NINJA loans - no income, no job, no assets - are but the most egregious example of sub-prime loans.
About 25 per cent of mortgages in the US were sub-prime loans. Half went to African Americans and a third to Latinos, the two groups most over-represented in lower income groups.
The business model for these loans was essentially that housing prices would continue to go up. It would be a bonus if employment also increased, real wages (including the minimum wage) grew and interest rates didn’t rise.
None of these turned out to be true. Unemployment has been increasing in the US. The minimum wage has fallen in real terms for a number of years. The Fed raised interest rates a few years ago to stop inflation.
But the real crunch was housing prices. As they began to fall the foreclosures started because lenders wanted to protect their positions. This only exacerbated the decline in US housing prices, which fell more than 15 per cent to June this year. This fall in house prices has cut the wealth of middle income Americans whose sole or main asset is their home.
Once the downward housing spiral began, cutting interest rates, as the Fed has done, couldn’t stop it.
It is understandable why borrowers would take out sub-prime loans. They wanted to be part of the great American dream, a dream that in many other ways is denied them. Couple that with the fact that public housing is grossly underfunded in the land of the free and sub-prime loans offered a taste of hope.
The loans were securitised. This means basically that the lender bundled them together and offered them in various forms such as trusts to investors. We are talking big bucks so the investors were major groups like foreign country sovereign funds - the Chinese and petro-dollar equivalent of our Future Fund - pension funds, hedge funds and investment banks.
The question is not only why lenders would lend to NINJAs, but also why investors would invest in vehicles whose base is loans to people who may well not be able to repay.
The general profit rate in industrial countries is lower now than ten years ago. It is much lower than the halcyon days of the 60s.
Without going into too much detail, there is a tendency for the rate of profit to fall. This comes about because labour is the source of value yet the competitive process forces business to invest more in capital than labour.
Back to Wall Street. The Middle East is flush with capital from petro-dollars. China’s rapid development (including large amounts of profit from dealing with the US) means it has a lot of capital to invest. Together with hedge funds, pension funds, investment banks and the like, these groups are all looking for a return on investment over and above the low general rate of profit.
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