Understanding the Economic Impact prior to Wells Fargo Foreclosures Essay

Understanding the Economic Impact prior to Wells Fargo Foreclosures - Essay Example As a result of the crisis, many institutions, including those that are not directly involved in lending collapsed while others merged to stabilize amidst the crisisIn 2007, United States was hit by financial crisis, which emanated from a crisis in the subprime real estate loans (commonly called subprime crisis). One of the financial institutions involved in mortgage lending that stood the crisis is Wells Fargo & company, although its rating dropped since 2007, in the light of the financial crisis. In response to the crisis, Wells Fargo & company and other companies increased foreclosure filings by 2008 to the highest record in historical. This paper provides an overview of the subprime lending industry and state the economy in Wisconsin just prior to subprime crisis and the Wells Fargo Foreclosures. Discussion Prior to 1980s, people in Wisconsin, US, had only two choices for obtaining a mortgage. According to Knapp (2010), one could obtain a home loan insured by either the Department of Veteran affairs or by the Federal Housing administration. Borrowers with good credits histories would typically obtain new loans from a bank, saving and loan or any other financial institution. Knapp (2010) elaborates that obtaining mortgage loans became much easier with the deregulation of the lending industries in the beginning of 1980. For instance, the monetary control act and the deregulation of the Depository institutions in 1980 removed the restrictions that imposed a ceiling on the interest rates charged on mortgage loans. One remarkable impact of the deregulation is that it led to the introduction of new mortgage loans, which included ‘adjustable rate mortgages that were particularly favorable to mortgage borrowers who had their credit profiles impaired. However, according to Knapp (2010), these events did not lead to an explosive growth in the mortgage industry until the securitization of mortgage loans in the late 1990s. The securitization option encouraged the majority of the existing mortgage lenders to adopt a new business model which Knapp (2010) refers to as â€Å"originate to distribute† business model. This new model required that the credit risk posed by the mortgages loans was not exclusively to be absorbed by the lending institutions. Rather, it was to be shared with other investors in the world who purchased the Mortgage-backed securities. Knapp (2010) further argues that by 2006, approximately one-fourth of all new mortgage loans in United States were made to subprime borrowers while the other ratio was securitized and sold to investors in the United States and around the world. The increased demand for high-yield mortgage-backed securities among investors, including institutions such as hedge funds institutions and large banks, led the lenders to ratchet up their marketing efforts. They then came up with new products, which were designed specifically for the sector of the mortgage market in order to persuade individuals who were deemed to be of high credit risks to obtain mortgage loans. Among the most popular of these products were the stated-income† and the â€Å"interest-only† mortgages. The stated-income loan required an applicant to simply report his or her annual income during the application process of the loan (Knapp, 2010). The lender depended on the applicant’s self reported income in the determination of the size of loan that one could afford. According to Knapp (2010), many applicants for the Stated-income loans grossly overstated their annual income so that they could purchase a larger home than was economically feasible given their actual incomes. An individual who obtained the Interest-only mortgage loan was required to pay interests on his