BY NOW, MOST OF US know that sub-prime mortgages are hurting many homeowners. But economists have warned that they could have repercussions for the broader economy too.
Those warnings came to life this month when two hedge funds run by the Wall Street brokerage Bear Stearns Cos., both heavily invested in sub-prime mortgages, lost much of their value. On Friday, the firm announced that it would pay more than $3 billion (since reduced by half) to bail out one of the funds. Skittish investors sent the Dow Jones industrial average plummeting almost 200 points. It was a stark reminder that the boogeyman of economists' imaginings is real.
When the adjustable interest rates of sub-prime loans spike, some homeowners can't make their monthly payments and go into default, which can contribute to downward pressure on home prices. Lenders have responded to delinquencies and defaults by tightening loan requirements, which can slow the real estate market too. Slowing home sales put thousands of people — from real estate agents to mortgage bankers to construction crews — out of work. Consumer spending wobbles. Governments lose tax revenues.
Things can also get volatile in the stock market, which treats the housing sector as a bellwether. In the bond market, fallout from the Bear Stearns and other hedge fund failures could make Wall Street rethink the way it evaluates risk — and make money for mortgages, and even corporate investment, harder to come by.
The news isn't all bad. Even the gloomiest sub-prime bears don't believe that the U.S. or local economies are sliding toward recession. Many lenders are helping sub-prime borrowers refinance — and save — their homes. According to economists, instances of burdensome interest rate spikes should slow after 2008. Until then, the sub-prime specter will continue to haunt us all.Copyright © 2014, Los Angeles Times