Friday, March 16, 2007

And the next casualty of financial de-regulation is...

Maybe it's just me, but there is a familiar ring to this.
As many as 1.5 million more Americans may lose their homes, another 100,000 people in housing-related industries could be fired, and an estimated 100 additional subprime mortgage companies that lend money to people with bad or limited credit may go under, according to realtors, economists, analysts and a Federal Reserve governor. Financial stocks also could extend their declines over mortgage default worries. [...] Subprime mortgages are given to people who wouldn't qualify for standard home loans and typically have rates at least 2 or 3 percentage points above safer prime loans. The portion of subprime loans that financed new mortgages rose to 20 percent last year from 5 percent in 2001, according to the Mortgage Bankers Association.

Subprime loans contributed to a home-ownership rate that reached a record 69.3 percent of U.S. households in the second quarter of 2004, up 5.4 percentage points from the same period in 1991, according to the U.S. Census Bureau.

"Probably the gain in home ownership over the last four, five years, is almost entirely due to looser lending standards,'' said James Fielding, a homebuilding credit analyst at Standard & Poor's in New York.

So, what seems to be happening is, lenders and borrowers are taking a risk. The lender is betting that the borrower won't default within the first 90 days and the lender is betting that one or both of two things will happen:

1. The value of the property will rise sufficiently over time to make the home worth more than the original mortgage;

2. The borrower's income will rise sufficiently to decrease the proportion of income required to service the mortgage.

But, if both those conditions reverse, the borrower is in a world of hurt and the lender is faced with getting the money back by foreclosing - on a property that is worth less than the amount of the mortgage.

And generally, those conditions reversed. Wages have not risen significantly enough to make a difference and the housing market is slumping, causing values to decline.

A good description of sub-prime mortgage lending is here. What it doesn't describe in much detail is the practices sub-prime lenders use to attract customers.

Some of the offers made by sub-prime lenders in the US suggest that the meltdown that is now occurring is, to a great degree, a crisis of their own making.

Subprime lenders make higher interest-rate loans to borrowers who are considered higher risk either because of low credit scores, high debt burdens or other factors. The subprime industry barreled into action during the housing boom, offering a slew of mortgage products including 100 percent financing, adjustable rate mortgages with low teaser rates, and loans with little or no income documentation. Subprime loans are 13.56 percent of the $10.03 trillion U.S. mortgage market, or $1.36 trillion, according to the Mortgage Bankers Association. That's about 5.77 million mortgages.
It doesn't take a genius to figure out what would come out of that kind of activity. And given the amount of money being tossed around the likelihood that a certain amount of fraud and malfeasance exists is fairly high.

All in all, it just has an air of familiarity about it. It is starting to sound an awful lot like something that happened in the 1980s.

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