The housing market led to the massive increase in subprime loans over the last three or so years. Underwriting standards were continually relaxed until only a pulse was required to get a loan. Now the proverbial chickens have come home to roost. 44 lenders have now either closed their doors, declared bankruptcy or sold off their assets. And in all probability it will get much worse.
The primary argument advanced by housing bulls right now is the damage of subprime mortgages will be contained. However, consider these numbers:
Far from being limited to the subprime market, the data show these risky loan features have become widespread. According to Credit Suisse, the number of no or low documentation loans -- so-called "liar loans" -- has increased to 49% last year from 18% of purchase loans in 2001, a nearly three-fold increase. The investment bank also found that borrowers put up less than a 5% down payment in 46% of all home purchases last year. Inside Mortgage Finance estimates that nontraditional mortgages -- mostly interest-only and pay-option ARMs that allow the borrower to defer paying back principal or even increase the loan balance each month -- which barely existed five years ago, grew to close to a third of all mortgages last year.
The Alt-A market, a middle ground between subprime and prime, has increased seven-fold since 2001 and accounted for 20% of home-purchase loans last year. Fully 81% of Alt-A loans last year were no or low documentation loans, according to First American Loan Performance. Why have borrowers employed this kind of risky financing? Because it was the only way many of them could afford a home in some of the hottest housing markets, where prices more than doubled in five years.
Let's break these numbers down.
According to Credit Suisse, the number of no or low documentation loans -- so-called "liar loans" -- has increased to 49% last year from 18% of purchase loans in 2001, a nearly three-fold increase
This is a poorly written sentence. I am assuming he means that nearly half of all subprime loans were "liar loans". This would make sense as credit standards have continually deteriorated over the last few years.
borrowers put up less than a 5% down payment in 46% of all home purchases last year.
This has a few very negative implications.
1.) Americans aren't saving. Period.
2.) There is little home equity, which would help to cushion the effects of dropping prices. This prevents homeowners from refinancing mortgages.
3.) Lending standards have really deteriorated.
Nontraditional mortgages .. increased to a third of all mortgages last year.
That means there are a ton of highly questionable loans on the market. This is probably one reason why the number of delinquencies has increased so dramatically over the last year.
The Alt-A market, a middle ground between subprime and prime, has increased seven-fold since 2001 and accounted for 20% of home-purchase loans last year. Fully 81% of Alt-A loans last year were no or low documentation loans,
An overwhelming majority of the middle tier of mortgage risk has no documentation. That means for practical purposes, these are subprime loans.
Here's where the real problem is going to come in.
It's not the size of foreclosure losses as a share of the economy that matters, it is the effect those losses have on the availability of credit. When banks (and investors in mortgage-backed securities) begin suffering losses, they inevitably pull back. This is why so many subprime companies have gone bankrupt virtually overnight; investors balked at buying subprime loans except at a steep discount, which produced immediate losses. In effect, their ability to profitably finance new loans was eliminated.
What's more, the bank regulators are only now beginning to tighten lending standards and will be under increasing pressure from Congress to do more. After growing by nearly 50% in the first half of 2006, nontraditional loan growth has turned negative since the bank regulators issued new guidelines last September. The CFO of Countrywide recently told an investor conference that 60% of the subprime loans the company is making won't meet proposed federal rules likely to take effect during the summer. The concern that tighter lending standards could reduce access to financing is the reason a widely watched survey of homebuilders conducted by the National Association of Homebuilders dropped earlier this week.
First, Countrywide is one of the largest mortgage lenders in the country. And over half of the loans they are currently making won't be made when new lending standards take effect. That means there will be a severe credit contraction, which is never a good thing.
The ride is going to get bumpier.