NationStates Jolt Archive

For those who don't know, "subprime" mortgages are essentially loans which are given to people who normally wouldn't be eligible. They may require much less documentation or income, have lower credit rating limits and so on.

Since housing prices have been going up steadily, mortgage brokers began offering these loans to more and more people, particularly poor people who normally could never own their own home. The idea was that if people couldn't pay back the interests, the house could be sold at a profit, the loan would be paid off and everything would be fine. Home ownership skyrocketed, as GW Bush was happy to point out whenever given the opportunity.

And Wall Street was happy as well. These loans could be chopped, repackaged, resold and just generally traded, and billions were made.

Unfortunately, house prices in some areas have begun to slow down pretty dramatically. Furthermore, many of the "teaser" loans (which offered very low initial interest rates which then increase later) are starting to default now as the higher rates kick in and people can't pay them. And once it defaults, and the house isn't worth enough to fully repay, money is wiped out.

This has begun to happen now. People are talking about a "subprime" collapse.

http://money.cnn.com/2007/04/02/news/companies/new_century_bankruptcy/index.htm?postversion=2007040213
But New Century's problems are not its alone. It said in a filing on March 12 that its lenders, including major financial institutions, can demand $8.4 billion in loan repayments that it can't repay. Among its creditors are units of Bank of America (down $0.64 to $50.38, Charts), Morgan Stanley (Charts), Citigroup (down $0.60 to $50.74, Charts), Barclays Bank (up $0.33 to $57.27, Charts) and UBS (up $0.02 to $59.45, Charts).

And the problems in subprime lending extend beyond New Century.

Lenders made $640 billion in subprime loans last year, nearly twice the level just three years earlier, according to Inside B&C Lending, which tracks the mortgage business.

The Mortgage Bankers Association says subprime amounted to about 20 percent of the nation's mortgage lending and about 17 percent of home purchases in 2006. Financial firms and hedge funds likely own more than $1 trillion in securities backed by subprime mortgages.

The mortgage bankers group reported in early March that about 13 percent of subprime loans are now delinquent, more than five times the delinquency rate for home loans to borrowers with top credit. In addition, more than 2 percent of subprime loans had foreclosure proceedings start in the fourth quarter.

Just how much the problems in subprime have hurt the already struggling real estate market remain to be seen. But the subprime mess is already leading to tighter lending standards, and that alone could further depress home prices, which are already undergoing their steepest, widespread decline in history.

The problem is that more defaults also mean more and more houses reposessed and for sale on the market, further deflating house prices. That could then start to also affect non-subprime loans.

And if that happens, that means that a lot of money is potentially going to be lost, and that means that the banks will suffer. And if the banks suffer, economic growth usually follows suit.

In short: this might be the beginning of the move towards a recession in the US.

Do you agree?

Ultimately, it hinges on just how big the subprime sector is and how overexposed banks are in it. The combination of liquidity (good) and difficulty to monitor (bad) makes it hard to measure the size of the sector and how much everyone is involved in it. This securitization of mortgages poses that speculative risk, and if it were to collapse it could cause some major problems.

Now, I wouldn't be too worried about the big banks; they've been sitting on piles of cash in recent years and they can weather this no problem. The concern would be the smaller ones that would go under and destabilize the whole market.

Even so, I'd be more concerned about the decline in consumer spending from these problems than any effects on the banking sector.

This is a neat summary, taken from The Economist: http://immobilienblasen.blogspot.com/2007/03/trouble-with-housing-market-anti-spin.html

It could be.

Heard on the news a dozen subprime lenders have closed. A coworker is trying to refinance and he couldn't get much of a deal as the reason he was given was the collapse of the subprime market.

It will probably bleed into the "real" mortgage market.

People thought I was nuts when I got a fixed. Now they think I was very astute to do it and get rid of the second. Damn thing would have been 11% now.

Probably more of a disaster is the predatory behavior of the credit card people pulling crap like universal default and 35% interest rates.

I think the disaster has already happened. New Century filed for bankruptcy today, and the problem is spreading into Alt-a* loans. (M&T had to cancel the sale of alt-a loans yesterday I think because no-one was interested in them at a price that made sense).

I think it's bound to cause a whole set of CDO defaults too, it just hasn't happened yet.

Then there are all the government pension funds, 401s, IRAs and funds which hold massive amounts of MBS, which are going to be affected by this as their value drops.

Add to that the inventory flood which is going to come onto an already oversupplied housing market, and even prime will be effected because the underlying assets which back prime mortgages will decline in value.

Finally, Bernanke is between a rock and a hard place a bit. On the one hand, lowering interest rates would seem to be indicated (as has been priced in by the bond market already), but inflation isn't moderating as quickly as the fed expected, and doing so could also start a sell off of dollar denominated assets seizing the credit engine which fuels so much of the US's consumer economy with foreign money.

Buy swiss francs I suppose.

*Alt-a are no-doc/no-down exotic mortgage products made to people with higher fico scores. There is no reason to suppose that they are any safer than subprime as they have the same non-existent underwriting standards.

For those who don't know, "subprime" mortgages are essentially loans which are given to people who normally wouldn't be eligible. They may require much less documentation or income, have lower credit rating limits and so on.

Since housing prices have been going up steadily, mortgage brokers began offering these loans to more and more people, particularly poor people who normally could never own their own home. The idea was that if people couldn't pay back the interests, the house could be sold at a profit, the loan would be paid off and everything would be fine. Home ownership skyrocketed, as GW Bush was happy to point out whenever given the opportunity.

And Wall Street was happy as well. These loans could be chopped, repackaged, resold and just generally traded, and billions were made.

Unfortunately, house prices in some areas have begun to slow down pretty dramatically. Furthermore, many of the "teaser" loans (which offered very low initial interest rates which then increase later) are starting to default now as the higher rates kick in and people can't pay them. And once it defaults, and the house isn't worth enough to fully repay, money is wiped out.

This has begun to happen now. People are talking about a "subprime" collapse.

http://money.cnn.com/2007/04/02/news/companies/new_century_bankruptcy/index.htm?postversion=2007040213


The problem is that more defaults also mean more and more houses reposessed and for sale on the market, further deflating house prices. That could then start to also affect non-subprime loans.

And if that happens, that means that a lot of money is potentially going to be lost, and that means that the banks will suffer. And if the banks suffer, economic growth usually follows suit.

In short: this might be the beginning of the move towards a recession in the US.

Do you agree?

On the other hand, I might soon be able to afford a house with my pauper's salary.

This does not spell doom for the American economy.
Most people have been smart enough to take this into consideration. Practically every significant financial institution has accounted for and corrected what exposure they had more then a year ago.

Housing is still strong in many markets, so when you look nationwide it is not that big of a deal. Rural areas especially are still seeing strong growth. Certain cities still have not seen a price drop and are not expected to (just prices holding steady for a couple years).

Personally, I see these foreclosures as offer a great opportunity for those previously discouraged by high prices to finally look into buying a house – and will do it with a little caution due to the media coverage of various mortgage types (reverse amortization loans especially). This provides a great opportunity for people to pick up a foreclosure at a discount.

Of course, this calls into question whether or not owning a home is all that great of an idea in the first place.

While it certainly was a boon to those who bought a decade ago, owning a home is not always better than renting. There have actually been a lot of studies showing that the economy as a whole is much better off with a population of renters than home owners. This is largely due to basic issues of mobility – when someone owns their home they are much less likely to be able to get a job outside of their area. Renters can move to take a job far away while homeowners generally cannot (without great expense).

This is one of the reasons why I think it fairly ludicrous that the US subsidizes homeownership to the extent that it does – irrespective of my personal libertarian leanings, the government should not be spending its resources on something of dubious benefit and potentially inhibiting economic growth.

Practically every significant financial institution has accounted for and corrected what exposure they had more then a year ago.
Well, first of all several of the major are now owed $8.4 billion (!) that they will have trouble getting back.

Most people have been smart enough to take this into consideration. Practically every significant financial institution has accounted for and corrected what exposure they had more then a year ago.


No, they really haven't. I'm not suggesting that Merril Lynch is going to bankrupt, but you have to admit that if twenty percent of its reserves are downgraded, it's going to hurt their business.

And as I pointed out, what happens to things like the NYC teachers pension fund which was heavily invested in New Century MBS? How do they account for bankruptcy.

And as accounting for this usually means buying CDS, and the prices of those are soaring while the price of MBS is fallings, I don't see how the exposure can be corrected. (Doubly so since some of this paper is little more than toxic waste).

Finally, look at the reset charts. Alt-a have a longer fixed rate period than subprime, but reset they will. Their customers are no more able to service the full cost of the mortgage than subprime customers, and there is no window open to refinance anymore unless magically house price appreciation starts up again. This is going to go on for the next three years or so and only get worse.