I must confess, I was a Boy Scout. In the process of earning my Personal Management merit badge, I learned about various basic financial issues, including the difference between fixed and adjustable rate mortgages. The basic difference is that the interest rate on fixed rate mortgages doesn't change, while the an adjustable rate mortgages follows the market interest rate. Thus, Boy Scout Jordan learned that, if you have an adjustable rate mortgage and market interest rates rise, then your monthly mortgage payment may rise as well. I also learned that not making mortgage payments can result in foreclosure. If every Boy Scout can learn these basic principles, they're clearly not beyond the reach of the average Joe.
Despite this, a wave of foreclosures is sweeping America as a consequence of the so-called subprime mortgage crisis. During September, Florida had one foreclosure filing for every 248 households in the state. Politicians and the media have frequently blamed the crisis on sleazy business practices by lenders and changes in the way banks handle mortgages. But don't just point fingers at the banks - the root of the problem is Americans' substantial lack of financial knowledge.
Complex changes in the mortgage lending industry encouraged lenders to make riskier loans, so over the last few years millions of Americans who do not qualify for normal interest rates seized the opportunity to take out mortgages. The loans they took out required little credit verification, small down payments and risky adjustable interest rates. This kind of lending is called subprime mortgage lending. This spring, rising interest rates and falling property values made paying one's mortgage more difficult, setting off a collapse of the subprime mortgage industry and a wave of foreclosures that continues today.
A congressional report estimates that 2 million homes bought with subprime loans might be foreclosed by the end of next year, meaning at least 2 million Americans took out loans they couldn't afford. This portrays a shocking lack of basic financial knowledge in the American public, yet politicians and the media still blame so-called "predatory lending practices" for the subprime crisis. Exploitative business practices clearly led some fraction of the now-defaulting public to take out the original loans. This is clearly wrong and should be stopped, but to blame "predatory practices" alone is to miss the point: that so much of the loan-consuming public was unable to recognize when a lender might be lying.
Many Americans have seriously overestimated how costly of a home they could afford to buy. Consequentially, we see that millions of Americans are willing to assume debt loads they can't handle. The American economy is consumer-driven, and to have so many consumers without a basic grasp of their finances is the recipe for disasters such as the subprime crisis, which is having harmful economic repercussions, such as the credit market collapse.
Community groups and the media must seize the problem and educate people in basic financial concepts. Students should be taught financial topics in high school (certainly this would be much more useful than the current state-mandated semester of economics). Most importantly, parents must take the time to educate their children about money management. Tighter government regulation can stop an exact repeat of the subprime loan crisis, but this is not a long-term fix, as the next consumer banking crisis will surely be something different. A public better educated about financial matters is the only way to stop a crisis before it starts.
Frisby is a Plan II, economics and math junior.
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