The sub-prime mortgage industry was a $1.5 trillion home lending business that targeted home buyers with poor credit. Sub-prime mortgages accounted for roughly 15 percent of all mortgages in the U.S. As a result of lending to those sub-prime borrowers, an estimated 2.4 million home owners are projected to face foreclosure over the next few years. 

Since 2006, 110 mortgage companies have shutdown or filed for bankruptcy, resulting in more than 80,000 people losing their jobs. Merrill Lynch, the second largest Wall Street investment bank, announced in October it's biggest loss in 93 years. This historical loss was due to an $8.4 billion write-down on its assets of sub-prime mortgages, asset-backed bonds and leveraged loans. The total losses related to sub-prime loans are an estimated $150 billion globally. How could this happen and who is to blame?

The stock market tumbled on the first day of trading after the 9/11 terrorist attacks . On this day, the Dow Jones Industrial Average experienced its largest one-day point drop in history - losing 685 points. In order to prevent the economy from falling into a recession, former Federal Reserve Chairman, Alan Greenspan, began to lower short-term interest rates (the price of money) to encourage business and consumer spending. Greenspan had the right idea since business and consumer spending accounts for roughly 85 percent of our $13 trillion economy - and his plan worked! Between 2001 and 2004, the federal funds rate was 2% or less and home purchases skyrocketed. Mortgage lenders and Realtors bombarded consumers with advertisements stating this is the "Best time to buy a house." According to the National Association of Realtors, in 2003 the 6.1 million existing homes sold set a new record.

At the end of 2004, housing prices were up 13 percent while the Dow Jones was above 10,000 and the economy appeared stable. Increased spending in the housing industry helped stir up economic growth and Greenspan began raising interest rates to manage inflation. After-which,  the cost of buying a house increased and housing transactions began to slowdown. Since fewer mortgages were being created, Wall Street investment banks like Merill Lynch, who purchased mortgage loans from lenders and "securitized" or repackaged them into securities then resold them to major investors, saw their profits decline. Investment banks  began "securitizing" increasingly more mortgage loans and by 2006 generated $6 billion from financing mortgages and other loans - up 60 percent since 2003.

The banks did not want to stop milking their cash cow and once home borrowers disappeared after higher interest rates appeared, credit standards were relaxed and lower quality loans were purchased. Since mortgage lenders like Country Wide Financial no longer owned the loans they issued they were eager to supply investment banks with plenty of sub-prime loans because they generated profits with very little risk. 

Creative and exotic mortgage loans were tailored to attract more borrowers with poor credit so they could purchase homes. For example, an "adjustable rate mortgage" (ARM), accounted for more than 45 percent of all sub-prime loans. An ARM is a mortgage loan with an agreed upon interest rate that is periodically adjusted as economic indexes, such as LIBOR (the interest rate London Banks charge each other) change. If interest rates go up, the monthly mortgage payment increases, and vice versa. 

The "interest only" and "NINJA" were other creative mortgage loans. The "interest only" loan allowed a borrower to have a lower monthly payment by paying only the interest due on the loan. However, the borrower could expect the payments to increase at a later date and begin paying off the principal amount of the loan. The unprecedented NINJA loan simply meant a borrower could have  "No income, No job, No assets" - And no problem getting approved for a mortgage!

Mortgage lenders made the loans, investment banks purchased the loans from the lenders, "securitized" them and resold them to investors like hedge funds, insurance companies, pension funds and foreign investors. Investors were eager to buy these mortgage-backed securities because they were considered by credit rating agencies like Moody's, to be "low risk" (AAA grade) investments.

How could the investments be considered "low risk" when they were based on payments from borrowers who had a history of not paying their debts? According to University of California at Berkley Professor, Robert Reich, "credit-rating agencies are paid by the same investment banks that package and sell the securities the agencies are rating. If an investment bank doesn't like the rating, it doesn't have to pay for it. And even if it likes the rating, it pays only after the security is sold. Get it? It’s as if movie studios hired film critics to review their movies, and paid them only if the reviews were positive enough to get lots of people to see a movie."

Who's to blame?
• The Federal Reserve kept interest rates low for four years and sparked sales of home mortgages.
• Wall Street investment banks relaxed their credit standards and began buying lower quality loans, only to resell them to hungry investors.
• Borrowers with poor credit history promised to pay and agreed to the creative and exotic mortgages issued by mortgage lenders only to default later.
• Credit rating agencies approved the sub-prime loans that Wall Street "securitized" and resold as mortgage-backed securities. 

It was not until June 22, 2007 that sub-prime shock started to be recognized as Bear Stearns, another investment bank, announced it would put up investment collateral of $3.2 billion. The reason for the collateral was to "bail out" one of its two sub-prime hedge funds which had lost nearly all of its value due to a rapid decline in the market for sub-prime mortgages. And on October 5, 2007 Washington Mutual, a commercial bank and mortgage lender, announced it would take a $820 million write down on its loans and securities.

Currently, Wall Street Banks: Citigroup, UBS, Deutsche Bank, Bear Stearns, Lehman Brothers, Goldman Sachs and Morgan Stanley have lost a total of $20 billion as a result of the sub-prime crisis. However, it is estimated that $500 billion in sub-prime mortgages will reset to higher interest rates over the next 12 months and mortgage lenders and investment banks all predict potential losses that could exceed more than $150 billion. 

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