Thursday, April 15th, 2010
The Securities and Exchange Commission (SEC) announced that it has proposed new rules to govern the field of bonds backed by consumer loans, perhaps best known in its incarnation of mortgage-backed securities sold during the subprime housing boom.
Background: What They Are, How They Work
So, what might this mean for borrowers and investors? Here’s a little background on asset-backed securities and what they do.
- Consumer loans: When you and other ordinary Americans take out mortgages and other loans, you go through a bank or other lender. When the loan is originated, that lender "holds your debt."
- Loan bundling: It has become common practice to "bundle" consumer loans (especially mortgages), which means to lump them together to sell off to investors. But, rather than selling off easy-to-trace sections of the bundle, many banks sell off sections composed of various loans. These sections are the securities.
- Asset backed securities: Because the securities theoretically earn money when consumers make payments on their loans, they’re known as "asset-backed securities."
- Bond ratings: During the subprime boom, credit agencies gave various asset-backed securities risk evaluations to help guide investors: high-risk securities had the potential to yield more money, but with a greater risk of consumers not paying. Lower-risk securities offered a lower earning potential, but with more security for investors.
Naturally, the system works well assuming everyone does what they’re supposed to: banks issue loans consumers can afford, credit agencies give honest ratings, consumers make regular payments, etc.
But, as we know from the collapse of the subprime market, that’s not necessarily how the system works in practice.
The Proposed Rules
The SEC’s proposed changes would essentially take out the role of the credit agencies. Rather than have credit agencies rate loans, bond issuers themselves would be required to:
- Keep larger portions of loans on their books, thus giving them an increased stake
- Provide regular reports on the exact loans that compose a bond
- Guarantee the risk level of their products
If these changes pass, it’s expected that they’ll help prevent a repeat of many of the problems that caused the subprime bubble to expand and burst.
Additional Resources
SEC Proposal on Asset-Backed Securities (PDF)
Posted in Credit and Bankruptcy, Mortgages, SEC, securities, subprime lending | Comments Off
Sunday, December 27th, 2009
The Credit Card Accountability Responsibility and Disclosure (Credit CARD) Act of 2009, which will take full effect in February, limits many practices now common in the credit card industry. Some, however—like issuing a card with an interest rate near 80 percent—will still be permissible under the new law.
Subprime Credit: Still a Bad Idea
The subprime lending boom and the “unconventional” lending techniques that accompanied it were major factors in the housing market’s explosion and collapse, and thus the current recession.
But just because people have grown more wary about some types of subprime lending doesn’t mean it’s disappeared entirely. In fact, according to an MSNBC article, some of the worst credit cards on the market are still as costly as ever.
The First Premier credit card reportedly provides a source of credit for people with limited or shaky credit histories – that is, the so-called subprime borrowers. But, because of the potentially high risks associated with having a blemished credit history, this card comes with some shockingly expensive terms:
- Initial limit of $300: Users of the First Premier card will have access to only $300 in credit when they open their accounts, an increase from the card’s former limit of $250. But that’s not even as much as it seems.
- Maximum permissible fees: The Credit CARD Act prohibits issuers from charging fees that total more than 25 percent of a card’s limit, and the First Premier charges exactly that: $75 in fees each year. Formerly, the first year’s fees totaled $256 – on a $250 limit.
- Astronomical interest rate: Presumably to make up funds lost from the limited fees, the First Premier issuers jacked up the interest rate on their card to a whopping 79.9 percent. The new law sets no limit on credit card interest rates, so while shockingly high, this limit is legal.
Avoid the Trap: Wait It Out
Naturally, getting tangled up with a card that carries a nearly 80 percent interest rate is not a good idea, no matter how badly you want to start rebuilding your credit after a bankruptcy filing or other financial stumbling block.
If you currently have a rough or limited credit history and don’t think you’ll qualify for a credit card with more favorable terms, your best bet may be to simply wait a while. With a few months or years of responsible and timely bill paying, you may qualify for much better credit products.
Additional Resources
Credit CARD Act of 2009 (PDF)
Posted in Credit Card, Credit and Bankruptcy, Interest Rates, subprime lending | Comments Off
