Discuss the story of Countrywide, an organization that was also a big player in the subprime market. How does Countrywide compare to New Century, particularly in time frame and facts? Describe your thoughts on why one company had a "happy ending" and the other did not.

These loans, usually adjustable-rate mortgages (ARMs), were known as sub-prime mortgages. They typically cost two or three points above those with less-risky credit reports and carry interest rate structures with low 'teaser rates for the first couple of years, followed by much higher rates. With potential annual adjustments of 2% or more, this reset or jump in rates frequently resulted in eventually raising the borrower's monthly payment by as much as 100% and increasing the loan payment to more than the borrower could handle.

Example: A $500,000 loan at a 4% interest rate for 30 years results in a payment of about $2,400 a month. But the same loan at 10% for 27 years (after the adjustable period ends) equates to a monthly payment of $4,220. A 6% increase in the rate caused slightly more than a 75% increase in the payment.  The total cost of the above loan at 4% is $864,000, while the higher rate of 10% results in a lifetime cost of $1,367,280.  If sub-prime borrowers could refinance, they could lower their payment assuming interest rates for their risk category is sufficiently lower than the adjusted rate of 10% (and after considering refinancing charges).  

After 2007, many homeowners could not afford to refinance. A special type of ARM is the interest-only ARM, which allows the homeowner to pay just the interest (not principal) during an initial period, and yet another type of ARM is the "payment option" ARM loan, in which the homeowner can pay a variable amount, but any interest not paid is added to the principal.  Nearly one in 10 mortgage borrowers in 2005 and 2006 took out "payment option" ARM loans, which meant they could choose to make payments so low that their mortgage balances rose every month.  But these subprime ARM loans were even made to people with credit scores high enough to qualify for conventional mortgages with better terms (these increased from 41% in 2000 to 61% by 2006) partly because they were quickly approved and because these borrowers were acquiring second homes and other properties as investments. In addition, mortgage brokers in some cases received incentives from lenders to offer subprime ARM's even to those with credit ratings that merited a conforming (i.e., non-subprime) loan.

Many mortgage holders who were granted these loans could not afford the mortgage payments because 

a.   Their household income was not high enough to make the mortgage payments after the ARM rates increased,

b.   Poor credit counseling,

c.   Predatory lending,

d.   Fair values decreased (speculators could not resell properties and could not pay the mortgage), and 

e.   Consumer overconfidence (thought they could refinance mortgage). 

(Many of the homeowners who took out ARMs believed they could re-finance later and escape the onerous effects of the high rates of interest they would pay when their rates were adjusted upwards. When they tried to re-finance, they found they had negative equity in the real estate they wanted to re-finance so they were unable to re-finance because they had insufficient collateral.  Thus, they had to pay the higher rate of interest.)  Why would originators lower their criteria for lending money so much?

It was now easier to get a home loan, so more people qualified. This increased the demand for housing which, in turn, drove up housing prices. 

The increased prices also attracted investors who were looking to buy houses as an investment so that they could sell it later to make a profit. This, too, increased the demand for housing and increased real estate prices. 

Because the fair value of real estate kept increasing, the consequences from all the "bad" loans given to people who could not afford them were delayed. Whenever people experienced difficulties making their mortgage payments, they could easily take another loan against the value of their house, because now it was worth more. 

The sub-prime mortgage market continued without serious repercussions as long as housing continued to increase in value and interest rates didn't go up. 

Meanwhile, the homeowners continued to incur more debt until it reached a level of $700 billion or 5% of the US GDP (gross domestic product) in 2004. 

As sub-prime mortgages began to reset and resulted in foreclosure, housing prices also declined. Because of the way these loans and CDOs were globally distributed, it affected the entire economy. Keep in mind that a single CDO package might contain as many as 100 sub-prime mortgage loans. The fallout from the sub-prime mortgages has affected the housing market, financial markets, the entire US economy, and the global economy.

The sub-prime crisis escalated in June 2007 when two Bear Stearns hedge funds collapsed. This had a rapid effect on other parts of the financial markets worldwide and negatively affected the money market sector that is critically important to banking and financial operations.

Basically, homeowners went into more debt (by taking out home equity lines of credit) in order to pay off their debts. 

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ANSWER Story of Countrywide and New century The story started with subprime loans when taking loans for real estate was difficult few corporations started providing subprime loans to borrowers who are ... View the full answer