It sure doesn't seem like the recent subprime lending crisis has any silver lining, does it? Companies that were heavily into the practice are facing major problems -- think of New Century Financial, Novastar Financial, and Fremont General. And as Richard Gibbons has pointed out, even bigger companies, such as General Electric
Then look at the many borrowers who tried to buy more home than they could afford, and who ended up (or will end up) losing their homes -- and perhaps some additional funds as well. That's not a pretty picture, either.
So is there any upside here? Well, yes. In a recent issue of The New Yorker, former Fool writer James Surowiecki offered an interesting contrary take:
But what's often missed in the current uproar is that while a substantial minority of subprime borrowers are struggling, almost 90% are making their monthly payments and living in the houses they bought. And even if delinquencies rise when [higher rates] kick in, on the whole the subprime boom appears to have created more winners than losers. (The rise in homeownership rates since the mid-nineties is due in part to subprime credit.) We do need more regulatory vigilance, but banning subprime loans will protect the interests of some at the expense of limiting credit for subprime borrowers in general. And while the absence of a ban means that some borrowers will keep making bad bets, that may be better than their never having had the chance to make any bet at all.
To appreciate the rise in homeownership rates that Surowiecki mentions, check out the graph accompanying this article from the Federal Reserve Board of San Francisco. It reflects an increase in homeownership from 64% in 1994 to a high of 69% in 2004. (We're roughly at that same high level today.) The rate had hovered around 64% for roughly the entire decade preceding 1994 before it took off.
To be sure, subprime lending isn't the only explanation for the increase. We can also thank:
- Extremely low interest rates.
- The aging of the average household, as boomers grow older. Older Americans are more likely to be homeowners.
- Innovations in home finance, such as home equity credit lines and streamlined refinancing processes.
- Strong appreciation in housing, in general, which likely attracted more buyers, who saw it as a good investment.
Good or bad?
So has subprime lending been good or bad, overall? Well, a better question might be: How can we continue to achieve the good, with less of the bad? In other words, how can we fuel continued growth in homeownership rates while decreasing the number of failed mortgages and foreclosures?
More regulation and oversight in the lending industry is one solution. Another is more education for borrowers. People need to understand what they're signing up for when they take out extra-risky loans. They need to appreciate just how high their monthly payments may get -- in the not-so-far-off future. They need to have realistic expectations for home price appreciation (for example, home prices can fall).
Americans should also come to appreciate the power of the stock market. If you don't have enough for a down payment or for some reason aren't ready to buy a home, that doesn't mean you can't sock away some money to grow over the long term in stocks. For many, if not most, of us, a simple broad-market index fund, such as one based on the S&P 500, can be all we need. It will instantly invest you in 500 of America's biggest companies, such as Southwest Airlines, Target, and United Parcel Service.
With the stock market's average annual gain over long periods of roughly 10%, that's enough to turn a single $5,000 investment into more than $30,000 in 20 years. (And of course, you can do even better than that with carefully selected stocks and mutual funds.)
Another silver lining in the crisis is that, as with many financial crises, it will likely offer savvy and attentive investors some attractive investment opportunities. Richard Gibbons offered some thoughts on this in his "Cash In on the Subprime Crisis" article. And Timothy Otte pointed out where else we might look for opportunities in "Thumb Your Nose at Subprime Woes."
Meanwhile, if you're interested in homebuying and -selling issues, visit our Home Center, which features lots of money-saving tips on mortgages and other issues. You might also want to check out these articles, especially if you'll soon be buying a new home:
- Buying a House Is Easy!
- So You Want to Be a Landlord?
- A Mover's Survival Kit
- 10 Things You May Not Know About Mortgages
- 10 Home Enhancement Tips
Longtime Fool contributor Selena Maranjian owns shares of General Electric and a DeWalt cordless drill by Black & Decker. United Parcel Service is a Motley Fool Income Investor selection. The Motley Fool is Fools writing for Fools.