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Essay: Neil Harl on Subprime Mortgage Foreclosures

posted on November 14, 2007 at 3:33 PM

While the demands of the next generation and the developing generation workforce are daunting, a troublesome economic matter seems to be persisting far longer than many experts thought it would. Professor Emeritus Neil Harl explains.

Just 23 years ago now, Iowa was facing the greatest crisis in its agricultural sector since the Great Depression. It was dubbed the farm debt crisis of the 1980s. Indeed, I published a book by that title in 1990.

The farm debt crisis and the subprime mortgage foreclosure debacle of 2007 share several parallels even though there are some clear differences. Both involved too much debt, concentrated in the hands of a relatively few borrowers. But the impact was (and now is) magnified in the hands of the lenders, some of whom are in jeopardy. Iowa lost 38 banks in the 1980s; some subprime mortgage lenders may well go under in the current crisis.

Both crises involved federal policies that tripped up borrowers – a sharp tightening of credit beginning in late 1979 for the farm debt crisis. And, for the current home mortgage problem, historically low interest rates in the past decade that lured borrowers into short term adjustable rate mortgages, producing crippling financial burdens for borrowers when interest rates rose and the short term initial interest rates ended. That was coupled with some over-statement of incomes and falsification of employment records which were aided and abetted by aggressive lenders.

The heart of both crises is (and was) that borrowers in trouble are often largely powerless to cough up larger payments to keep loans performing.  And that problem could well grow in magnitude if the weakness now centered in housing spreads beyond the housing sector, the economy weakens and unemployment begins to rise. The widespread loss of a second paycheck could exacerbate the problem exponentially.

A lesson learned in the 1980s was that once losses have occurred, as collateral values fell, debt restructuring became the order of the day. Lenders should always be expected to do what is in their own best interest. That could mean

  1. reduced interest rates (when the usual lender reaction is to raise interest rates for those in default),
  2. stretched out loan repayment plans and even
  3. forgiveness of principal. The emphasis should be on preventing foreclosures where possible, which tend to weaken home values, and enabling problem borrowers to keep up their payments.

Finally, we should not forget that prudence in lending is never out of style. Regulators should push that message aggressively with the tools to prevent another problem of this magnitude.

Tags: agriculture debt Iowa mortgage crisis