Editor's note: I qm moving to post at the secondary blog(also see new articles below). See stories at the overflow blog. --- Freddie Mac to Refinance Loans
$20 Billion to Help Subprime Owners
By Dina ElBoghdady
Washington Post Staff Writer Thursday, April 19, 2007; D01
Freddie Mac, one of the nation's largest mortgage investors, plans to buy about $20 billion worth of mortgages that would primarily refinance the loans of people in danger of losing their homes.
The McLean company is targeting the loans of subprime borrowers, who typically have blemished credit records or other factors that make them risky to lenders. Since the housing market softened, many such borrowers have missed payments and defaulted at record rates in parts of the country.
Freddie Mac's announcement followed the unveiling earlier this week of a similar campaign by its larger rival Fannie Mae, which plans to allow lenders to qualify more subprime borrowers for refinancing.
Richard F. Syron, Freddie Mac's chief executive, announced his company's plan at a Capitol Hill briefing yesterday. The goal is to buy fixed and adjustable-rate mortgages with more affordable terms, starting midsummer, he said.
The idea is that if more troubled borrowers could refinance their homes, they would not lose them, and if investors such as Freddie Mac are willing to buy these loans, lenders would be willing to make them.
Freddie Mac is allocating money to this troubled sector "because it's needed and because, quite honestly, it's a good business opportunity," Syron said in an interview. Considering that the average mortgage is $150,000, the $20 billion Freddie Mac has allocated would cover about 130,000 mortgages, he said.
Freddie Mac has not decided exactly what terms it will set for the loans it will buy. Fannie Mae's program, HomeStay, would allow lenders to refinance without having to wait until the borrowers clear unpaid bills on their credit reports. It also would stretch the loan term to a maximum of 40 years from the current 30-year limit. Fannie Mae has not placed a dollar amount on how many such loans it would buy.
Neither government-sponsored enterprise has gained approval for its plan from federal regulators.
The heightened activity comes as both companies face pressure to demonstrate that they perform a public service. The House Financial Services Committee, led by Rep. Barney Frank (D-Mass.), has passed a bill to tighten regulation of the companies and to require them to contribute to an affordable housing fund. Frank said the public has not received enough value in return for the commercial advantages Fannie Mae and Freddie Mac get from their government ties.
Individual lenders are also under pressure to stem foreclosures. Yesterday, big lender Washington Mutual said it will refinance up to $2 billion in subprime mortgages.
Freddie Mae and Fannie Mac, created to promote homeownership, do not lend money to borrowers. Rather, they invest in mortgages and usually package them into securities for sale to investors.
Neither company buys many subprime loans from lenders, but they are fairly active in investing in securities backed by such loans.
Freddie Mac plans to keep the loans affected by yesterday's announcement in its portfolio, Syron said. That way, it can launch the program quickly and alter loan terms if necessary, which is difficult to do if the loans are sold to investors.
The loans Freddie Mac buys under this program would not be limited to refinancing, though refinancing is the initial focus now that millions of people have adjustable-rate mortgages with low teaser rates that will soon spike.
Fannie Mae (NYSE: FNM) and Freddie Mac (NYSE: FRE) made progress on their recent word that they would offer new subprime products when top execs from each government-sponsored enterprise testified on Tuesday before the House Financial Services Committee.
Fannie discussed a new three-pronged initiative, dubbed "HomeStay." The program involves working with lender partners to help homeowners stave off immediate foreclosure through financial incentives and workout solutions, expanding lending options to help refinance subprime borrowers out of ARMs and into long-term fixed rate products, and counseling future homeowners about making appropriate mortgage choices.
Freddie spoke about restricting subprime investments, eliminating no-income, no-asset verification loans ("liar loans"), and urging subprime lenders to escrow borrower funds for taxes and insurance. The GSE also announced the midsummer introduction of more consumer-friendly subprime mortgages in the form of 30-year and possibly 40-year fixed-rate mortgages and ARMs with reduced margins and longer fixed-rate periods. Freddie also called upon regulation that ensures uniform and consistent consumer disclosures.
Going forward, a combination of increased consumer education and regulation restricting predatory practices is vital. Certainly, swapping out of an ARM and into a long-term fixed-rate mortgage makes sense for most subprime borrowers. But while these suggestions are commendable, they will not serve as a panacea for all existing subprime ills. With close to 2.4 million homeowners facing default on their subprime mortgages over the next several years, foreclosures will mount despite sensible refinancing options and increased financial awareness.
Nor should Fannie and Freddie be charged with curing the system. Given their blemished accounting records, the GSEs provide easy targets for retribution by politicians seeking to capitalize on public clamor for subprime reform. Fannie and Freddie should not bear this blame. In the same congressional testimony, Fannie counted less than 2.5% of its business as subprime, and Freddie reviewed a litany of unilateral, voluntary steps taken since 2000 to improve subprime practices.
As Congress continues to debate regulation of the mortgage finance giants, it would be wise to bear in mind that the missions of the GSEs is to enhance liquidity, stability, and affordability in the housing market. Fannie and Freddie demonstrate their commitment to that goal, and should not be regulated as a proxy for the irresponsible practices of certain subprime mortgage lenders. While internal housekeeping issues at Fannie and Freddie remain, one hopes that regulatory measures will not be imposed which will hamper their ability to responsibly and flexibly meet the needs of the market.
Published: April 17 2007 19:56 | Last updated: April 18 2007 01:11
The US Supreme Court on Tuesday stepped into the subprime lending crisis with a potentially far-reaching ruling that limits the power of individual states to regulate mortgage lending.
The ruling came as federal bank regulators responded to criticism that they had been slow to act over the crisis and cleared the way for lenders to offer relief to distressed homeowners.
Regulators told banks they would “not face regulatory penalties” if they offered borrowers new terms.
The Supreme Court ruled 5-3 that banks regulated by the federal Office of the Comptroller of the Currency had a broad shield from additional state regulation.
Though it did not directly involve subprime lending, it could have a big impact on the ability of states to act independently on predatory lending and throws the spotlight on federal authorities.
Many consumer advocates had hoped that individual states would be able to step in more quickly than federal legislators or regulators.
Several congressmen are trying to craft a national solution to the burgeoning crisis in subprime mortgage lending.
Allen Fishbein, director of housing for the Consumer Federation of America, said after the court decision: “This is really disappointing news.” He said it could work to the detriment of consumers.
The case, which tested whether Michigan could regulate the mortgage-lending subsidiaries of Wachovia, a national bank, split the court in an unusual way, with its most liberal member, John Paul Stevens, joining conservatives Chief Justice John Roberts and Antonin Scalia dissenting in defence of the right of states to regulate in this area.
Eliot Spitzer, then attorney-general of New York, had argued that states cannot protect their citizens from predatory mortgage practices if they are pre-empted by federal regulators.
By John Dizard, Financial Times Published: Apr 16, 2007
In the middle of one of their more impressive disasters, the rapid meltdown of "investment grade" paper made of chopped-up subprime mortgages, the credit rating agencies are within a few weeks of having their monopoly formally blessed by the SEC.
The agencies - Moody's, S&P and Fitch, along with their counterparts in Canada and Japan - are always good for a mocking aside among Wall Streeters, as if they're an ethnic group stereotyped as mentally inferior. The agencies are famous for missing disasters-in-the-making, such as Enron, Worldcom, and now the subprime mortgage mess.
Yet we should all be as stupid as they are. Hereditary peerages have been nudged out of the House of Lords, the Big Three American auto companies may bumble on only at Toyota's sufferance, but the ratings agencies have survived what might have been a serious attack on their monopoly. In fact, their position is stronger than ever.
The Credit Rating Agency Reform Act of 2006, which was signed by President Bush in September, is now being implemented through the SEC's rule making process. The rating agencies kicked and screamed and testified throughout the "reform" process as if they were actually threatened by it. They may even have believed they were.
No, forget that thought. They aren't really that stupid.
Their monopoly status has been protected up to now by the SEC's designation of them as Nationally Recognised Statistical Ratings Organisations. There wasn't a formal proceeding to be "recognised", just a long, long, series of "no-action" letters that meant that their ratings counted, and those of others did not. Others could apply to be NRSROs, but somehow, nothing would be done with the applications.
The effect of the "reform", codified in the new law, is to formalise the position of the rating agencies. The idea of the law was to increase competition. The way it's written, and the way it's being implemented by the SEC, will be to admit one or two small, new entrants, and then to slam the door shut.
The SEC's proposed rules (196 pages of spritely government prose) is to say: yes, we will consider letting you compete with Moody's and S&P. But you must replicate their entire structure, balance sheet, and staffing. You must have this in place, without being recognised by us, for at least three years, all the while somehow charging for this un-"recognised" service.
It's as if Apple were to be permitted to compete with IBM only if it first replicated IBM's bureaucracy. Even defence contractors face more of a competitive threat.
The oddest proposed requirement is a non-specific one for "financial resources". Either rating agencies should have no capital requirement, since they have no liability for their ratings, or a requirement for hundreds of billions of dollars of capital, in case they are legally liable. Anything in between is just a gratuitous barrier to entry.
This is particularly ludicrous given that the ratings agencies assert that they are are immune from legal liability for their work, since as "First Amendment" people, the ratings opinions are protected speech under the Constitution.
Sean Egan, the chief executive of the Egan-Jones rating agency in suburban Philadelphia, expects his company's application for NRSRO status to be approved shortly after the rules are published. It's been at the SEC for nine years, but what with one thing and another, the SEC didn't get around to formally considering it until now. Unlike Moody's, S&P, and Fitch, all of Egan-Jones' revenues come from investors who subscribe for its service, not the issuers.
"There was a lot of pressure to reform the system as a result of Enron and Worldcom," Mr Egan says. "At the beginning of the discussions about the new law, there was talk about disallowing compensation from issuers, but that went by the wayside. That is the core conflict, which will continue to exist."
The agencies reply by pointing to their ever-lengthening codes of conduct. Anthony Miranda, at Moody's, says its code "is very specific in detailing how we do business. We model it to mitigate any conflict of interest. We are very attentive to reputational risk".
There's no reason to doubt the sincerity of Moody's, or the other NRSROs. However, human nature being what it is, as Mr Egan says, "People do respond to incentives." And one big incentive is to keep the issuer-customer happy.
However, while the agencies have dodged any slow-moving bullets that could have come from the SEC, there's another threat on the horizon. I understand that there are US states' attorneys-general who are looking over losses to state investment funds from what had been considered "investment grade", subprime housing based paper. As one person familiar with the lawyers' thinking says, "you could argue that the rating agencies voided their First Amendment protection when they got too involved in the underwriting process this cycle. They weren't placing the securities, but they could have gotten too involved in structuring these deals behind closed doors".
This would only be determined to be the case, if it were, after long, long rounds of litigation. But the attorneys-general have a lot of time, a hunger for headlines, and staffs with nothing really better to do than litigate against rich Wall Street institutions.
Washington Post Staff Writer Tuesday, April 10, 2007; A01
ATLANTA -- The man was one slick fraud artist.
Phillip Hill lured people to fancy cocktail parties in a $1.9 million mansion. He asked to use their names and credit histories in real estate deals, promising to make them rich. Most got $10,000 checks on the spot for signing up.
By the time the scam unraveled, the credit of those participants had been ruined, hundreds of upscale properties had fallen into foreclosure and real estate prices had plummeted in some of this city's most exclusive neighborhoods. Hill is about to go to federal prison.
Many experts have concluded that the nation's real estate boom of recent years was fueled in part by weakened lending standards that sparked excessive demand and drove up prices. Now, some are worried that the looser standards may have permitted a boom of another kind -- a big expansion of mortgage fraud.
No one knows exactly how extensive the crime has become, but new data from the federal government suggest that it has jumped tenfold since 2000. Prosecutors are finding cases all over the country in which sham transactions, based on fraudulent appraisals, led to homes changing hands at far above their real value. Mortgage lenders failed to carry out the most elementary safeguards.
In some neighborhoods, mortgage fraud became so extensive that it drove up overall home prices. That is what happened in Atlanta. Hill, 50, was convicted last month in what authorities call one of the biggest mortgage-fraud cases in U.S. history. It involved 400 fraudulent loan applications; nearly $100 million in mortgages; and 120 closing attorneys, appraisers, mortgage brokers and others who prosecutors say were in on the scam.
Federal prosecutors say this kind of fraud is hardly unique to Atlanta -- the lax lending standards that Hill exploited have existed throughout the country in recent years.
In Broomfield, Colo., Gerald Small pocketed $21.5 million and bought two jets after he got bogus home loans using personal information from people who responded to a help-wanted ad; he was convicted. In Kansas City last year, Brent Michael Barber was sentenced to 12 years in prison for paying residents of a low-income neighborhood $2,000 each to use their names in 300 fraudulent loan applications. In Jacksonville, mortgage broker J.R. Parker and closing attorney Dale Beardsley were convicted in 2005 for a fraud scheme in which they netted $14 million in cash, six luxury cars and two $1 million homes.
Federal law enforcement officers say that with heavy demands on them from homeland security, they have had the resources to shut down only the worst offenders.
"By the time we prosecute, the damage has been done, the neighborhoods are already destroyed and the money is gone," said David E. Nahmias, the U.S. attorney who oversaw the Hill case.
In Atlanta, entire neighborhoods and condominium developments, especially those in affluent areas, were hit by organized fraud rings. Initially, these schemes pumped up housing values for everyone as artificially high appraisals helped the swindlers get inflated loans. Legitimate home buyers rushed in to get a piece of what they thought was a soaring real estate market. Now as the fraud is being exposed, their home values are taking a hit.
As more of these cases come to light around the nation, the question is: How much did an epidemic of fraud contribute to the frenzied housing market of recent years?
Liar Loans and Straw Buyers
Thirty years ago, most Americans got their mortgages at a savings-and-loan association from bankers who obeyed conservative lending rules. But sweeping changes in the finance world have created a far different system. It has helped raise homeownership to record levels, but many real-estate professionals say it also has led to far looser lending standards.
Nowadays, instead of poring over paperwork for weeks, lenders often verify loans through electronic underwriting programs in which numbers can easily be tweaked. About 70 percent of Americans get their home loans from independent mortgage brokers, many of whom are paid bonuses for pushing higher-interest loans.
Close to 90,000 brokers have joined the profession since 2000, according to Wholesale Access, a research firm in Columbia. The field is lightly regulated. Eighteen states do not require criminal checks, the Conference of State Bank Supervisors reports. Undoubtedly, most mortgage brokers are honest, but some have played central roles in recent fraud cases.
The housing boom brought another change. Mortgages are no longer held for long by banks but are packaged together as massive bonds and sold on Wall Street. Propelled in part by demand for these bonds, companies began offering loans that required little or no documentation of borrowers' income.
These "stated income" loans were designed for a limited purpose: giving self-employed people a crack at homeownership. But during the boom, the number of such loans exploded to the point that they became a running joke in the industry, earning the nickname "liar loans." Estimates vary widely, but research suggests that they made up a significant portion of all mortgages during the boom -- 58 percent in a study by First American LoanPerformance.
Mortgage lenders in theory have a right to compare loan documents to a buyer's tax returns, but they rarely do. In the few cases where it has been done, results were startling. In a study published by the Mortgage Asset Research Institute, one lender sampled 100 stated-income loan applicants and found that 90 had exaggerated take-home pay by 5 percent or more and that nearly 60 inflated their pay by more than 50 percent.
Mortgage originators often neglected extensive document verification because it slowed loan approvals. "Everyone in the mortgage industry is trying to approve loans faster than their competitors," said James Croft, founder of MARI in Reston. "They all offer the same basic rates and the same basic mortgage products. But if I can get the loan faster, that gives me a competitive advantage."
Many industry experts say stated-income loans became an invitation to fraud, while mortgage brokers -- paid commissions to put loans through, not slow them down -- often looked the other way.
In this climate, industry people say, fraud of two types became easier.
In the first type, known to law enforcement as "fraud for housing," people lied on their mortgage applications to get into homes they otherwise could not afford. Even on a loan where the buyer is asked to provide no proof of income, lying about it on the application is a federal crime.
A more insidious type -- "fraud for profit" -- also spread. Involving scam artists taking advantage of the looser standards, many of these schemes drew in corrupt appraisers willing to overstate the value of properties, "straw buyers" who were paid to lend their names and credit histories to a transaction, and closing attorneys who kept banks in the dark.
The growth of mortgage fraud has outpaced other types of financial crimes, the Treasury Department reports. From 2002 to 2004, mortgage fraud reports nearly doubled each year. Over that period, mortgage fraud convictions by federal prosecutors fell.
The Treasury Department received a record 37,313 mortgage fraud reports in 2006, 10 times more than in 2000. But the true incidence is almost certainly higher because the government gets reports only from regulated institutions, not including the nation's 53,000 mortgage-broker firms.
"Nobody wants to go in there and expose how big this is," said Chris Klein, a finance manager at Howard Hanna Mortgage Services, a Pittsburgh mortgage broker, echoing the comments of several brokers around the country. "In the industry as a whole, it's a running joke. If you want to get a loan done, any loan, you can get it done."
Hill's 'Business Model'
Phillip Hill allegedly ran small-scale frauds in Florida and elsewhere for years, and he was caught and convicted in one case. But when he arrived in Atlanta in the late 1990s, that past was invisible. It is now apparent that he came to town with big plans.
Described as soft-spoken but charismatic, Hill broke into the city's elite circles by throwing lavish parties at an estate a few blocks from the Georgia governor's mansion. Influential people began coming to him for their housing needs. Hill rented homes to several prominent Atlanta figures, including Robert L. Nardelli, the former chief executive of Home Depot.
Prosecutors said Hill and his accomplices sought short-term loans from friends and associates, including business leaders and professional athletes. The ring bought homes, then transferred them to straw buyers Hill had recruited. Using inflated appraisals and other doctored papers, the group took out big mortgages that allowed it to repay the short-term loans and pocket hefty sums.
Some home prices were inflated by 100 percent or more. One estate was pumped from $1.9 million to $5.5 million in two weeks, according to court documents. Hill's personal take from the scheme is estimated at $14.5 million, prosecutors said.
Prosecutors think most of the straw buyers, some just college students, did not know what Hill was doing with their names and credit histories. Several later testified that Hill's attorney flipped through loan documents so fast at closing that they hardly read what they were signing. Most apparently thought they were becoming the owners of homes Hill would maintain and rent out to make the monthly payments.
In truth, neither happened. Most homes fell into disrepair. Others were stripped of their appliances and fixtures, including the mansion where Hill hosted his cocktail parties. As the scam unraveled, more than 300 homes fell into foreclosure.
Mortgage lenders later acknowledged that they failed to perform basic checks into hundreds of Hill loans. They estimated their losses at $41 million. Some of that will be absorbed by Fannie Mae and Freddie Mac, the huge government-created housing corporations in Washington that help package home loans into bonds for sale on Wall Street.
At trial, defense attorneys argued that Hill was unaware that his "business model" was against the law and that his underlings doctored loan applications without his knowledge. The jury did not buy it. On March 14, Hill was convicted of 166 counts of fraud and money laundering. He has not been sentenced, but after the verdict, Judge Thomas W. Thrash said Hill "is looking at spending the rest of his life in prison."
Hill's attorney, Bruce H. Morris, said his client maintains his innocence and plans to appeal.
Nine accomplices, including appraisers, real estate agents and closing attorneys, were convicted. Thirteen others pleaded guilty. Many straw buyers saw their credit ruined.
Hardest-hit by the scheme were honest homebuyers. Mortgage fraud experts estimate that Hill's scam, and others like it, have put several thousand homes into foreclosure, driving down values.
Bill Cleary was one of the first to buy a condo in Deere Lofts, in a bustling area in downtown Atlanta. He was lured by the amenities -- hardwood floors, high ceilings -- as well as advertisements glamorizing the area. In 2001, he paid $213,000 for a two-bedroom unit.
Then Hill bought 40 units at a discount from the builder and started flipping them for about $400,000. The non-Hill condos left on the market were quickly snatched up.
But all of Hill's units ended up in foreclosure. Because Hill stopped paying homeowner dues, the condo association nearly went bankrupt and the building went downhill. Three years after Cleary bought his place, comparable two-bedroom units were selling for $130,000. "All of the promises they made went up in smoke," Cleary said of the developers.
Anne Fulmer's neighborhood, in Atlanta's affluent northern suburbs, has been hit by four mortgage fraud rings since the late 1990s.
The scams motivated Fulmer and others to form a coalition of prosecutors, police, homeowners and real estate agents to fight back. The Georgia Real Estate Fraud Prevention and Awareness Coalition got a tough mortgage-fraud law through the state assembly.
In national surveys, Georgia has been identified as a fraud hot spot. But Fulmer says that is because people there have become so aggressive about identifying the problem. She says she wonders how many homeowners across the country bought in neighborhoods where values were driven up by fraud but don't know it yet.
"It happens everywhere and anywhere," said Fulmer, who is now vice president of Interthinx, an anti-mortgage-fraud company. "If the true scope was discovered, I think it would cause a major crisis."
By Saskia Scholtes in New York Tue Apr 3, 1:55 PM ET
This year's crop of commercial property mortgages could face sharply higher defaults than in previous years amid pervasive loose lending practices and overconfidence in the sector, according to Fitch Ratings.
The warning echoes the turmoil in the risky US subprime home loan market, where lax underwriting and a sharp slowdown in the housing market have resulted in a steep increase in mortgage payment problems in recent months.
Unlike the residential market, commercial property values are still rising. But Fitch said the recent downturn in the market for subprime residential mortgages "should caution investors about the dangers of mixing aggressive underwriting with reliance on continued price appreciation".
The agency said defaults on commercial mortgages originated this year could be up to 15 per cent higher than in recent years. Bonds backed by commercial property loans have become popular in recent years as investors have sought to diversify holdings and tap into rising US commercial property prices.
The phenomenon has granted borrowers easy access to capital and prompted the development of new, more highly leveraged debt structures.
Fitch said properties were also increasingly financed with no money down or even with loans for more than 100 per cent of a property's value as owners borrowed greater amounts upfront to pay interest costs, betting that cash flows would improve quickly enough for the property to be self-sustaining.
"Real estate professionals are structuring loans today with the expectation that cash flow will continue to rise in a commercial real estate market that has already experienced dramatic upward trends," said Eric Rothfeld, senior director at Fitch.
"Fitch is seeing the market financing the higher value prematurely, based on the expectation that it will occur, but well before it does or does not come to exist," he added.
For instance, the rating agency said it had seen underwriting on numerous office properties where the existing cash flows were adjusted to reflect continued long-term growth in property values and rents, even when properties were vacant or leases were not due for renewal within the life of the loan.
Fitch warned that, in some parts of the commercial mortgage market, there were signs that such aggressive lending practices were already causing problems.
Banks and financial services companies topped the list of most actively traded sectors in the US credit default swap market last month amid increasing concerns over the industry’s exposure to problems in the subprime mortgage market, GFI, the inter-dealer broker, said on Monday. A recent spike in late payments and defaults on home loans has prompted a flurry of CDS trading in banks and financial services companies with exposure to the troubled industry.
New Century Financial, one of the largest sub-prime lenders in the US, has filed for Chapter 11 bankruptcy.
New Century sought protection from creditors after it was forced by its backers to repurchase billions of dollars worth of bad loans.
The company said it would immediately cut 3,200 jobs, more than half of its workforce, as a result of the move.
Sub-prime lenders, who target customers with poor credit histories, have suffered from a downturn in the market.
Shares in New Century were suspended in March on fears the company may be heading for bankruptcy, following a sharp rise in people defaulting on their loans.
We suspect the problem in the sub-prime area is just the tip of the iceberg for the mortgage market as a whole David Shulman, University of California Anderson Report
New Century's creditors include investment bank Goldman Sachs and Britain's Barclays bank.
The company said it planned to sell its loan servicing operations to Carrington Capital Management for $139m (£70m), subject to bankruptcy approval.
Barclays deal
Leading US economists warned on Monday that the current tide of defaults in the sub-prime mortgage sector would continue to weigh on the US's slowing housing market.
"We suspect the problem in the sub-prime area is just the tip of the iceberg for the mortgage market as a whole," said senior economist David Shulman, in the University of California's quarterly Anderson Report.
"For all practical purposes, the sub-prime market is in the process of shutting down."
The slowing US housing market, coupled with rising US interest rates, has meant fewer sub-prime customers have been able to keep up with mortgage and loan repayments.
In a separate development, Barclays Bank said it was buying US sub-prime lender EquiFirst for $76m - substantially less than the $225m the UK firm first offered for the group.
Barclays, which is in merger talks with Dutch bank ABN Amro, said the lower price reflected growing problems in the US housing and sub-prime markets.
However, a spokesman for Barclays said: "We think EquiFirst is positioned for profitable growth."
By Dina ElBoghdady Washington Post Staff Writer Saturday, March 31, 2007; A01
DEARBORN HEIGHTS, Mich. -- Janet Laitis leaned on a chain-link fence in her front yard, dragged on a cigarette and pointed to the homes on her block that lenders have seized in just the past two weeks.
"There. There. There," said Laitis, 70, pointing across the street, down the street and then to the modest ranch house next door. "This neighborhood is deteriorating before my eyes."
Within a square mile of Laitis's house in this bedroom community outside Detroit, more than half the 96 homes on the market are foreclosed properties. The situation is not uncommon in pockets of the industrial Midwest, where a record number of people are missing their mortgage payments and losing their homes.
While lax lending policies have been blamed for the unfolding home-mortgage crisis across the country, the distress in the Midwest has been exacerbated by fundamental problems with the economy. The region has been devastated by a severe drop in manufacturing jobs as the U.S. automobile industry shrinks.
"There's a structural shift going on that's undermining the unionized, industrialized states, and Michigan is leading the way," said Donald Grimes, a senior research specialist at the University of Michigan. "When you talk to people in Michigan, you can tell from their voice and their demeanor that they are just depressed."
The housing bubble of recent years has burst and home prices are under pressure in many parts of the country. How far they fall will be determined in large measure by the strength of the economy, experts say, since job and income growth ultimately determine how much people can pay for housing. The U.S. economy is growing, but the pace of growth has slowed markedly of late.
States like Michigan and Ohio, struggling with their particular economic problems, illustrate just how bad things could get in the housing sector if the national economy falls into a recession. They are, moreover, politically important swing states; rising anger there over the housing situation could help determine the outcome of the 2008 presidential election.
Michigan has lost 305,000 jobs since 2001. Economists estimate that 40 percent of the cuts came from automakers and their suppliers, who have shed jobs each of the past six years as they have tried to regain their competitive edge.
About 65,000 people moved out of Michigan from July 2005 to July 2006, the U.S. Census Bureau reported. The migration eroded already weak demand for houses, which in turn hurt prices. In the last three months of 2006, Michigan was the only state in the nation where home prices fell, dropping 0.4 percent from the same time in 2005.
Even during the first half of the decade, when home prices jumped in most of the country, Michigan's stagnated. Dana Johnson, chief economist at Comerica Bank, said home prices typically outpaced income in most of the nation during the housing boom. But in Michigan, income plummeted and dragged housing down with it.
Cash-strapped homeowners could no longer sell their homes or refinance their way out of trouble. Many got stuck with adjustable-rate mortgages offering low teaser rates that spiked in later years. Now many borrowers are struggling.
"It's been a spillover from the weak economy to the housing sector," Johnson said. "What we've seen here is a one-state recession."
Losing Jobs and Value
Brian Minjares, 40, is living that recession first-hand. His story is proof that no one in Michigan is immune to the state's financial woes.
Three years ago, he left his job at a financial services firm to start his own practice with a partner in the Detroit suburb of Southfield. Minjares took out a home equity line of credit to finance the business. At the time, his house was appraised at $350,000 and he owed $275,000, he said. The bank gave him a loan equal to 100 percent of his equity.
As the housing crisis worsened, the value of his home dropped to $260,000. Minjares could not afford to sell it because he owed more than it was worth. He could not afford to keep it because, as the rates on his loans adjusted, his monthly payments jumped to $3,000 from $2,100.
Meanwhile, his client roster was drying up. With the auto industry in decline, many of his customers' businesses crumbled. "So they had no money to give me to invest for them," Minjares said. He coped by running up credit-card debt.
But he fell behind on his payments and the bank foreclosed on his Colonial in Flat Rock, not far from Detroit. Minjares shut down his business and now sells cleaning products. He rents a condominium from his brother.
"You just have to cut your losses and run," Minjares said. "You have to take into consideration your marriage and your health and you say to yourself: 'It's just a house.' "
Ralph Newkirk, an agent with the Michigan brokerage Real Estate One, hears similar stories every day. The foreclosure situation is so extreme that his firm created a division two years ago with 25 agents who sell only foreclosed homes; Newkirk heads it.
Back then, the average sales price on foreclosed homes was about $70,000. Since then, the price has more than doubled, suggesting the problem is no longer confined to low-income neighborhoods in Detroit. "The problem is moving out to the suburbs," Newkirk said. "It's spreading like a cancer."
A Tangible Form of Pain
Michigan's strong tie to the auto sector has been a source of pain before. Strikes damaged its economy in 1967 and high oil prices crippled Detroit in the 1980s.
But Michigan's most recent trouble is "the most severe crisis in the state's existence," defying the pattern of past economic cycles, when Michigan bounced back quickly, said David Littmann, senior economist at the Michigan's Mackinac Center for Public Policy.
This time, the rest of the country recovered from the 2001 recession, but Michigan's per capita income remains 7 percent below the national average, Littmann said. For the first time since the Great Depression, Michigan is a poor state relative to the rest of the nation.
"This is not a cyclical problem anymore, and housing is the most tangible form of the pain," Littmann said.
For most of the past year, Michigan has ranked among the three states with the highest percentage of late mortgage payments and foreclosures, surveys by the Mortgage Bankers Association show. In the fourth quarter, it came in third, behind Ohio and Indiana, with 2.39 percent of its loans in foreclosure.
Many economists say, and union officers agree, that those hardest hit are not auto workers who lost jobs. Many received buyouts that should keep them afloat for a while. And because they tend to be older, some have paid off their mortgages.
Those feeling the worst squeeze, rather, are workers at the auto supply companies, such as Max, 44, an engineer who spoke on condition that his last name not be used because he is embarrassed by his situation.
Max bought a condominium in the Detroit suburb of Plymouth using a traditional fixed-rate mortgage more than five years ago. But three years later, his firm took away company cars from its workers, hiked insurance premiums and cut raises and bonuses -- raising Max's monthly living expenses and reducing his pay.
Max responded by refinancing his condo twice. Though he did not realize it then, the second loan was adjustable. Over time, his monthly payments rose from $1,500 to $1,800 to $1,950.
"I wasn't even reading the paperwork," said Max, who makes $106,000 a year.
Weeks ago, Max turned in his keys to his lender. The bank paid him $500 and took possession of the condo earlier than it otherwise could under Michigan law.
In fact, across the country, official foreclosure numbers do not capture the full scope of the mortgage problem, since many people are doing what Max did. Others are signing over their deeds to the bank in lieu of foreclosure to lessen the damage to their credit records. Some have been granted permission from their lenders to sell the property for less than they owe on the loan.
Signs of Trouble
As the problems grow, at least one type of business is booming in Michigan -- those that help manage foreclosed property. Take the case of Property Maintenance Inc., which changes keys, mows lawns, shovels snow and repairs foreclosed-upon homes in Michigan so that they are ready for sale.
Deanna Simmons, who created the company in 2002, said the revenue of her six-employee firm shot up from $20,000 in the first year to $1.6 million last year.
Driving through the streets of a working-class neighborhood in Dearborn Heights, Simmons points out the tell-tale signs of a foreclosed house: mail boxes overflowing, fliers piling up, shades drawn.
Once inside, she can tell which people left angry. They're the ones who leave all the water faucets running or take the door knobs with them. "They do anything they can to make it difficult for the mortgage companies, like they're trying to get back at them," she said.
Simmons spots the home next door to Laitis, the Dearborn Heights resident alarmed by the foreclosures on her street. The white ranch house is not for sale yet, but the tell-tale signs are there.
Laitis said her neighbors, a couple in their 40s, left recently after they learned their house would be foreclosed upon. The husband, a carpenter, had lost his job. The wife did not work. They crammed what they could into their white Bonneville and drove off without saying goodbye.
Laitis said the house was paid for at some point but the couple took out a $75,000 home equity line of credit to buy a car and build a garage, now half-finished.
Lots of people can't afford their mortgage or can't afford rising property taxes, Laitis said. For her, the taxes have become onerous. She wondered aloud if she could lose her house for failure to pay them. She could.
"Maybe I'm going to be the next one out of here," she said.
Following the US subprime mortgage alarm, some investors have been reassured by rebounding indices and optimistic pundits. But the biggest risk of all lies in thinking that risk has been conquered. It has not - it merely slumbers, so long as massive quantities of cheap credit allow the roll-over financing of future rounds of debt. If this slows sharply, the subprime housing turmoil is the tip of the iceberg.
Mar 28, 2007
By Max Fraad Wolff
The subprime mortgage market is in a state of flux. Risk reduction and risk sharing financial products are being stress-tested and the results are unclear.
Recent announcements by HSBC, New Century and others have rattled volatility-complacent investors. Rapid downward repricing has occurred and global contagion has emerged. A few weeks out, some smiles are evident as indices have whipsawed and jawboning has reassured investors. Others see catastrophe on the horizon. We are in neither camp.
Estimates are that there is about US$1.5 trillion in subprime housing loans in the US market. Slowing house-price appreciation calls into question repayment on some of these loans. The greater risks and lessons are symbolic. The subprime boom and the risks from a rapid deterioration in the market are much bigger than subprime. Questionable loans and the misallocating credit models that generated them are everywhere. Trillions of dollars in managed speculative wealth seeks returns greater than traditional low-risk assets offer.
Global deregulation and consolidation of banks and financial intermediaries creates a world of opportunity. New risk and asset securitization innovations enable products to arise to meet the ravenous hunger that fuels a global credit boom. Risk redistribution and repricing derivatives proliferate to "offset" and safeguard the rising exposure required. We may be on the brink of testing our new portfolio and solvency safety equipment.
Lehman Brothers and Bear Stearns base cases call for subprime national defaults of $200 billion to $250 billion over the next two years. This would translate into 1 million to 2 million residential-unit defaults. The next 22 months will see nearly $1 trillion in adjustable-rate mortgages resetting, with $650 billion in subprime. Industry base cases assume average house prices will be flat to 2% down across the next two years. Given the scope and size of recent house-price appreciation, the projected housing-market correction is very modest. Confidence derives from many questionable assumptions. Default risk and hedging products must turn in stellar performances, fear must not grip markets, and contagion must be limited. This is possible and has happened before. This best case requires us to thread the needle.
Risks must be measured against private US housing stock valued at $20.6 trillion on January 1 and total mortgage debt of $9.7 trillion on the same date. The sheer size and recent growth of household net worth is constantly and impressively invoked to sooth. Household real-estate assets increased by 50%, or $6.857 trillion, from 2002-07. During the same period, the Federal Reserve Z1 Flow of Funds records an increase of $3.708 trillion, 62%, in mortgage liability. Disposable personal income increased by $1.851 trillion or 24% over the period. Net worth grew by $16.829 trillion, or 43%. It has been a crazy few years. All this growth of wealth and debt amid asset inflation is made possible by new markets, methods and innovation in risk hedging and sharing.
The rise of collateralized debt obligations, credit-linked notes, over-the-counter finance and custom derivative products are the enablers. The subprime situation, credit quality, hedging techniques and products must all be considered together. Across the past three years there has been a steady decline in the quality of mortgages written and creditworthiness generally in the system. Credit-default protection has been extended to lower credit-quality-rated debt.
Massive international capital flows and global financial deregulation have grown exponentially over the past decade. Cross-border capital movements have increased more than threefold to more than $7 trillion since 1996. This has made far more credit available at much lower cost. For riskier borrowers - subprime - this has meant a maiden voyage deep into debt. The securitization and sharing of default risk has allowed issuers to share loss risk and markets to grow.
The sheer mass of managed wealth has reduced the returns to traditional safe investment grade assets. Thus supply and demand are generated by the same forces. These forces include rising risk/return appetite, global upward distribution of wealth, financial deregulation and financial innovation. Risk-management products have been inexpensive and the hunt for yield intense. There is more capital chasing riskier assets to gain acceptable returns. Lower-quality loans are made, hedged, bundled and sold. The serious systemic risk associated with the recent subprime episode stems from the prospect that the new financial architecture is less robust and more highly correlated than assumed. The rising cost of hedging debt positions and greater fear of lending to riskier borrowers is far more worrisome to us than the US subprime market.
New risk product and the rapid growth of established hedging and sharing contracts and trading techniques have boomed. From a systemic perspective, this does not reduce total default or shock exposure. Redistribution and repricing of risk occur. This is valuable and acts as a shock absorber for intermediaries that would otherwise have to restrict activity or ride unsound direct loss exposure. As higher risk assets are sold or hedged, there has been a tendency to use the raised cash to purchase other risky assets in the hunt for yield.
A prime example comes from the CDO (collateralized debt obligation)/mortgage-securitization process. As banks issue mortgages they assume a first loss position (FLP) to be able to sell off the loans for securitization. If we assume a fully funded standard contract, the banks pass the loans to a special purpose entity/vehicle (SPV) that sells the loans and assumes the loss position. Losses from "unlikely" system shocks are partially passed to the buyers of the securitized loan bundle, but that first loss position means the banks still bear risk. In addition, the total reduction in risk achieved hangs heavily on what is done with bank proceeds generated by this process. You guessed it, the evidence is that banks make further loans and repeat the process. The good news is that banks have a more diversified, riskier portfolio. The bad news is that risk exposure does not fall, it rises. The total risk in the system rises and is diversified and more broadly shared. This is the good news and the bad, out of our brave new era.
We see subprime as risk and valuable lesson. This market is in for a rough run. There are sweet dreams of containment; they defy reality. There is no such thing as a subprime neighborhood. Subprime is concentrated more heavily in some areas than others; it is everywhere. Thus broader housing-weakness questions are when and how bad, not if. Hundreds of billions of dollars in loans were made to people who clearly could not repay, absent significant annual house-price appreciation and cash-out refinancing. This means that we made housing loans to create housing-price appreciation on which loan repayment was predicated. Sometimes we are tempted to think that this credit boom has gotten a bit out of control. There is no long-run safe substitute for earnings, savings and income growth when increasing credit. This is not to say there cannot be a lot of money made, valuable financial innovation and long periods of great returns.
The other vital lesson involves our brave world of fully managed risk and nearly perfectly hedged positions. Have other markets and asset classes become dependent on credit growth to drive up asset prices to allow further credit growth? A huge Maginot Line of default defense has been erected to keep loss exposure out. Many valuable and potent new risk-management techniques and products have been developed. Riskier borrowers remain risky to all the various parties that extend credit to them. This showed up fast and furious as the cost of credit-default protection shot up and interest-rate premiums snapped into correlated action with every increase in subprime stress.
The greatest risk may be in thinking that risk has been conquered. It cannot be. It has not been. Risk has simply been redistributed and repriced, downward. As perceived risk fell and sharing grew, new monies were freed up for riskier lending and new, riskier projects. Loans went through and new projects were launched. Default risk continued/continues to grow as credit grows and allocations hunt for return. There is no innovating around this basic reality of financial gravity.
We are looking for periods of contagious fear in credit-risk-reduction markets feeding back and forth with particularly risky asset markets. The real danger slumbers - we hope - so long as massive quantities of cheap credit allow the roll-over financing of future rounds of debt. If this slows sharply, or runs in reverse, US subprime housing turmoil is the tip of the iceberg. There has been a lot of subprime allocation of capital and risk across the past few years. Subprime will either become a heeded warning shot across the bow, or a prelude to violent repricings to come.
Max Fraad Wolff is a doctoral candidate in economics at the University of Massachusetts, Amherst, and editor of the website GlobalMacroScope.
Contrary to what large banks and financial medias tried to make us believe last week, and in line with LEAP/E2020's anticipations, the US housing market keeps falling.
Indeed, as described in GEAB N°13 (already anticipated in November 2006 in GEAB N°9: "LEAP/E2020 Alert - Banking and financial sectors at the center of the impact phase of the global systemic crisis, via 'hedge funds' and 'bad quality credit'"), the most important financial operators - for a large part heavily involved in housing and subprime mortgage loans - are beginning to be affected by the current giant financial rout.
New Century Financial Corp. (Other OTC:NEWC - news), the troubled subprime mortgage lender, said on Wednesday it voluntarily terminated its relationship with Freddie Mac (NYSE:FRE - news), and that "several" of its own lenders plan to sell loans that had backed $17.4 billion of credit lines.
The Irvine, California,-based company also said it has entered agreements with regulators in Idaho, Iowa, Michigan and Wyoming to stop lending, following similar agreements with or orders from several other states.
The developments may move New Century closer to bankruptcy, an outcome many analysts already expect.
New Century disclosed the developments in a filing with the U.S. Securities and Exchange Commission. It did not immediately return a call seeking further comment.
The company had been the largest independent U.S. provider of home loans to people with poor credit before running into financial difficulties as delinquencies and defaults mounted.
New Century's decision to end its relationship with Freddie Mac means it cannot sell mortgage loans to or act as the main servicer of any mortgage loans for the mortgage financier.
Fannie Mae (NYSE:FNM - news), another mortgage financier, cut off its own ties with New Century earlier this month.
New Century's own lenders, meanwhile, are moving to preserve their own stakes in case of bankruptcy.
Earlier this month, Barclays Plc (BARC.L) took possession of $900 million of mortgages, while Morgan Stanley (NYSE:MS - news) said it is auctioning $2.48 billion of loans.
Another week has passed with most of the progressive community mesmerized by the political game playing in Washington. Don’t we realize yet that a totally compromised political process in Washington, built around wheeling and dealing, will not have the courage or the consciousness to do what must be done to stop the Iraq War?
The House’s latest watered down “withdrawal” bill will never become the law in an environment laced with veto threats and the White House’s efforts to mobilize the military against the Democrats — as if somehow the soldiers can be viewed apart from the war. Alas, the votes to prevail are not there.
Don’t we also realize the debate over what Alberto Gonzalez did or didn’t do is a sideshow. Sure he “did it,” and yes, he’s been caught—but so what?
Let’s acknowledge that the GOP is not the only party that politicizes the Justice System—and, yes, the Clinton Administration did clean house of US Attorneys in its time. The problem here is deeper than mere partisan bickering.
Unfortunately, if Gonzo goes—as he may—another legal Neanderthal who may play the game with an even harder line will replace him.
The mainstream AND indy media focus on every tick and burp in Washington assumes that the politicians are the real power—and often ignores the big money and corporate clout stage-managing the process.
Too many bloggers focus on the smoke and mirrors of politics, as if it is a recreational sport or parlor game, taking polls too seriously and trends not seriously enough. There’s still more of an obsession over the scandal of the day than over the interests in the wings—the people who are financing the politicians and orchestrating their maneuvers.
The political crisis engages the bashing brigade of message point polemicists on the right and left who both tend to ignore economic interests. They are the forces that are devastating the lives of so many Americans who have lost their jobs, can’t pay their bills and are victimized by the growing inequality in our nation, which does not seem to have become a political issue yet.
No one’s marching on the banks or Wall Street to demand economic justice.
Think of all the soldiers who join the military because the pay is better or they have no other choice. Think of all the poor Iraqis being killed by poor Americans who return to find themselves going even more deeply in debt. They are the ones being victimized by payday lenders whose signs advertising easy money line the boulevards outside military bases. Speak to military families and you will find that their lives are harder than ever.
And then meet the folks who are among the 1.1. MILLION Americans on the verge of losing their homes in America because of the subprime loans they took at usurious rates in order to improve their lives by putting a nicer roof over the heads of their families. The companies that gave them the mortgages with no credit checks made small fortunes doing so, but so overplayed their greedy hands that now some have lost BILLIONS and hurt the whole economy. Some economists fear a recession (or worse) because of this time bomb.
How did it happen? The federal regulators were absent without leave and, according to the Wall Street Journal, 52% of the loans were made by scores of predatory independent companies that are not regulated. As Alan Fishbein of the Consumer Federation of America put it, “Only when the market experienced losses and lenders started to shut their doors did real attention start to be paid to the issue.”
What we are seeing, according to Robin Blackburn in Counterpunch, is vicious and legitimated loan sharking. He writes: “In recent times high-profile Wall Street investment banks have brought slick financial reasoning to the base art of loan-sharking. The most vulnerable Americans have been targeted for loans they can ill afford. Those with poor credit histories can be charged at double or triple the interest of a customer in good standing with the rating agencies.”
The details of all of this money grubbing are now in the press, which was also asleep at the switch and is just waking up to the impact that this crisis is having on working America. The story has finally moved from the business section to the news section, from page 50 to page l. Unless something is done, these headlines will lead to breadlines.
While some politicians are starting to talk about this crisis, you have to wonder what they are willing to do. If they won’t really challenge the Bush Administration on the war, even as the war and the President’s popularity sinks into the toilet, do they have the guts to take on the power of the big banks?
Knock, knock progressive bloggers and activists: let’s get on this issue like white on rice. (That’s not a racial allusion—a large percentage of the victims here are, predictably, Americans of color.)
Knock, Knock MoveOn: I wrote to one of your decision makers who told me that this issue is not on a list of issues members said they care about. But the list was made last year. Guess what? This crisis that has long been warned about only just erupted! No one anticipated Katrina either.
Let’s expose the real power in this country—the economic engine driven by the financialization of consumerism that sells us what we don’t need and lends us what we can’t pay back. As we fight the military-industrial complex, let’s not ignore the credit and loan complex.
Last week, in a story about mounting foreclosures, the Journal noted that most of us need not worry about the problem, which, translated, means that the upper class and parts of the middle class can ride out the crisis. That struck one of the readers of the News Dissector blog on MediaChannel.org as amusing. Faith Carr wrote:
“My family was ahead of the curve on this insanity. After a job loss, losing our 5/3 home, and the bankruptcy before the legislation change, we are living humbly in a 27-year-old trailer in the country. Just wait until those making 100K + have one tiny little bubble in their lives. Gonna fall like the house of cards it is.”
So beware: this crunch affects all of us, and yes, we can do something about it. My film IN DEBT WE TRUST is just rolling out. Help us organize screenings to educate people about the roots of the crisis. The website STOPTHESQUEEZE.ORG just announced a campaign by Americans for Debt Relief Now to make this issue our own.
Rising defaults on US subprime mortgages - home loans to borrowers with poor credit histories – have forced dozens of lenders to close, and caused market mayhem. Will this harm the economy?
Recent problems in the risky subprime mortgage sector did not appear to have spilled over into other parts of the credit markets, Timothy Geithner, president of the Federal Reserve Bank of New York, said. - Mar 23 2007
Investors punished the stocks of US companies involved in mortgage lending to risky “subprime” borrowers amid signs that the shake-out in the industry is far from over.
HSBC and New Century Financial served up a bitter pill for investors last week. News that they faced more significant difficulties than expected with their portfolios of loans to US borrowers with weak credit sent markets reeling.
Investors in mortgage bonds reacted bearishly to news that HSBC and New Century Financial faced bigger-than-expected difficulties with their portfolios of loans to US borrowers with weak credit.
Concerns over risky US mortgage lending mounted as a key indicator of credit problems hovered at record levels, another small mortgage lender failed and a big homebuilder admitted borrowers’ difficulties could damage its business.
Investors have signalled trouble in store for the giant crop of US "subprime" mortgages launched this year, pushing up the prices for credit insurance that will...
The rapid decline of subprime lender New Century Financial has added a new sense of urgency to first quarter earnings reports due this week from Wall Street investment banks Lehman Brothers, Bear Stearns and Goldman Sachs.
The meltdown in the giant US subprime mortgage sector gathered speed as shares in several leading lenders plunged and HSBC said it would take at least two years to fix its portfolio of bad home loans in the US.
In the closing days of last year, something came un-stuck in a small but important corner of the US mortgage market, causing pain for investors and resulting in several mortgage lenders shutting their doors. The problem was that for some home buyers last year, it had become too easy to get a mortgage.
Sometimes all you have to do is ask. And sometimes it’s important to ask more and drill down a little to get to the truth. But most people don’t. Particularly in the hedge fund world.
US financial regulators proposed new guidelines for the troubled subprime mortgage industry, saying they were worried borrowers did not understand the risks of the loans
Investors in mortgage-backed bonds and other complex debt products could be left nursing substantial losses as troubles grow in the risky US subprime mortgage market.
The giant US subprime mortgage business is displaying a new-found caution with lenders tightening loan standards and cutting ties to overly aggressive brokers.
This is turning out to be a very happy bonus season from one end of the global street to the other. Whatever the real source of excess global liquidity, it has led to some fat cheques being written by the compensation committees at banks and dealers, writes John Dizard.
Growing numbers of hedge funds have placed bets on a slump in the US housing sector in recent weeks, weakening a key index tied to the performance of subprime mortgages, according to dealers.
In mortgage market's next big blowup, many Americans face losing their home
MarketWatch
Last Update: 2:32 PM ET Mar 23, 2007
WASHINGTON (MarketWatch) -- For the first time in the nation's history, a significant number of Americans are being threatened with the loss of their home even though they still have a steady, good-paying job.
It's not just an issue for people with poor credit, those with subprime loans. It also affects people with good enough credit to qualify for a prime loan. Known as Alt-A mortgages, these loans were written for 1 in 5 U.S. mortgages and could have a big impact on the economy and on credit markets -- bigger, perhaps, than the effects of the recent shockwaves buffeting the subprime-lender market, economists say.
Specialists threatened Few independent subprime lenders may be left after mortgage crisis.
Unlikely suspects GE, GM and H&R Block are in the subprime business -- but originators owned by these larger companies have better survival odds.
In coming months and years, the credit crunch that's now squeezing mainly the poor is likely to hit millions of middle-class homeowners who took out risky loans during the great housing boom earlier in the decade. More than 1 million families will lose their homes in the next few years, by one estimate. Another study predicts 2.2 million foreclosures.
This threat is new in American history. Its impact on the economy, and upon the American Dream, is uncertain.
In the past, homeowners have generally lost their home to foreclosure only when they suffered a major life-changing event, such as loss of their job, a major illness or death of a family member. A big jump in foreclosures was unheard of outside a recession that brought high unemployment.
But now, because of the recent popularity of loans geared to let people buy a more expensive home than they can truly afford, all it will take is the passage of time to trigger a default. At some point, all these loans are adjusted to switch from a low, subsidized monthly payment to the full amount required to pay off the loan.
In the not-too-distant future, millions of Americans may receive a letter advising them of their mortgage "reset" or "recast" with the same dread they now feel for a pink slip or for bad news from their oncologist. The only difference: They know (or should know, if they noticed what they were signing) exactly what's coming: An average monthly increase of $1,512 in their monthly mortgage payment.
Because this risk is so novel, experts don't have a clear grasp yet on how big of an impact the credit crunch might have on the economy. Most economists say the problems won't spread too far beyond the poor, and that the extent of the losses to families, mortgage underwriters and investors will be small in the context of a $13 trillion economy.
But others think the risks are widespread and that the economy could be hit hard by the failures in the credit market. It could take years to fully recover.
"This is different," said Mark Zandi, chief economist for Moody's Economy.com, who warns that the problems in the subprime mortgage market will spread. "It will mean the difference between an economy that will glide through the slowdown and an economy that sputters."
'It will mean the difference between an economy that will glide through the slowdown and an economy that sputters.'
— Mark Zandi, Moody's Economy.com
"The risks are all negative," Zandi said.
According to a Credit Suisse report, tighter lending standards, increased foreclosures, more supply on the market, lower prices, and less construction of new homes will affect all parts of the market.
"It's not just a subprime issue," Ivy Zelman, a housing analyst for the bank, wrote in the report.
Researchers are studying three major channels through which a mortgage meltdown's shockwaves could rattle the economy.
The most direct way would be through falling home prices.
Demand will continue to fall. Tougher mortgage underwriting standards will eliminate about 20% of the potential buyers, including 50% of the subprime buyers and 25% of the Alt-A buyers, according to estimates by Credit Suisse.
The supply of homes would also grow.
Foreclosures and homes dumped on the market by desperate sellers would further depress prices, which in turn would further depress voluntary home sales and home building in a vicious downward spiral, some analyst say. Housing would remain a drag on the economy and on employment for far longer.
Payment shock
In a weak market, some homeowners facing a large payment shock would find it difficult, if not impossible, to refinance their loan or sell their home for what they owe on it. About 13% of the owners who face a mortgage rate reset this year have less than 5% equity in their home, and therefore will not be able to refinance unless they have other assets.
If prices fall 5%, the percentage with no equity would grow to 23%, according to Christopher Cagan, director of research for First American CoreLogic, a mortgage research firm in Sacramento. And if prices fall 10%, it would jump to 35%.
And then there's the chilling effect of a slowdown on consumer spending. According to Federal Reserve data, consumers have taken about $3 trillion in equity out of their homes in the past five years, adding about 7% to disposable incomes every year. That boost kept the economy humming and has driven the personal savings rate below zero for the first time since the Great Depression. If home prices fall or even flatten out, consumer's ability to fatten their wallets based on home equity would be curtailed.
Even consumers who didn't take out any equity increased their spending during housing's big heyday, and they'll probably slow their spending as prices flatten out. Homeowners experiencing rising equity felt richer and didn't feel the need to save as much. Economists say consumers spend about 5 cents of every extra dollar in housing wealth.
In addition, households faced with much steeper mortgage payments would cut back on discretionary spending to avoid defaulting on their mortgage.
The third transmission channel is financial.
In dollar terms, the scale of the potential losses from resets of adjustable-rate mortgages is insignificant when compared with the size of the capital markets. Cagan estimates losses of just $112 billion out of a $9 trillion mortgage market, leading him to conclude that mortgage resets won't break the economy or the financial system.
The deeper question is what will happen to investor sentiment. "This has the potential to undermine global investor confidence," said Zandi of Economy.com. The result could be a general drying up of credit, even to the most qualified and untainted borrowers.
And once investors turn cautious, it's difficult to predict how it will play out. After all, in the Asian financial crisis of 1997-98, even countries with sound policies were punished by investors rushing to get their money out of Asian markets. There's not much reliable information about who owns the riskiest mortgages.
Investors who eagerly bought these risky mortgages on the secondary market are having second thoughts, not just about subprime mortgages, but also all the other bits of paper in their portfolio that they didn't pay much attention to. They are finding out that there's not as much collateral in the collateralized debt obligations, known as CDOs, as they were led to believe.
In a paper issued last month, Joseph Mason, a finance professor at Drexel University and visiting scholar at the Federal Deposit Insurance Corp., and Joshua Rosner, managing partner of Graham Fisher & Co., concluded that the market hasn't accurately priced in the risk of default on non-traditional loans, or of the even-more complex mortgage-backed derivatives they are spun into.
The quality of the underlying asset is opaque to the investor as well as to regulators.
"Even investment-grade CDOs will experience significant losses if home prices depreciate," Mason and Rosner wrote. And decreased funding for mortgages from big investors "could set off a downward spiral in credit availability that can deprive individuals of home ownership and substantially hurt the U.S. economy."
In the worst-case scenario involving a credit crunch, "a vicious cycle of lower spending, weaker hiring and income gains, tighter credit and still lower spending could result, pushing the economy into recession," according to a recent report by Goldman Sachs.
Lemming loans
So far, defaults and foreclosures in the subprime market have received all the attention. The latest data show that more than 14% of subprime adjustable-rate loans were delinquent at the end of 2006, compared with 2.3% for prime fixed-rate loans.
However, Goldman Sachs economists have concluded that delinquency rates are rising nearly as fast for the riskiest prime ARMs, the loans some are calling "toxic loans," or "exploding mortgages."
It might be more accurate to call them "lemming loans," however, because that metaphor best describes the mass insanity and suicidal financial consequences of such loans.
Subprime generally refers to borrowers with a poor credit history. It was a market that accounted for about one-fourth of the mortgages written in the past three years, up from less than 10% five years ago.
America's housing bubble wasn't fed by subprime borrowing alone. Especially on the coasts where home prices were soaring, many buyers with excellent credit, high incomes and good jobs took out more debt than they can repay. Nationally, these Alt-A loans accounted for about 20% of mortgages last year, and more than half of the loans in the states with the frothiest housing markets, according to Credit Suisse. In 2003, Alt-A loans were about 5% of the market.
It used to be that the mortgage industry refused to lend more money than borrowers could repay. There were strict standards requiring a hefty down payment and limiting the size of a loan. These standards helped create the largest secondary mortgage market in the world, which gave big investors the confidence that they'd get their money back with a nice return if they funneled trillions of dollars into the U.S. housing market.
But that was before lenders realized they could make more loans and earn higher profits if they bent the standards, right under the noses of the investors who bought those mortgages.
The result was an explosion of exotic mortgages, all designed to maximize the amount of the loan: adjustable-rate loans with little or no money down, loans with no documentation of income or assets, loans with a simultaneous second mortgage, mortgages with low initial "teaser" rates, and even mortgages with monthly payments so low they don't even pay all the interest due.
If it hadn't been for the extra leverage created by lemming loans, the housing bubble would have never gotten off the ground. It's how ordinary bungalows began to be priced like mansions -- suddenly families with ordinary incomes were getting approved for almost unlimited credit.
Easy credit fueled the bidding wars.
Falling prices
During the big housing bubble, all these loans performed well. With rising prices giving homeowners additional equity, they could always roll one lemming loan over into another, and they could usually take thousands of dollars of equity out as cash. The credit rating agencies gave their seal of approval to these loans.
Now, however, home prices are no longer rising, and that could make many of these loans go sour in a hurry.
According to the S&P/Case-Shiller index, U.S. home prices were up just 0.4% in December 2006 compared with December 2005, and prices were falling in most metro areas at the end of the year. Even in the San Francisco Bay Area, prices fell at a 5.5% annual rate in the last half of 2006, and 9.2% in San Diego.
The best predictor of whether a loan will go bad isn't the credit score of the borrower, but whether the loan is a fixed-rate loan or an adjustable-rate loan with an extra layer of risk, said Cagan of First American CoreLogic. He predicts about 1.1 million families will lose their homes in the next few years because of mortgage rate resets.
Last year, 55% of the Alt-A loans came with simultaneous second mortgages. The average loan-to-value ratio was 88%. More than 80% of Alt-A borrowers chose to provide no documentation of their income, and 62% took an interest-only or option ARM that reduced payments at the beginning with the promise of higher payments later. More than one quarter of the Alt-A loans were one-year adjustable loans, not the five-year adjustable that has been the standard for prime borrowers.
"Cumulative foreclosures on 'teaser-rate' mortgages -- which are classified as jumbo or Alt-A rather than subprime -- could significantly exceed those on subprime mortgages," Jan Hatzius, chief economist of Goldman Sachs, wrote in a research note.
The danger of the lemming loans is that as more of them go bad, more homes will come on to the market. That will drive down prices even more, taking away what little equity the remaining homeowners have and eliminating any chance for them to refinance their loan or sell the house for what they owe. And even more homeowners will go off the cliff.
Cagan figures that every percentage point drop in home prices will mean another 70,000 foreclosures.
According to Cagan's research, about 8.4 million households have adjustable-rate mortgages that are expected reset to a higher rate in the next few years. About 1.3 million have mortgages with initial teaser rates below 2% that will reset to a much higher payment when the introductory period elapses. On average, they'll face an increase of $1,512 in their monthly payment.
About one-third of those families will lose their homes, Cagan estimates.
Someone with a $500,000 mortgage (not uncommon in the Bay Area where such loans are popular) with a 2% teaser rate could find her $1,850 monthly payment rising to $3,500 or more. That would represent a mortgage payment of more than 50% of the median household income ($86,300) in San Francisco.
In the past, homeowners were expected to keep all their debt service to less than 38% of their gross income.
Negative amortization
For homeowners already stretched to the breaking point, the mortgage reset will be catastrophic. But there's something even worse: negative amortization.
Regular amortizing loans pay off part of the principal each month, and eventually the borrower owns the home free and clear. But negative amortizing loans add to the principal each month. The loan balance literally gets larger each month.
Large percentages of recent buyers ranging from California and Florida to Washington and Virginia will face an additional shock because they took out a negative-amortization loan. Nationally, about 10% of the loans taken out in the past two years had negative amortization, including about 24% of the loans in California and 29% in the Bay Area.
These loans allow buyers to make minimum payments that don't cover all the interest due each month. The interest that isn't paid is added to the principal. The shocker comes when the principal grows to a pre-determined level (perhaps 110%, or 115% of the original loan) and the loan is "recast" immediately as a fully amortizing loan, in some cases resulting in a doubling of the monthly payment.
This comes on top of any scheduled reset of the mortgage rate.
Negative-amortization loans were most popular in the areas with the fastest-growing prices during the real-estate bubble. Now most of those same areas have experienced falling prices, meaning the house may be worth less than what the owner owes the bank.
Even among those who believe the credit problems in the mortgage market will have a big economic impact, only a few economists are calling for a full-fledged recession this year. But they all think the risks are rising.
