RENEE MONTAGNE, host:
Also not good for the economy is foreclosures. Now there's new concern in financial markets about a kind of mortgage that could bring another wave of foreclosures. Unlike subprime loans, most people who took out adjustable rate mortgages, or option arms, had good credit. Still, as NPR's Wade Goodwyn reports, they may no longer be able to afford their mortgage payments.
WADE GOODWYN: Option arms had lots of different names. They were marketed as cash flow option loans or interest-only loans, even pick-a-payment loans. The bankers had their own name for this: innovative financing. In this case innovative meant that for the first five years the borrower didn't have to make much of a loan payment, for a while anyway.
Richard Bove is a bank analyst who's been following the mortgage crisis.
Mr. RICHARD BOVE: I'll be honest with you. I think a lot of people were speculators in that they were thinking that if I could hold this house for three years, the value of the house is going to rise dramatically; I can sell the house, take the big profit, and I won't be there when the time comes for the mortgage to reset to the much higher monthly payment.
GOODWYN: Bove says that this type of loan was first created in 1970. The Emergency Home Finance Act was one answer to the growing social and racial unrest in the nation's cities - home ownership as a means to stop angry Americans from burning down their neighborhoods. But the experiment was a failure. Defaults and losses were widespread, and the practice was largely abandoned, which leads to the question: why did the banks do it again?
Mr. BOVE: I think that the bankers always feel that this time around we can do it differently. But that's just poor thinking, because the fact of the matter is that there is 30 to 40 years of history which tell you that this type of lending simply doesn't work.
GOODWYN: With option arms the borrower is allowed to make nominal mortgage payments, but of course nominal doesn't pay down the loan, so the amount owed can grow every month, and it can gradually or even quickly become much more than the house is worth. When the loan resets, payments can jump as much as 60 percent.
If the borrower is able to flip the house at a profit before the reset, none of this is a problem. But these days, of course, with the bubble burst, it's a major problem. And it's a migraine for the banks too, because unlike much of the subprime mortgage lending, more of these loans have tended to be held by the banks on their books.
Mr. BOVE: Unfortunately for the banks that were involved in this, they're now losing literally tens of billions of dollars. The biggest players in these markets were companies like Bear Stearns and Lehman Brothers and to a lesser degree Merrill Lynch. And we've already seen that Bear Stearns doesn't exist anymore. Companies like Washington Mutual and Lehman have been raising capital. You know, for some of these companies it's clearly touch-and-go.
GOODWYN: If you're one who's inclined to smirk when overzealous bankers are getting their just desserts, you might want to think again. Trillions of dollars which could be stimulating the nation's flagging economy are instead being soaked up in the mortgage debacle fallout.
Chris Whalen is the managing director of Institutional Risk Analytics.
Mr. CHRIS WHALEN (Institutional Risk Analytics): Investors have now pulled back from this market, so you have four or five trillion dollars worth of private label securitizations of all kinds - auto loans, mortgage paper, you name it - that's now without investor support.
GOODWYN: As investors pull out and available credit contracts, so do growth opportunities for American business.
Mr. WHALEN: And this is flowing through all different segments of the U.S. economy - housing, receivables, finance for small and medium-size companies. There's just no credit out there. And the banks are in a defensive posture. They don't want to take more risk right now.
GOODWYN: The Federal Deposit Insurance Corporation warned this week that the outlook for the industry is worsening. The number of bad loans is at its highest level in 15 years and earnings declined 86 percent in the last three months. The number of banks on the government's list of troubled institutions has grown to 117.
Wade Goodwyn, NPR News, Dallas.
NPR transcripts are created on a rush deadline by Verb8tm, Inc., an NPR contractor, and produced using a proprietary transcription process developed with NPR. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.