How Subprime Home Loans Become Risky Investments

This is the VOA Special English ECONOMICS REPORT.

As the American housing market has cooled, worries about investments based on risky home loans have heated up.

Last month, two hedge funds operated by the investment bank Bear Stearns nearly collapsed under debt. They had borrowed billions of dollars from lenders and invested in securities tied to subprime mortgages.

Bear Stearns agreed to provide over one and one-half billion dollars to rescue one of the funds. Investors in the other could lose everything.

The trouble at Bear Stearns is an example of the risks involved with mortgage-backed securities. These investments have helped drive home ownership rates in the United States to nearly seventy percent. But as interest rates have risen, some homeowners now find it hard to pay their mortgages, and keep their homes.

Americans usually need a mortgage loan to buy a house. Subprime borrowers are people without strong credit histories. Lenders can charge them more because there is a greater chance they will not be able to pay back the loan.

Subprime lenders often depend on credit to make the loans. Once processed, the loan is usually sold to an investment bank. Loans with similar levels of risk are grouped together and then sold to investors worldwide as mortgage-backed securities. The higher the risk, the higher the return.

The Government National Mortgage Association, known as Ginnie Mae, and two other organizations known as Fannie Mae and Freddie Mac produce most mortgage-backed securities. But investment banks have increased their share, led by Lehman Brothers. Last year, it processed more than fifty billion dollars in securities backed by subprime mortgages.

Being able to sell their loans offers mortgage lenders a way to raise money to make new loans. But being able to spread their risk can also be seen as an invitation to make bad loans.

Last week, federal agencies released the final version of a statement on subprime lending. It provides guidance to lenders to make sure borrowers are able to pay back mortgages with adjustable interest rates. The aim is to avoid payment shock as the rates increase, often after a low starting rate. The agencies also warn against lending activities that harm the interests of homeowners.

And that's the VOA Special English ECONOMICS REPORT, written by Mario Ritter. Transcripts and archives of our reports are at voaspecialenglish.com. I'm Steve Ember.