Out of the Frying Pan – in to the Fire: The Case of Adjustable Rate Mortgage for Funding of Homes of the Underprivileged

Abstract

The topic of Adjustable Rate Mortgage (ARM) in its first glimpse, takes us to the reader of terms like Global Financial Crisis, Meltdown, Subprime crisis and its horrors. Global Financial Crisis (GFC) – The greatest of all financial crisis after the great depression of 1930, emancipated from a complicated interplay of policy to improve home ownership, by greater credit supply, laxed terms, overoptimistic assumption of real estate growth, predatory lending stunts instincts, and option to offload the balance sheet by securitization, poor remuneration to promote short term gain versus long-term value and last but not the least and macro-prudential governance shortfalls. The reason we discuss GFC here is that ARM were employed by Financial Institutions to finance the subprime i.e. the under-privileged. So did it work? No, it actually coasted them a USD 4.1 Trillion losses, 9 Million families displaced and thousands unemployed. Notwithstanding the fact that, a lot many other factors such as weak underwriting, monetary tightening, moral hazard across the value chain, unrealistic assumption on real estate valuation contributed to the GFC. Farhi, E., & Tirole, J. (2009) termed the GFC as Collective Moral Hazard while reviewing the role of macro prudential regulation, Interest rates, Lender and Investment Banks. This article would assess the structural dynamics of ARMs and subsequently rationalize its inability to alleviate or address the financing needs of the underprivileged.