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How Did It All Start?

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Financial planners offered their perspectives on how the sub-prime decline developed.

Sub-prime mortgages have deteriorated in the last year, casting a shadow on the real estate market, and potentially, on securities markets, in general.

Easy capital prompted lenders to go out and write sub-prime loans and then wrap them together and sell them off to larger institutions, says Scott Leonard, a certified financial planner and president of Leonard Wealth Management, Redondo Beach, Calif. They have short-term money to back the loans since they do not plan to hold them for the long term, he continues.

But, then big institutions decided they do not want any more of these loans, leaving the lenders with a long-term obligation and short-term money to back them, Leonard explains. Sub-prime lender bankruptcies increase and those who assume the mortgages will be able to obtain them at favorable rates, provided home owners do not default.

John Deyeso, a certified financial planner with FinancialFilosophy, New York, says a vibrant housing market created opportunity for alternative lenders, which he described as not under the marginal requirements of the Fed.

Consequently, he says, renters could obtain sub-prime teaser rates and 0% down options; “sign the loan papers and just move in.” Rates jumped, these new homeowners defaulted and went back to renting, he says.

With no “skin in the game,” they just walked away when rates rose, Deyeso adds. So, the sub-prime market “collapsed” because rates went up, not because the economy turned bad, he explains.

The home buyers were not harmed, but the buyers of sub-prime debt or institutions issuing credit default swaps may be, Deyeso continues. The issuers of credit default swaps are other financial institutions that compensate the mortgage poolers in the event of default, he says.


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