Reversal of fortune

August 12, 2007

As European banks scrambled last week to curtail the widening repercussions of the U.S. subprime mortgage mess and deal with a threatened liquidity crunch, discussion turned to whether the Federal Reserve Board would bail out investors caught up in the crisis. The boomerang effect of Americans' reliance on subprime mortgages can't be underestimated, but efforts to manage the fallout should not lose sight of those in danger of losing their homes.

Until last week, the subprime crisis was marked by a cascade of failing lenders, delinquent loans and foreclosures. And then a French bank stopped withdrawals from three investment funds ensnared by the subprime crisis. That triggered Europe's central bank and the Federal Reserve to pump billions into the banking systems to keep credit available as U.S. stocks plummeted.

Whether the actions by the central banks quell concerns or exacerbate the situation will become clear soon enough.

But even if the liquidity crunch eases and the financial markets correct themselves, the collapse of the subprime market will continue to be felt across the country as jobs are lost, loans are tougher to get and homeowners struggle to keep their houses. Experts predict that autumn will bring another wave of delinquencies and foreclosures as the next level of subprime mortgages resets. The effort, at least locally, must remain on attempts to shore up the housing market.

In Maryland alone last week, American Home Mortgage Investment Corp. laid off hundreds of employees in the state while seeking bankruptcy protection; Fieldstone Investment Corp. of Columbia, a subprime lender, quit taking loan applications; and state Licensing Secretary Thomas E. Perez announced the first prosecution of a "foreclosure rescue scam," evidence that criminals are exploiting homeowners' woes.

To keep homeownership available for low-income buyers, regulators must ensure that lending practices are reasonable and realistic. New guidelines issued by the Federal Reserve say loans should be made based on a borrower's ability to pay the entire cost of the loan, not a lower-priced introductory rate - but they are only guidelines.

The increasing rate of home foreclosures is leaving cities such as Baltimore, Cleveland and Riverside, Calif., with a growing vacancy problem. Urban Institute scholar Edward M. Gramlich offers this remedy: State and local governments should invest in the newly vacated homes to address a shortage of rental and affordable housing. That's one way to reap some benefit from a housing bubble gone bust.

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