A large chunk of consumer spending is on the purchase of homes and
obtaining mortgages. Housing in turn fuels appliance sales, home furnishings
and construction. In 1940 44% of US citizens owned their own homes, by 1960 62%
of Americans owned their homes. Currently nearly 70% of all housing is owned by
its constituents. The increase in home ownership has resulted in more and more
US citizens becoming indebted, US household debt is $11.4 trillion (2006). This
is a staggering figure considering 20% of US households now have more debt then
assets. This debt represents enormous confidence in the future of the economy
because the actual money doesn’t exist. This debt is seven times the amount of
dollars in circulation (M1 Money Supply), which is only $1.3 trillion (2007).
Lenders assume the money will exist when it comes time for people to repay
their debts. The importance of the consumer to consume to the US economy was
outlined by Richard Robbins expert in anthropology in his award wining book
‘global problem and the culture of capitalism,’ ‘a couple of days after the al
Qaeda operatives crashed two planes into the world trade centre on September
11th US congress members met to plan a message to the stunned public. “We’ve
got to give people confidence to go back outside and go to work, buy things, go
back to the stores, get ready for thanksgiving, get ready for Christmas,” said
one member of congress, echoing the message of the president ‘get out’ he said
“and be active members of our society.” (CNN 2001).
‘The fact that after one of the most shocking events in US history
government officials were urging citizens above all to shop and work is ample
testimony the significance of consumption in the effective working of our
economy and indeed for the whole society.” Creating the Subprime Market The
Sub‐prime mortgage market differs from the prime (primary) market as it
comprises all those people who do not meet the criteria for a mortgage in the
mainstream market. The adoption of the Depository Institutions Deregulatory and
Monetary Control Act in 1980 was part of the deregulation drive that eliminated
many restrictions to lending, this resulted in loans reaching unprecedented
levels which led to the mainstream mortgage market becoming saturated and
reaching its peak of profitability. Those with patchy credit histories and of
low income were turned away from mainstream mortgages at a time when the market
was buoyant due to consumer spending and borrowing.
The Sub‐prime market was carved out after this point as 25%
of the US population fell into this category and represented a market
opportunity. Hence US lenders gave mortgages to people who had little means to
pay for a mortgage and charged them a rate of interest much higher than the
commercial rate due to the increased default risk. They issued these mortgages
safe in the knowledge that if the buyer defaults, then they would be able to
repossess the property, and sell in a buoyant property market. By the start of 2007,
the sub‐prime market was valued at more then $1.3 trillion. Traditional
banks stayed away from this risky market and instead remained focused on prime
lending and questioned some of the business practices of sub‐prime
companies such as their aggressive lending and accounting practices. Between
1994 and 1997 the number of sub‐ prime lenders tripled, going from 70 to
210. Because such institutions were not banks they possessed no customer
deposits and in order to expand many lenders turned to the stock market for
funding. Companies such as Money Store, AMRESCO Inc, Dallas and Aames Financial
Corporation, all raised capital through placing some of their companies on the
stock market. Relatively young lenders such as Long Beach Financial
Corporation; Irvine, California‐ based New Century Financial Corporation;
Delta Funding Corporation; and Cityscape Financial all took their companies
100% public.
By the end of 1997, the top 10 lenders accounted for 38% of all
sub‐prime lending. The collapse of the Russian rouble and long term
capital management in 1997 resulted in a number of foreclosures leading to the
demise of six of the top 10 sub‐prime lenders. This left an enormous
vacuum in the sub‐prime industry that resulted in a series of
acquisitions by commercial banks such as Washington Mutual's acquisition of
Long Beach Financial Corporation. Associates First Capital, the third‐largest
sub‐prime originator at the time, was purchased by Citigroup Inc. In
2001, Chase Manhattan Mortgage Corporation acquired Advanta Mortgage
Corporation, the 16th‐largest sub‐prime lender at the time for $1
billion. In 2003, HSBC Finance Corporation acquired sub‐prime powerhouse
Household Finance, which had earned the rank of largest sub‐prime lender
in the two years prior to its acquisition by HSBC.
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