Subprime Loans Started the Recession?
Subprime lending or the handing out of subprime loans, in the lending industry is a financial term that was popularized by the media starting with the credit crunch of 2007 and involves financial institutions lending to borrowers who do not meet prime underwriting guidelines. Subprime borrowers are more likely not to pay the money back, and somehow the lenders knew this but just the same lenders lent money to them not anticipating perhaps that 2007 was a year that would be the start of a severe financial crisis that would hit the world. That financial crisis unfortunately is still with us two years after its start, and there is no telling even when things will be back to normal again.
When lenders gave subprime loans to people some two years ago even if they had a history of not paying loans back, a recorded bankruptcy, or with limited debt experience, maybe they thought the financial situation then would somehow improve in a few months. They were quite wrong as the experts even say that things will get worse yet before we can hope for the economic crisis to get satisfactory resolution.
There is no standardized definition of this kind of loans, but in the US subprime loans are usually classified as those where the borrower has a credit score below figures that are industry standards in the approval of loan applications. Subprime loans encompass a variety of credit types, including home mortgages, auto loans, and the issuance of credit cards.
Subprime loans are actually non-conforming loans, or those that do not meet Fannie Mae or Freddie Mac guidelines. Those guidelines from the major fund sources in the US are normally about the size of the loan, a high debt-to-income ratio or about the lack of income documentation that a borrower is supposed to provide. Risky, to say the least of the subprime loans, but the lenders just plunged ahead with the approval of applications for them. This could be because the lenders were awash with cash then and did not really know what to do with them.
Proponents of subprime lending, when it started, maintained that the practice was aimed at extending credit to people who would otherwise not have access to the credit market. It would have been good if the borrowers of subprime loans had intentions of using the proceeds to set up more enterprises that would spread the money to a bigger world market especially to people who practically do not have any paying capacity. This would have led to the creation of a bigger market for the goods produced by the companies in the manufacturing sector.
Unfortunately the subprime loans were not used for job-creating and productive enterprises, but only to save people already deep in the quagmires of debts. That made the situation even worse which led to what is now a major slowdown of the world’s economy. People now are reaping the bad effects of the subprime loans which in the first place should not have been issued at all.
Subprime lending evolved with the development of a demand in the marketplace for loans to high-risk borrowers with imperfect credit. Due to the extensive use of credit cards by the public for practically everything that they bought, many credit card holders failed to meet their monthly debt obligations on time and soon the number of defaulting credit card debtors snowballed and they became a group that needed financial assistance to pay for their debts. This led to the subprime loans which the lenders could not help handing out as many were asking for the loans.
So, on the side of the borrowers, subprime loans became a necessity that they have to resort to, wanting of any other means to raise money to meet their mounting debts. Those times that the subprime loan came into being were actually the first signs of a financial crisis building up in the entire economy. People were unaware though of those beginnings of a major economic crisis as they continued the unabated use of credit cards in their daily buying of even the smallest items that they need for the household.
The first subprime loans were initiated in 1993. Many companies entered this portion of the lending market when the prime interest rate was low, and real interest became negative allowing modest subprime rates to flourish. Borrowers who were good lending risks were becoming fewer as everyone made full use of their credit cards. As the number of people with problematic credit histories increased, lenders began studying how to provide them the subprime loans hoping to still make money out of their lending operations. Thus the start of the subprime loans made it clearer that the world was headed for the recession that we are now confronting.
The money lenders who are in the business of making loans available to people with the loan interest earnings as their main source of business income, have to go on with their operations so they can survive also the turbulent times now.
Traditional lenders were more cautious in their operations and historically turned away potential borrowers with impaired or limited credit histories. But their revenues from their traditional loans also began dwindling as fewer people availed of their secured loans since it became easier to borrow from the subprime industry that was fast building up. In the developing competition between lenders the more conservative ones may have decided to stop operations in the meantime that the state of the economy was becoming bad. But the bolder ones took over the subprime loans as their statistics showed that money can still be made on the subprime loans, enough to sustain the business of subprime lenders.
The entire world now however is searching for more practical solutions to the economic crisis. The subprime loans however may not work completely for this effort if no productive projects are put up by the borrowers to create the needed jobs for people who have been terminated from their companies that either downsized or totally closed down.
