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Last Updated: Thursday, 23 August 2007, 23:03 GMT 00:03 UK
Shrewd lenders spark US mortgage chaos
By Joe Lynam
Business reporter, BBC News, Milwaukee, Wisconsin

Crippled by domestic violence and with no income, Peg at least still has her home. Now, though, even the very roof over her head is in jeopardy.

Boarded up house in Milwaukee
Ever more houses in Milwaukee are boarded up

A divorcee from a white middle class family in suburban Milwaukee, Peg had run up large medical bills and was too proud to tell her own family that she was paying for everyday expenses with her credit card.

Then a man called and offered to help consolidate her bills and pay off her credit card.

The man was friendly and appeared to understand her situation, and he wanted to help.

The way he explained it, all she had to do was refinance her house at a really low rate of interest and she would get rid of those mounting bills.

Heck she'd even get a nice cheque to buy some new furniture.

Tempting proposition

Peg only met the man once, on the day when she read the contract, the day when he stood over her as she signed.

A couple of months later and the "really low" interest rate had jumped dramatically and Peg is now in court, fighting eviction, claiming she was hoodwinked into signing the deal.

As tales surrounding America's housing crisis and the now infamous sub-prime mortgage problem come to the fore, it has become clear that Peg's case is more the rule than the exception.

"This is not a poor, black or Hispanic thing," explains Michele Derus from the Milwaukee Sentinel Journal, who has been following the growth of sub-prime loans for more than two years.

"This is a suburban white problem.

Katie Doyle from Legal Aid Society Milwaukee
Medical care can bankrupt people, especially older people
Catie Doyle, senior attorney with the Legal Aid Society of Milwaukee

"If you drive around this city you'll see plenty of houses with boarded-up windows and For Sale signs in the driveway."

In the US, foreclosure rates - that is homes being repossessed by lending institutions - have hit the kind of levels not seen since the 1960s, according to the website marketoracle.com.

Wisconsin in America's Mid-West is experiencing above average rates of default.

In Milwaukee alone, 20 to 25 new homes with a combined market value of some $2m (1m) are being foreclosed, or repossessed, every day. State-wide there was a 34% rise in the number of people who faced eviction in 2006 and Ms Derus believes that that number will double this year.

"The question many people ask me is why would anyone go for a sub-prime loan in the first place?" she says.

"These new brokers selling sub-prime loans are a friendly face offering to do all the paper-work for you at very tempting starting rates. Many people are still afraid of the big scary bank and prefer dealing with brokers."

Warning signs

A sub-prime mortgage is where someone with a poor credit or financial history is given a home loan at higher than normal interest rates - after being lured by lower introductory rates at first.

They now account for one in five mortgages in the US.

Paradoxically, as many as one third of those who took out sub-prime loans would have qualified for "normal" or "prime" interest rates in the first place.

Some observers say the fact that Wisconsin should end up with a large middle class sub-prime problem is a warning for the rest of the United States as it is famed for its financial conservatism.

"I guess it's our Germanic heritage," says Catie Doyle, senior attorney with the Legal Aid Society of Milwaukee, who works pro bono (for free) helping less well off citizens fight eviction and legal action after signing "unconscionable" sub-prime contracts.

"The people here hate owing money," Ms Doyle says. "We have traditionally saved more than other states and don't take financial risks."

Ms Doyle recites the story of a local woman called Patricia who suffers from cerebral palsy but no mortgage because she inherited her house.

After having run up credit card debts to pay for her medical bills, Patricia was persuaded by a mortgage broker to refinance her entire home just to repay her smaller healthcare debts, she explains.

"That's the problem here in America," she says.

"Medical care can bankrupt people, especially older people. Brokers who sell these sub-prime loans based on "teaser" introductory offers, have a fiduciary duty to tell the borrower about all the risks involved."

But many fail to do so, Ms Doyle's clients tell her.

"Unfortunately for the people we talk to, [the brokers] include all the down sides to the loans in the small print," she says.

Chain reaction

With sub-prime contracts often running to more than 100 pages of financial jargon, the proverbial devil is usually found in the detail.

Milwaukee County Court House
Repossessions and court evictions are rife in Milwaukee

This makes brokers the key part in the Five B's that make up a sub-prime chain that has led to recent global problems.

Put simply, banks and lenders approach brokers or middle-men to sell their loans to borrowers.

The less financially literate the borrower, the more likely it is that they will be sold a sub-prime mortgage at an above average rate of interest.

Once the borrower signs on the dotted line, the broker gets a commission. Meanwhile, all responsibility for that loan is passed on to the bank or lender.

The lender can then repackage these mortgages as bonds, which are traded on international money markets.

This all worked well for a while as house prices soared in America, though once interest rates started to rise and house prices cooled, home-owners with sub-prime loans soon owed more money than their houses were worth. They were trapped by negative equity.

That then exposed the bank that had re-sold that mortgage as a bond, and this is behind the recent falls in the world's money markets.

Cold comfort

The brokers who sold mortgages to the likes of Patricia and Peg operate in a regulatory grey area.

The National Association of Mortgage Brokers (NAMB), the body that represents them, says they have done no wrong and point out that borrowers should always examine the fine print in any contract and could always avail of the three day cooling-off period on offer.

Many brokers have also accused homeowners of trying to buy houses that were well beyond their means.

Both the banks and the NAMB have called for consumer education on the real risks involved in taking out a mortgage.

But the US Congress is now actively looking at changing the law and putting the onus of responsibility more on these financial middle-men.

That offers little comfort to the thousands of Wisconsinites and potentially millions of Americans who face eviction because their home loan costs have spiralled out of control.

In an ironic twist, though, property owners are now taking legal action in larger numbers.

If nothing else, coming before the courts allows them to stay in their homes until a judge makes a final ruling on whether an "unconscionable contract" had been signed.

"I've been talking about this for more than two years now, but no one would listen," says Ms Derus as she bangs the desk at the Milwaukee Journal Sentinel.

"Now that the markets have been all over the place, people are calling me."



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