Posted by: Michael Mandel on March 16
Anyone who is interested in understanding the subprime mess should read Peter Coy’s story, “Under The Fed’s Hammer
How Fed rate hikes have turned into a regressive tax on weak borrowers.”
In past business cycles, when the Fed raised interest rates, the impact was democratic: Companies large and small had to pay more to borrow, and so did most households. Everyone suffered.
This time around, though, most borrowers have been able to escape the Fed’s interest-rate hammer. As the Fed has boosted short-term rates by more than four percentage points since 2004—the biggest move since the early 1980s—corporations and households with good credit have easily switched to long-term loans, where rates have barely budged over the past three years. “A prime borrower has options,” says Robert Moulton, president of Americana Mortgage Group Inc., a Manhasset (N.Y.) mortgage broker.
Which leaves one group of Americans to absorb the brunt of tight money: families with poor credit. These typically low- to moderate-income families have always relied heavily on short-term borrowing. But they are even more vulnerable today because so many of them bought homes during the boom using subprime adjustable-rate mortgage loans (ARMs) tied to short-term interest rates. As rates have gone up, loan payments are beginning to skyrocket.
To summarize—the entire weight of the Fed’s rate increases are falling on subprime borrowers. Everyone else has been able to escape. That explains why the subprime market has been suffering so badly, and why the pain is not likely to spread.
Michael Mandel, BW's award-winning chief economist, provides his unique perspective on the hot economic issues of the day. From globalization to the future of work to the ups and downs of the financial markets, Mandel-named 2006 economic journalist of the year by the World Leadership Forum-offers cutting edge analysis and commentary.