As the banks have become aware of just how much bad lending has been going on over the past five years, they have begun taking drastic measures to cut down their exposure to the subprime mortgage mess. Many lenders have gone out of business, filed bankruptcy, or stopped making loans to unqualified applicants, but this has caused a general drying up of credit in the economy. The subprime debacle is leading directly to a much more generalized credit meltdown, as homeowners in trouble will be unable to refinance their homes to save them from a financial hardship, and they will fall further and further behind on all of their bills. A quick refinance to consolidate and lower bills is simply not an option for a great number of homeowners now.
Banks are not even lending to each other very much right now. Many of the large banks, such as Chase, GMAC, and Washington Mutual, although they were not large players in directly lending to loan applicants in the subprime market, were voracious buyers of these loans. They would buy large numbers of bad loans, package them, and sell them to investors or hedge funds managers, who believed the returns would justify the enormous risks involved.
However, the mistake was in believing that real estate prices would just keep rising; if the homeowners with the bad loan defaulted, the banks would simply sell the property for a huge gain. Whether the owners made the payments or not, the investors would make money in a steeply rising real estate market. Of course, these geniuses failed to realize that large numbers of foreclosures would inevitably lower the home values in areas hit hard by defaulted loans. Once this happened, the charade could not last much longer and everyone realized just how toxic are loans made to people who could not afford to pay them back.
Now, with trillions of dollars of bad mortgage debt floating through the economy, banks are desperately attempting to reduce their exposure to the risks. If another bank requests to borrow money from a large lender, what is the reason? Because they are experiencing a short-term liquidity problem, or because the only way to stay in business for another few days is borrowing money that they will eventually default on once their mortgage clients default in even large numbers?
No one even really knows who owns these subprime mortgages, so every lending decision by a bank to another bank is now consumed by a fog of suspicion and distrust, which explains why credit is still scarce despite the Federal Reserve’s repeated lowering of the interest rate and direct injections of newly-printed money into the economy.
Of course, all of this reduction of risk, refusal to lend money to homeowners in trouble, and direct involvement in the economy by the central bank just leads to more problems for homeowners. They are unable to figure out who owns their mortgage, because the loan has been sold numerous times and is now in the hands of some hedge fund who sells the servicing rights to another company which then sells those rights to various other companies. Even courts now are throwing out some of these foreclosure because the plaintiffs can not prove their own the loan; while this is a positive development for homeowners, it does not allow the mortgage contract to be performed as written and leads to more confusion as to just what is going on with these subprime loans.
The homeowners are unable qualify for a loan to fix their problems temporarily, because banks are no longer lending money to people in their financial situations. And they can not even afford to keep up with rising prices any longer, as the Federal Reserve inflates the money supply, decreases the purchasing power of the dollar, and bails out banks directly. While no one party should get a direct bailout, the fact that the banks are getting it just to prop up their bottom lines for the short term will not do a single thing to provide help to homeowners falling behind. They still do not qualify for a new loan, whether the lenders have been given free money or not.
And the new money given to the lenders just increases the possibility of more foreclosures, which increases the chances that the banks will request more bailouts in the future, leading to more inflation and more foreclosures, and so on. This cycle of stealing purchasing power from the average consumer to give to the big banks because they may not make as high of profits as they once expected is no excuse for the act of stealing money from the homeowners to begin with. When the Federal Reserve, owned by the large banks to begin with, prints money to give to the large banks, this is nothing but outright theft from homeowners. As the money supply increases, money becomes worth less, but those who have access to the newly-created money can continue to prosper at the expense of those who do not.
With bad lending practices, absolutely confusing loan paperwork and unclear chains of ownership, and continually relying on inflation to bail them out of these poor decisions, the banks have been shooting themselves and their clients in the foot at every opportunity. Extracting as much profit as possible from the people through lies and manipulations is one thing; believing their own lies is entirely another. Of course, it always helps when the banks do not have to worry about things like accountability or being punished in the market. After all, they exercise inordinate control over the market through interest rates and money supply, and will begin the next bubble after the currently bursting one’s fallout has been cleaned up.