cities on the West Coast, began to increase rapidly. To take advantage of rising demand, major construction companies threw up big housing tracts, charging much higher prices. With the price of new homes rising quickly, the price of existing homes soon followed suit, and price increases spread throughout the country.

In just under 10 years, home prices on a national level rose by 85% above the official rate of inflation with much bigger price increases along the East and West coasts.

As housing prices rose, politicians, academics and the mass media magnified the hype that the home is the best and most solid investment. On cable TV, for example, there were regular programs on A&E, the Learning Channel, House and Garden – all promoting the supposed advantages of buying and selling real estate. Even the staid PBS television pledge specials featured financial gurus pushing the same line.

The Mortgage Rip-Off

Of course, as prices rose, increasing numbers of homeowners couldn’t afford the monthly payment on traditional fixed-rate 30-year mortgages. Construction companies, looking to recoup their investment as quickly as possible so that they could start to build new housing tracts, worked in conjunction with the banks to offer ever more “creative financing,” which seemingly brought down the monthly payment on the ever more expensive homes. They set up much riskier and in the long run much more expensive adjustable rate mortgages (ARMs) and interest-only mortgages with a large balloon payment at the end of a fixed term. This same type of mortgage was then offered to people buying existing homes. Not too many people could afford to pay $500,000 for a home that only a few years earlier had cost $120,000.

The most famous of these mortgages were “subprime,” a class of very complicated and tricky forms of credit, which were very profitable for the companies that issued them. These mortgages contain low introductory teaser rates, under which the monthly payments for the first couple of years are kept low. After that, interest payments skyrocket. Besides that, the loans are filled with hidden fees and penalties. In the business they are called exploding credit payments.

Like payday loans, rent-to-own furniture and appliances, and all those credit cards with loan-shark interest rates and penalties, subprime mortgages are predatory loans in which the biggest financial companies squeeze the poor, working class and lower levels of the middle class.

Buyers were tricked into taking out these predatory mortgages with all their resets and penalties, traps and hooks, buried deep in the fine print. When buyers did discover just how dangerous and risky the mortgages were, the mortgage companies and banks assured them they could always refinance or sell their home and still make a profit. After all, wasn’t absolutely everyone saying that no matter how outrageous the price of a house, prices would be even higher in just a few short years?

Not only were ordinary people pushed to buy into a classic speculative bubble, they were saddled with extremely expensive predatory loans on top of that.

Workers weren’t the only ones to fall prey to these subprime mortgages. Housing prices became so high, even more privileged layers of the middle classes couldn’t afford them. An analysis of more than 130 million mortgages by the Wall Street Journal (October 11) found that from 2004-2006, when housing prices hit their peak, similar kinds of high cost loans were also written for prime, or “low risk,” borrowers. In pricey areas such as Miami, said the Wall Street Journal, mortgage companies and banks pushed subprime loans as the answer to sky-high housing costs, steering upper-class home buyers into the same kinds of very expensive adjustable rate mortgages and interest only mortgages as lower-income people.

Real estate speculators played a major role in the game, and subprime mortgages, with their low initial payments, fit their needs perfectly. Since they were buying houses on credit in order to quickly re-sell them at a profit, that is, flip them, they had no intention of holding onto the houses that they bought anyway. Last year, during the height of the bubble, speculators accounted for 13% of all high rate home loans, practically a 50% increase since 2004.

Thus another layer of speculators helped drive up house prices, although the main drivers of the housing bubble were the lenders themselves, who flooded the housing market with ever more predatory loans. As the market reached its peak, in 2005 and 2006, subprime and other high interest loans made up close to half the mortgage market. And the subprime mortgage market wrote new mortgages worth close to half a trillion dollars in each year – 2004, 2005, and 2006.

Not surprisingly, at the housing market’s peak, prices had become so high, home buyers couldn’t even afford the small down payment. But that didn’t stop lenders from making the deal. On the contrary, they simply offered to make an additional loan to cover the down payment also. Between 2004 and 2006, volume on these second mortgages to cover the down payment doubled to constitute 22% of all mortgages written.

The Subprime Money Machine

The market in predatory, high-cost loans was not inhabited only by giants in the mortgage business, such as Countrywide Finance and IndyMac. Big savings and loans, like Washington Mutual, jumped into the market. Major commercial banks, like Wells Fargo, Citigroup and HSBC, built up subsidiaries geared to selling subprime mortgages. So did the big Wall Street investment houses, like Lehman Brothers and Goldman Sachs and such insurance giants as AIG. Big industrial companies, such as GM and GE, used their financial arms to set up their own companies to grab a share in this market. Even the H&R Block tax preparation company, which already made big profits by providing instant (high cost) loans on their clients’ tax refunds, had their own predatory real estate loan subsidiary.

The mortgage companies were just one cog in the subprime-mortgage money machine. They borrowed the money for the mortgages from Big Wall Street investment companies and commercial banks. Countrywide Finance, for example, borrowed 40 to 50 billion dollars every month. The mortgage companies then sold the mortgages to other banks and investment companies, which “securitized” the mortgages, turning them into various forms of speculative financial instruments.

In other words, all those financial companies started with something simple, a person’s home, a place where people live. Around this, these financial “geniuses” constructed something absolutely massive, an unimaginably huge financial superstructure. This superstructure produced nothing itself. But it still managed to collect the lion’s share of the money, paid for by the people living in that house.

Mortgage Meltdown

In early 2005, the volume of home sales began to drop off, even as construction companies continued to churn out new housing tracts and condos. To spur sales, construction companies began to throw in tens of thousands of dollars worth of incentives, such as an all-expense-paid Caribbean cruise, expensive appliances (a “free” jumbo-sized flat screen HD television!), granite counter tops, marble bathrooms, an extra bedroom, den, or lawn. When that didn’t attract enough new buyers to keep inventory from continuing to grow, builders cut prices outright. Some used long weekends to hold nationwide home sales (“No deal will be turned down!”). Their profit margins had been so large, they could cut prices substantially, and still make money. These price cuts then generalized, spreading to existing home sales.

This fall in home prices coincided with the first big wave of subprime mortgages resetting at much higher monthly payments. The first to get hit by the fall in prices were the individual speculators. Suddenly, they were stuck holding properties they couldn’t flip or unload. Speculators have accounted for more than one-third of all foreclosures.

Not far behind have been millions of people with subprime and other forms of high interest mortgages, who had been given all those false assurances not to worry about the mortgage resets because they could always refinance or sell. But with their homes worth less than their mortgage, they could do neither. By 2006, foreclosures were running twice as high as in the previous year. In 2007, they practically doubled again.

In other words, the collapse of the predatory debt, which had been so instrumental in pumping up the housing bubble, was feeding and reinforcing the collapse of the housing market.

The foreclosed houses were dumped on an already over-saturated housing market. The Commerce Department reports that the homeowner-vacancy rate, which measures the number of vacant homes for sale, had reached levels never seen since it began to keep records in 1965. The ratio of housing inventory to sales of unsold homes grew to be so large, it would take close to a year to sell all the houses. The longer homes stay on the market, the more downward pressure on home prices.

The fall in housing prices carries risks even for those holding the safest, 30-year fixed rate prime mortgage. As prices tumble, their homes can become worth less than what they owe on the mortgages. To protect their loans, the banks have the right to call in those mortgages. That is, the banks can demand that the homeowners make up the difference between what they owe on their mortgage and the sinking price of the house by paying a large lump sum immediately. If the homeowner doesn’t pay up, the bank can take over the house. And if prices continue to fall, the banks can demand that the homeowner come up with further lump sum payments – or lose the house.

The Government to the Rescue... of the Capitalists

It would seem logical that the banks and mortgage companies servicing the mortgages would try to forestall this wave of foreclosures by working out some kind of payment schedule with the homeowners, allowing them to stay in the home and keep paying. That way, money would continue to come in, while there would be fewer vacant homes to further drive down prices. But mortgage companies have not done that; obviously because they don’t want to do anything that would cut into their profits. Less than one percent of all defaults are being renegotiated. Instead, the mortgage companies have pushed the mortgages to default and foreclosure as quickly as possible, so that they can resell the house and issue a new mortgage!

At the same time, the government has not lifted a finger to aid or support all the homeowners who are being kicked out of their homes. Plenty of politicians have sworn to help homeowners in danger of losing their homes. It was nothing but talk, justifying the massive government bailouts of the banks and other financial companies that created and profited from the housing bubble and the subprime mortgage market and that now face huge losses. The Federal Reserve flooded the money supply with cheap money. It also changed the rules of how it loans money to the banks, making it much easier and cheaper for them to borrow money at very cheap rates, money they can lend out at a very big profit. Of course, this money does not come free. Either the Federal Reserve gets it from the U.S. Treasury Department, which itself is financed by taxpayers. Or else, the Fed inflates the money supply, thus creating more inflation which eats away at the living standards of the majority of the population. Either way, the masses of people pay for the bail-out of the wealthy few, as both taxpayers and consumers.

Government rescue attempts have continued. In mid-October, the U.S. Treasury Department announced it is working with the three biggest commercial banks, Citigroup, Bank of America and JP Morgan Chase, to set up a special fund to reduce losses from financial instruments based on mortgages that are now in default. Just one bank, Citigroup, is supposed to have seven funds, with a combined face value of 100 billion dollars, that in reality have little or no value left in them.

Over the years, Big Business and High Finance have fulminated over how government regulations and intervention were getting in the way of doing business and making profits. They pontificated over the need for “smaller” government, more individual responsibility and “self reliance.” They pushed for legislation making it harder for individuals to use bankruptcy protection to wipe the slate clean and get out from under their debts. Now that these same companies are in serious trouble, they are the first ones to demand that the government intervene, at a very high cost, to rescue them.

Economic and Social Impact

Millions of people are being kicked out of their homes, with millions more threatened. Countless working class neighborhoods in cities and suburbs are filling up with vacant homes and lots, bringing blight, crime, vermin and disease. But the price paid by the working population doesn’t stop there.

The end of the housing boom and the beginning of the housing crisis has brought big job losses. Over the last year, the construction of private homes has dropped by about 40%, leading to a big loss of construction jobs, which some estimates place at half a million jobs. A major share of this job loss has not shown up in the official statistics because many of the jobs were held by undocumented immigrants. But it shows in other ways. Statistics on remittances to Mexico and Central America show that workers are sending less money home than before.

The housing crisis is also beginning to impact other job sectors. The recent collapse of mortgage companies led to immediate job cuts in that sector. Employment related to real estate credit dropped by almost 9% from a year earlier. And now the big financial companies, including Bank of America and Citigroup, have announced what promises to be the leading edge of very big job cuts across the board – which will especially impact New York City, the center of the financial industry.

There are many other jobs related to the housing and construction markets that are being hit. These include producing and selling home furnishings and appliances, hardware, lawn care, etc. Sales have slowed considerably at WalMart, the biggest store in the country, and Home Depot, which provides supplies and equipment for contractors and those who work on their own homes. Growing unemployment will weigh heavily on the rest of the working class, and be used by the bourgeoisie to try to impose new rounds of sacrifices.

The deflation of the housing bubble has also pushed people to rely increasingly on the most costly form of credit: credit cards. Taking on more debt has been one of the main ways that people have been able to make ends meet, to bridge the growing chasm between falling incomes and skyrocketing expenses. In the last 20 years, the household debt load doubled in relation to income, hitting record levels. Until very recently, homeowners were encouraged to take out home equity loans, treating their homes like a personal ATM. Every year, tens of billions of dollars from home equity loans were used to consolidate debt from high interest credit cards, as well as pay for everything, from cars to medical bills to everyday expenses. Now with home values sinking, that avenue of credit is being closed off. In fact, people have begun resorting to their credit cards to make their house payments, thus coming full circle. At the same time, credit card companies are boosting interest rates, putting the screws even harder on ordinary people.

For the last six years, the housing and related industries accounted for about 80% of the already very anemic growth of the economy and jobs. Now that housing is in a severe contraction, the capitalist class will try to protect itself by making the working class pay for that crisis.

One thing is sure: the capitalists are coming for the workers. With the housing crisis, the big financial companies are literally taking homes from millions of people. In the plants and workplaces, they are trying to turn the clock back a century, imposing 50% wage cuts and tearing up all their promises and guarantees to retirees.

Can the capitalists get away with this? It depends on whether the workers find the way to mobilize their enormous forces and power in order to defend their own interests.