Now, US govt is giving out subprime loans

“There are few references
in life so common as that to the lessons of history. Those who know it are doomed to
repeat it.”
— John Kenneth
Galbraith in A Short History of Financial Euphoria

Once bitten, twice shy? Not if it’s the government of the United States.
In a bizarre piece of logic, the Barack Obama-led administration has been giving out subprime loans through the Federal Housing Administration (FHA), a government agency.
Prime home loans are the best part of the market, where only borrowers with good credit ratings get a home loan. Subprime home loans are the worst, typically involving borrowers with very bad credit history and who won’t get a loan in the normal scheme of things. No reiterating how the shower of such loans opened the floodgates of the current financial crisis upon us.

Why then is the US government giving out these loans again, and through a government agency? Experts say the idea may be to prop up the housing prices, which have gone on a free fall.

“It probably is to support the financing on the housing finance market and therefore housing prices generally, as well as supporting the home ownership aspirations of the lower socio-economic part of the society,” says Satyajit Das, a risk consultant and author of Traders, Guns & Money: Knowns and Unknowns in the Dazzling World of Derivatives.

The US Federal Reserve has maintained interest rates at close to zero percent for some time now. Despite this, banks are not willing to lend.

“The US government is desperately trying to inflate the economy and it wants to get credit flowing again in order to stabilise American housing.

So, if the commercial banks are repairing their balance sheets and won’t lend, then the US government has taken over this role of credit creation,” says Puru Saxena, the founder and CEO of Puru Saxena Wealth Management and the editor and publisher ofMoney Matters, a monthly economic newsletter.

John Rubino, co-author of The Collapse of the Dollar and How to Profit From It, agrees: “The government is handing out newly printed paper currency to virtually anyone in an attempt to prevent a 1930s style crash.”

The subprime loans issued by FHA are converted into financial securities and sold to banks. Unlike the earlier batch of subprime securities, these come with a government guarantee. The FHA currently insures loans worth a whopping $560 billion.

Worryingly, these subprime loans from the FHA require a down-payment of just 3.5% of the value of the house being bought. This means just about anybody with a little bit of money lying around can take such a loan, irrespective of whether he or she in a position to repay.

The result is for all to see. In a report released on June 18, the US Department of Housing and Urban Development, which oversees the FHA, had said the rate of default on these loans exceeded 7%. Also, more than 13% of these loans had been defaulted on by more than 30 days.

“Of course it is very risky,” says Saxena. “However, politicians only care about the near-term outlook so that they can get re-elected. Who cares about the outcome 10 years from now? The bartenders are back again, giving more drugs to the addict so that the party can keep going. Needless to say, they don’t care about the long-term health of the addict,” he adds.

“Subprime lending should be strictly private sector, buyer beware. No government guarantees,” says Rubino. Experts feel these loans will lead to another crash in the days to come.

“I am sure it will lead to another epic bust in a few years time. When central banks start raising interest rates again, then we will see another massive crash,” says Das “It depends on the size and scale, but if it is government guaranteed, it will inflict losses on the government rather than on private bank balance sheets.”

The irony is perhaps best expressed by Shah Gilani, a retired hedge fund manager and noted expert on the global credit crisis, in an article for DNA: “Perhaps our ultimate fate is that of the permanently punchdrunk veteran boxer who rues his decision to stay in the game, realising that he fought “one bout too many.”

If that’s the case, that “one bout too many” could be Subprime Crisis II, arranged by the very market referees whose job it was to protect us from such beatings.”