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Real Estate News and Advice |
October 7, 2008 |
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 Mortgage Sector Shaking Economic Foundation
by Broderick Perkins
More evidence reveals the growing chasm between those who can have home loans and those who can't as lenders tighten standards for subprime loans but not prime. Meanwhile, fallout from the mortgage market and other housing market woes finds experts second guessing initial forecasts that the economy is safe from turmoil in the housing market. The Federal Reserve's April 2007 Senior Loan Officer Survey found recently that while the vast majority of senior loan officers, 85 percent, said credit standards on prime mortgages remained unchanged in the last three months, more than 56 percent said credit standards on subprime mortgages "tightened somewhat" or "tightened considerably" and 45.5 percent likewise said credit standards on nontraditional mortgages tightened considerably or somewhat in the past three months. The responses came in a special set of questions the quarterly survey put to loan officers of domestic banks. "In order to track developments regarding the major categories of residential real estate loans, the April survey asked banks to report separately changes in standards on and demand for prime, nontraditional, and subprime residential mortgages," the survey said. For the purposes of the survey the loans were defined as followed: Prime loans: These are mortgages made to borrowers that typically had relatively strong, well-documented credit histories, relatively high credit scores, and relatively low debt-to-income ratios at the time of origination. The loans include fixed-rate loans, standard adjustable rate mortgages (ARMs) and hybrid ARMs. Nontraditional loans: These are mortgages that include ARMs with multiple payment options, interest-only mortgages, and "Alt-A" products such as mortgages with limited income verification and mortgages secured by non-owner-occupied properties (second homes, vacation homes, investment homes, etc.). Subprime loans: The subprime category home loans includes loans to borrowers with one or more of the following characteristics: weakened credit histories that include payment delinquencies, chargeoffs, judgments, and/or bankruptcies; reduced repayment capacity as measured by credit scores or debt-to-income ratios; or incomplete credit histories. Only 16 banks in the survey wrote subprime mortgages, all 53 wrote prime loans and 44 wrote nontraditional mortgages. While lenders were tightening standards, making it more difficult to obtain some loans, demand remained strong for home-buying mortgages across all survey categories during the same three months. Among prime loans, 68 percent of the officers surveyed said demand remained the same or was moderately stronger; for nontraditional mortgages, 78 percent of the officers said demand remained the same or was moderately stronger; and for subprime loans, nearly 69 percent of loan officers said demand remained the same or was moderately stronger during the past three months. The mortgage demand-supply imbalance is hurting lower-income households most and in several ways. Already at their financial wits end, one-in-four low-end households pays more than 40 percent of their income on debt payments, most of it housing, according to a recent Brookings Institution Metropolitan Policy Program study "Borrowing to Get Ahead and Behind: The Credit Boom and Bust in Lower-Income Markets". It only takes one ARM adjustment to send some subprime household budgets into a tailspin. If a credit card payment is sucked into the vortex, not only does the household face foreclosure, but the credit card company reacts with a skyrocketing interest rate increase penalty, further exacerbating the household's financial woes. There's now a much smaller sanctuary, if any, in a refinance, because the borrower likely can't qualify, under stiffer credit standards today, for the same loan he or she received two or three years ago. It's not just the low-income household suffering from lenders pulling the red carpet out from under buyers, though that would be plenty. Mortgage companies failing, consolidating, laying off workers, and tightening purse strings stings the economy too. Housing is, after all, an economic cornerstone creating jobs and revenues in sales, finance, insurance, building and rebuilding, as well as infusing local economies with tax revenues -- just for starters. Equity gains, when available, gives consumers more spending power, the power that fuels the economy. Conditions are chipping away at the cornerstone. Foreclosures in sufficient numbers bring prices down and with them go property tax collections. Unfortunately, the lower prices don't necessarily generate more home buys. Fewer homeowners means less for local services funded by property taxes. In the Fed's recent loan officer survey "mortgages secured by non-owner-occupied properties" are also considered among the nontraditional mortgages -- 45.5 percent of which now face tighter credit standards than they did three months ago. That creates another group of buyers who can't circulate cash in the market. Federal Reserve Chairman Ben Bernanke, speaking at a financial conference in Chicago recently said any downturn would stop at the housing market and not spread to the rest of the economy as the Fed cracks down, especially on abuses in the mortgage industry. The sky isn't falling, but others say the economy has already been run over by high oil prices and now it's beginning to feel like, well, a house fell on it. Mortgage-backed securities comprised of the riskiest loans are getting squeezed by defaults and foreclosures. That means the cash flow necessary to pay investors is slowing. The investors? Retirement plans like 401(k)s, state government pension funds, small investors and other larger entities including large domestic and foreign banks, private investors, and others. Subprime loans are responsible for the fastest-growing segment of mortgage-backed securities industry, growing from an estimated $95 billion in 2001, to $450 billion last year, according to Securities Industry Financial Markets Association, a New York-based industry trade group. Unfortunately, investors who helped finance the housing boom will lose as much as $75 billion on the subprime-based securities, according to Pacific Investment Management Co., a major bond fund manager. More money that can't circulate. Housing market woes my not bring the economy to its knees, but it's certainly smacking it around. Just days after Bernanke's speech, the National Association for Business Economics put it bluntly. "Results for the first portion of the year indicate that the expansion has descended from its cruising altitude," said Carl Tannenbaum, NABE president and chief economist at LaSalle Bank/ABN AMRO in Chicago. "Residential investment remains a dominant force dampening growth in 2007. Nearly half of our forecasters think that the bottom in housing will not be reached until the fourth quarter of 2007 or later." Published: May 23, 2007 Use of this article without permission is a violation of federal copyright laws. 
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