Whose Mortgage Crisis?

Anya Kamenetz

March 15, 2007

Anya Kamenetz is a freelance writer, the author of Generation Debt and a journalistic fellow of the Freelancers Union. She can be reached at her website, anyakamenetz.blogspot.com.

“A Mortgage Crisis Begins to Spiral, and the Casualties Mount,” read the headline in The New York Times last week. I clicked on the link expecting to read about the growing numbers of victims of “exploding” subprime mortgages, suddenly stuck with unaffordable payments as interest rates tick up and housing prices fall. Instead, the “casualties” of the headline were the subprime mortgage bankers and brokers, multimillionaires who are losing their red Ferrari convertibles and private jets now that the housing bubble has officially burst.

Yes, this current stock slump looks to a lot of people like the tech bust 2.0, and it may very well affect the whole economy. The economic big picture is an important angle, also explored by the Times here, here and here.

But what about the angle involving real people who are actually going to lose their homes? "Subprime" lending is a creature of our recent unprecedented era of unrestricted credit. It is the business of providing mortgages at exceptionally high interest rates to people with poor or spotty credit histories, who in this economy, tend to be lower earners, less educated and disproportionately minority. It also often has an uglier name—predatory lending.

In the just-passed era of record-low interest rates, the lenders who are now in trouble dangled homeownership before millions of people who never dreamed of such a thing before, enticing people into barely affordable contracts with low introductory rates and zero percent down, helping drive housing prices up and inflating our homeownership rate to the highest in American history. Not to mention minting money for themselves.

And President Bush bragged about it, because it looked like progress. He repeatedly cut funding for Housing and Urban Development programs, even in the wake of the Katrina diaspora crisis. Yet, because of the proliferation of subprime loans, he was able to tell a black audience in 2005, “Today, nearly half of all African Americans own their own homes. And that's good for our country.” It was the ultimate in privatization.

Unfortunately, sometimes the risk gets so high that owning is not really owning. The Center for Responsible Lending, a nonprofit that takes on all forms of predatory lending, estimates that predatory mortgage lending costs Americans more than $9.1 billion each year. And African Americans and Latinos are more likely to get subprime mortgages even when they have the same qualifications as whites. "Nontraditional loans in the subprime market are seriously eroding the traditional benefits of homeownership," Michael Calhoun, the Center’s president, has said. "By their very nature, they pose a high risk of losing valuable home equity or foreclosure."

Now the brokers are going to take some losses and switch to trading something else—fine for them. But what about the millions of marginally middle-class people stuck up to their neck with higher and unaffordable monthly payments? Their futures hold delinquency, defaults, foreclosures and bankruptcy.

According to Barron's , during the next two years homeowners can expect increased monthly payments on an estimated $600 billion of subprime mortgages. The last quarter of 2006 had a record rate of foreclosures. Senator Christopher Dodd, D-Conn.,, the chairman of the Banking Committee, told reporters that the next 18 months may bring as many as 2 million more.

America is at another Enron moment. Rather than shedding a tear for the traders who pumped up this market, we are now required as a country to reexamine the responsibility that creditors have to borrowers—to make a sane assessment of the ability to repay, not merely to make as much money as they can out of the risk. It is high time to block predatory lending of all kinds by reinstating usury laws, limiting interest rates, penalties and fees that creditors can charge.

Will our Democratic lawmakers accept this moral challenge? The jury’s still out. On the one hand, 14 Democratic senators voted for the credit-industry-authored bankruptcy bill in 2005. On the other hand, Senator Carl Levin, D-Mich., recently held some pretty harrowing hearings on predatory credit card industry practices, in which he raked over the CEOs of the top three credit card issuers in the country.

Several lawmakers, including Ted Kennedy, D-Mass., and Hillary Clinton, D-NY, have introduced reforms of the extremely predatory practices of student lenders. And Senator Chris Dodd and Representative Barney Frank, D-Mass., are each discussing introducing legislation on subprime lending, Dodd to protect the borrowers already trapped and Frank to restrict these risky mortgages going forward.

I have high hopes that predatory lending could become the moral values issue of 2008. In the meantime, let’s keep in mind who the real casualties are.

Subprime Meltdown Snares Even Borrowers With Better Credit

Subprime Meltdown Snares Borrowers With Better Credit (Update3)

By Jody Shenn

March 22 (Bloomberg) -- The subprime credit crunch is beginning to ensnare even borrowers with better credit.

Lenders are increasingly refusing to lend to homebuyers who can't make a down payment of more than 5 percent, especially if they won't document their income. Until recently such borrowers qualified for so-called Alt A mortgages, which rank between prime and subprime in terms of risk. Last year the category accounted for about 20 percent of the $3 trillion of U.S. mortgages, about the same as subprime loans, according to Credit Suisse Group.

``It's going to be very difficult, if not impossible, to do a no-money-down loan at any credit score,'' said Alex Gemici, president of Parsippany, New Jersey-based mortgage bank Montgomery Mortgage Capital Corp. Companies that buy the loans ``are all saying if they haven't eliminated them yet, they'll eliminate them shortly.''

Tighter lending standards may slash subprime mortgage sales in half this year and Alt A mortgages by a quarter, according to Ivy Zelman, a Credit Suisse analyst in New York who covers homebuilders. The new requirements will force some prospective homebuyers to save more money for a down payment or risk being denied credit.

Pulling Back

Bear Stearns Cos., General Electric Co.'s WMC Mortgage, Countrywide Financial Corp., IndyMac Bancorp Inc., Goldman Sachs Group Inc., Lehman Brothers Holdings Inc. and Credit Suisse have all said in the last two weeks they're pulling back from buying Alt A mortgages sold with no down payment or in a refinancing of the house's entire value. Such companies facilitate the mortgage market by buying loans and repackaging them for sale as bonds to buyers such as insurers and hedge funds.

``We've been warned,'' said Cheryl Hand, manager of Prudential New Jersey Properties' office in Manalapan, New Jersey. She said she's hoping a client of her realty brokerage who's been approved to buy a home with nothing down won't have the loan quashed before the closing.

Mortgages are categorized as Alt A when they fall just short of the typical standards of Fannie Mae and Freddie Mac, the two largest U.S. mortgage companies. Some mortgage lenders require a credit score of at least 700 for an Alt A mortgage, while others will accept a score as low as 620. The maximum score is 850. The average credit score is in the 600s, according to Bankrate.com.

Besides some loans requiring no down payment or proof of income, they are often made to buy a second home, a rental unit or to speculate on real estate. Also often falling into the category are loans that are ``option'' adjustable-rate mortgages, whose minimum payments can fail to cover the interest owed.

Defaults Rising

Consumers borrowed 100 percent of their home's value on about 18 percent of Alt A loans made last year, according to Bear Stearns, the largest mortgage-bond underwriter. Another 16 percent had loan-to-value ratios above 90 percent as well as limited documentation, they say. The category comprised about 5 percent of new loans in 2002, according to Credit Suisse.

Late payments of at least 60 days and defaults on Alt A mortgages have risen about as fast as on subprime ones, to about 2.4 percent, according to bond analysts at UBS AG. Loans in the category made to borrowers with low credit scores, equity and documentation are doing about as badly as subprime loans, according to Citigroup Inc. and Bear Stearns analysts.

Rapid credit tightening that's ``been isolated to the subprime world has really migrated'' in the past two weeks to Alt A offerings that involve borrowing nearly all of a home's worth, said Brian Simon, senior vice president at Mount Laurel, New Jersey-based mortgage bank Freedom Mortgage Corp. ``We're just hopeful it will settle down soon.''

California Prices

A borrower would have to come up with $23,750 to make a 5 percent down payment on a typical home in California, based on a $472,000 median price estimated by DataQuick Information Systems in La Jolla, California. She'd have to show enough income to pay $2,730.87 a month with a 30-year fixed-rate mortgage at 6.15 percent.

``It doesn't help somebody to get into a home when they can't afford to make the payments and continue living there,'' said Ann McGinley, owner of Action Mortgage, a brokerage in Santa Rosa, California, that's turned away a ``few buyers'' with good credit who may have been able to get loans last year.

While loans issued only on the basis of the borrower's ``stated'' income can be abused, they're appropriate for a divorcee with alimony who ``doesn't want to show an underwriter her paperwork because it's private'' or a borrower with a reliable roommate, she said. ``I personally have made a couple of real estate agents angry by advising people to not buy.''

Limits Welcomed

Some lenders say it's high time that buyers are discouraged from buying real estate with no money down.

``Could we have a little skin in the game from the borrower, please,'' said Rick Soukoulis, chief executive officer at LoanCity, a San Jose, California-based lender that stopped making mortgages last week to customers who want to borrow more than 95 percent of the value of their house due to the shrinking secondary market. ``Something to lose if you go into default?''

LoanCity, which made about $6 billion in mortgages last year, went out of business on March 20.

The slump in subprime loans has ``drastically eroded'' appetite for bonds backed by Alt A loans, according to a March 9 report by Credit Suisse. The extra yield that investors typically demand on the parts of the securitizations with the lowest investment-grade ratings have risen to 3.50 percentage points over the one-month London interbank offered rate from 2.15 percentage points in September, according to Bear Stearns.

Resale Woes

``If you couldn't sell something, you wouldn't do it either,'' UBS analyst David Liu in New York said. Part of the problem is falling demand for ``piggyback'' home-equity loans used to make down payments, he said.

New York-based Citigroup will no longer buy home-equity loans made to borrowers who won't prove their incomes and want more than 95 percent of their home's value, according to e-mails from salespeople. Mark Rogers, a spokesman, declined to comment.

New York-based Bear Stearns, the third-largest Alt A lender according to newsletter National Mortgage News, last week stopped buying such loans without down payments of at least 5 percent. For borrowers not fully documenting incomes or assets, the maximum loan-to-value ratio will be 90 percent.

Short Notice

Bear Stearns' EMC Mortgage unit told loan sellers of the changes on March 13, giving them a day's notice. On Feb. 26, EMC said it would start requiring down payments of only 5 percent in the low-documentation category, giving sellers until March 12 to submit loans under the old standards. On March 1, the deadline moved to March 6. EMC didn't change ``full documentation'' programs then.

People with poor or limited credit records or high debt burdens can take out only subprime mortgages, and typically pay rates at least two or three percentage points above prime loans. Subprime lenders have been increasingly raising their standards since mid-2006, and started cutting out nothing-down lending in late January, Montgomery's Gemici said. People who qualify for prime mortgages don't experience any trouble getting a loan.

The subprime meltdown might have been prevented if the Federal Reserve had acted faster, a Fed official said today.

``Given what we know now, yes, we could have done more sooner,'' Roger Cole, the Fed's director of banking supervision and regulation, told the Senate Banking Committee in Washington.

Going Forward

Bear Stearns will finance 25 percent to 30 percent fewer non-prime mortgages this year as it tightens credit, Chief Financial Officer Sam Molinaro said on the company's earnings call last week.

``Last year, we did about 50 percent less in subprime than we did the year before,'' Mary Haggerty, co-head of Bear Stearns' mortgage finance department, said in an interview, adding that it has been tightening Alt A standards since December. ``We always try to be ahead of the market.''

Countrywide Financial, the nation's top home lender, this month stopped making any loans with down payments of less than 5 percent when borrowers are ``stating'' both income and assets.

Since they have good credit, most borrowers able to take out loans with little down and high monthly payments relative to their pay or potentially rising ones knew the risks, Countrywide Financial CEO Angelo Mozilo said in an interview.

``People are adults and made choices in their lives because they wanted to own a home of their own,'' Mozilo said. ``America's great because people can make those decisions for themselves. The complaints about the loans only came when the opportunity for enrichment was gone'' because home prices flattened out.

To contact the reporter on this story: Jody Shenn in New York at jshenn@bloomberg.net .

Last Updated: March 22, 2007 15:55 EDT

America's housing market: Cracks in the façade

Special Report

Mar 22nd 2007 | NEW YORK AND WASHINGTON. DC
From The Economist print edition

America's riskiest mortgages are crumbling. How far will the damage spread?

CASEY SERIN knows all about the excesses of America's housing bubble. In 2006 the 24-year old web designer from Sacramento bought seven houses in five months. He lied about his income on “no document” loans and was not asked for anything so old-fashioned as a deposit. Today Mr Serin has debts of $2.2m. Three of his houses have been repossessed; others could share that fate. His website, Iamfacingforeclosure.com, has become a magnet for those whose mortgages are in trouble.

Mr Serin and people like him are Wall Street's biggest uncertainty just now. How many Americans are saddled with mortgages they cannot afford on houses that are losing value? The answer matters to anyone who bought high-yielding mortgage-backed securities when a booming property market made mortgages look safe. It also matters to investment banks, which packaged the securities and often own subsidiaries that originate mortgages. It may determine whether America's economy falls into recession. It could even affect the outcome of next year's elections.

Most of the damage so far is in the “subprime” mortgage market, which lends to people whose income is too low, or whose credit history too patchy, to qualify for an ordinary mortgage. On March 13th the Mortgage Bankers Association reported that 13% of subprime borrowers were behind on their payments. Some 30 of America's subprime lenders have closed their doors in the past three months. The cost of insurance against default for the riskiest tranches of subprime debt has soared. The worst effects may not be felt until the mortgage payments of many borrowers with no equity in their homes rise sharply.

Is this a mere irritant in America's vast economy, or the start of something much worse? Opinion on Wall Street is divided. Most argue that the mortgage mess, though a blight on anyone caught up in it, will not spread. The number of mortgages at risk is too small for defaults to threaten everyone else. Even if a fifth of the $650 billion of adjustable-rate subprime loans went bad, that would be a blip in the $40 trillion market for debt. If repossessions extended the housing downturn, it would not derail an economy that—housing apart—remains healthy, with unemployment of 4.5% and jobs growing strongly.

Cellar signal

Growing numbers of pessimists disagree. They think the subprime squeeze marks the start of a broader credit crunch that could drag the economy into recession. Stephen Roach, the famously gloomy chief economist at Morgan Stanley, recently called subprime mortgages the new dotcoms. Just as the implosion of a few hundred internet ventures in 2000 sparked a much broader stockmarket correction and an eventual recession, so the failure of the riskiest mortgages may distress the rest of a debt-laden economy.

To try to assess who is right, you need to know the share of mortgages potentially at risk. And you need to understand the channels through which subprime defaults could spread to the wider economy.

America's residential mortgage market is huge. It consists of some $10 trillion worth of loans, of which around 75% are repackaged into securities, mainly by the government-sponsored mortgage giants, Fannie Mae and Freddie Mac. Most of this market involves little risk. Two-thirds of mortgage borrowers enjoy good credit and a fixed interest rate and can depend on the value of their houses remaining far higher than their borrowings. But a growing minority of loans look very different, with weak borrowers, adjustable rates and little, or no, cushion of home equity.

For a decade, the fastest growth in America's mortgage markets has been at the bottom. Subprime borrowers—long shut out of home ownership—now account for one in five new mortgages and 10% of all mortgage debt, thanks to the expansion of mortgage-backed securities (and derivatives based on them). Low short-term interest rates earlier this decade led to a bonanza in adjustable-rate mortgages (ARMs). Ever more exotic products were dreamt up, including “teaser” loans with an introductory period of interest rates as low as 1%.

When the housing market began to slow, lenders pepped up the pace of sales by dramatically loosening credit standards, lending more against each property and cutting the need for documentation. Wall Street cheered them on. Investors were hungry for high-yielding assets and banks and brokers could earn fat fees by pooling and slicing the risks in these loans.

Standards fell furthest at the bottom of the credit ladder: subprime mortgages and those one rung higher, known as Alt-As. A recent report by analysts at Credit Suisse estimates that 80% of subprime loans made in 2006 included low “teaser” rates; almost eight out of ten Alt-A loans were “liar loans”, based on little or no documentation; loan-to-value ratios were often over 90% with a second piggy-bank loan routinely thrown in. America's weakest borrowers, in short, were often able to buy a house without handing over a penny.

Lenders got the demand for loans that they wanted—and more fool them. Amid the continuing boom, some 40% of all originations last year were subprime or Alt-A. But as these mortgages were reset to higher rates and borrowers who had lied about their income failed to pay up, the trap was sprung. A new study by Christopher Cagan, an economist at First American CoreLogic, based on his firm's database of most American mortgages, calculates that 60% of all adjustable-rate loans made since 2004 will be reset to payments that will be 25% higher or more. A fifth will see monthly payments soar by 50% or more.

Few borrowers can cope with such a burden. When house prices were booming no one cared. Borrowers refinanced or sold their homes. But now that prices have flattened and, in many areas, fallen, those paths are blocked.

The greatest difficulties threaten borrowers whose house is worth less than their mortgage. Just under 7% of all American homeowners had this “negative equity” at the end of December 2006 estimates Mr Cagan, using a sample of 32m houses (see chart 1). Among recent homebuyers, the share is even higher: 18% of all people who took mortgages out in 2006 now have negative equity. A quarter of all mortgages due to reset in 2008 are in the same miserable state (see chart 2).

Higher payments and negative equity are a toxic combination. Mr Cagan marries the statistics and concludes that—going by today's prices—some 1.1m mortgages (or 13% of all adjustable-rate mortgages originated between 2004 and 2006), worth $326 billion, are heading for repossession in the next few years. The suffering will be concentrated: only 7% of mainstream adjustable mortgages will be affected, whereas one in three of the recent “teaser” loans will end in default. The harshest year will be 2008, when many mortgages will be reset and few borrowers will have much equity.

Mr Cagan's study considers only the effect of higher payments (ignoring defaults from job loss, divorce, and so on). But it is a guide to how much default rates may worsen even if the economy stays strong and house prices stabilise. According to RealtyTrac, some 1.3m homes were in default on their mortgages in 2006, up 42% from the year before. This study suggests that figure could rise much further. And if house prices fall, the picture darkens. Mr Cagan's work suggests that every percentage point drop in house prices would bring 70,000 extra repossessions.

The direct damage to Wall Street is likely to be modest. A repossessed property will eventually be sold, albeit at a discount. As a result, Mr Cagan's estimate of $326 billion of repossessed mortgages translates into roughly $112 billion of losses, spread over several years. Even a loss several times larger than that would barely ruffle America's vast financial markets: about $600 billion was wiped out on the stockmarkets as share prices fell on February 27th.

In theory, the chopping up and selling on of risk should spread the pain. The losses ought to be manageable even for banks such as HSBC and Wells Fargo, the two biggest subprime mortgage lenders, and Bear Stearns, Wall Street's largest underwriter of mortgage-backed securities. Subprime mortgages make up only a small part of their business. Indeed, banks so far smell an opportunity to buy the assets of imploding subprime lenders on the cheap.

Discredited

Although subprime is a small direct threat to Wall Street it could still inflict pain on bankers—and the broader economy—in other ways. Investors are shunning subprime and all mortgages that seem risky. Spreads have dramatically widened on the securities backed by riskier mortgages and the pooled and debt-laden collateralised-debt obligations (CDOs) based on them. The issuance of subprime-related CDOs has plunged. That is a worry, because investors' appetite for these securities fuelled the boom in riskier mortgages.

Lenders' reluctance and tightening loan standards may combine to form a classic credit crunch. Several lenders, including Countrywide, America's largest mortgage lender, have stopped making no-money-down mortgage loans. HSBC has cut back on second-lien loans. Freddie Mac recently announced it would no longer buy some subprime loans. No one is sure how dramatic, or lasting, the pull-back will be, but Credit Suisse thinks the number of originations in subprime markets could fall by some 50% in the next couple of years and Alt-A loans may fall by a quarter. Even if the shift is confined to America's riskiest mortgages (and there is little evidence yet of tighter lending standards spreading), its effects may climb up the housing ladder.

Just when some would-be buyers find it harder to borrow, rising numbers of repossessions will increase the supply of homes for sale. The backlog of unsold homes is already high, at over 3.5m existing homes, or more than six months' sales. Counting the properties that have already been repossessed—and hence are all but certain to be for sale—that figure rises by about a fifth. Add the likelihood of some 1m more repossessions as adjustable-rate mortgages are reset, and you have the makings of a housing glut.

Falling demand and soaring supply bodes ill for construction and house prices, the main ways housing affects the broader economy. Builders have already cut back. The pace of housing starts is down 33% from its peak in January 2006. Plunging residential investment is the main reason America's GDP growth has slowed to 2.2%. But, as Nouriel Roubini and Christian Menegatti point out in a recent report, that retrenchment is modest by historical standards. In the seven construction busts since 1960, housing starts fell, on average, by 51% from their peak. The mortgage crunch makes matters worse. To work off inventories, builders will have to cut back more, dragging output growth down for longer. Job losses in construction and related industries, which have so far been mild, are likely to rise sharply.

A glut of unsold homes will also push down prices, particularly in areas such as California and Florida, which had a disproportionate share of riskier loans. House prices have already been falling in parts of both states, as they have in Midwestern states, such as Michigan, where manufacturing industry has shed jobs in recent years. Will those declines accelerate and spread?

By many measures, America's house prices are still too high. David Rosenberg of Merrill Lynch points out that the ratio of income to housing costs is still some 10% worse than its historical norm and 20% worse than levels at the end of the last housing downturn in the early 1990s. Take out a chunk of potential borrowers; add in some repossessed homes and house prices could be hit hard. If falling prices raise the rate of default, that could in turn worsen the credit crunch, putting yet more pressure on prices. Wall Street's gloomiest seers think average house prices could fall by 10% this year. If so, the economy could well enter a recession.

Consumers have shrugged off the housing slowdown thus far: real consumer spending is still growing at annual rate of some 3%, thanks largely to strong job and wage growth. But they are unlikely to shrug off a 10% plunge within one year, particularly since America's homeowners have become used to their housing wealth rising by well over 5% a year. No one is sure just how responsive consumer spending is to changes in house prices. Economists normally reckon that a $100 drop in wealth eventually reduces spending by $3-5 a year. But some recent studies suggest the “wealth effect” from housing may eventually be more than double that. Given that Americans have $20 trillion of housing wealth, a 10% price drop could easily halve the pace of consumer spending growth, sending the economy perilously close to recession.

Such a dramatic drop in national house prices this year is possible, but not yet probable. Unlike share prices, house prices rarely plunge in nominal terms. Unless repossession forces a sale, homeowners prefer to sit tight when markets are weak. If house prices stagnate, consumption may suffer a little, but not too much, so long as jobs stay plentiful and wages grow. If so, the mortgage crunch will be a grinding drag on America's economy; one that unfolds over several years, hitting some people and some regions hard, but not, in itself, a macro-economic disaster.

The bursting of the stock-market bubble in 2000 led to a plunge in investment at American firms. To stave off recession, the Federal Reserve loosened monetary policy. Short-term interest rates fell to historic lows, propping up consumer spending, but also fuelling the housing bubble and sowing the seeds of today's upheaval.

Any such loosening is much less likely today. As the statement at their meeting on March 21st made clear, America's central bankers are still more worried about inflation than about recession. And with reason. Core consumer price inflation, which excludes the volatile categories of food and fuel, has accelerated, to 2.6% at an annual rate in the three months to February. With inflation higher than they would like, the central bankers are in no hurry to slash interest rates. They would lose little sleep if output growth stays sluggish or unemployment rates inch up.

The Senate and the houses

In contrast to the dotcom bust, then, the consequences of the housing market's troubles may be felt more sharply on Capitol Hill than at the Fed. Politicians, particularly the Democrats now in charge of Congress, are clamouring for quick action. Hillary Clinton has declared the market “broken”, accused the Bush administration of standing by and demanded something be done. Chris Dodd, chairman of the Senate Banking Committee and another Democratic presidential candidate, is also up in arms.

George Bush often boasts about rising rates of home-ownership under his watch. Hundreds of thousands of repossessed homes, many of them from borrowers who are black and poor, would be politically incendiary. The Centre for Responsible Lending reports that half of the mortgages taken out by blacks in the past few years were subprime. If a fifth of those default, one in ten recent black homebuyers may end up losing his house. Many of these people have stories to tell of being duped into taking on mortgages that they did not understand and could not afford.

Pressure is mounting to right the wrongs—real and perceived. Attorneys-general from New York to California have started to investigate fraudulent mortgage lending. Rather as after Enron, the securities regulator in Massachusetts has demanded that UBS and Bear Stearns hand over internal details of their research coverage of subprime lenders. Congress has already held hearings on predatory lending. More are planned.

Ideas abound on what must be done. Mrs Clinton has called for a “ foreclosure time-out”. Pressure groups want Congress to rewrite the rules of the Federal Housing Administration (FHA), a federal organisation charged with providing affordable mortgages to the poor, so it can refinance subprime mortgage loans in default. Calls for other types of bail-out will rise.

America's four federal bank regulators are also scrambling to respond. Earlier this month they proposed stricter lending guidelines on adjustable subprime loans. But federal regulators play a limited role in subprime markets. Many of the riskiest mortgages were made by independent, non-bank lenders—such as New Century, Ownit and Fremont. These outfits (which are now collapsing) are overseen by state regulators, not federal ones—and the quality of state oversight varies widely. Only half of states have laws against predatory lending. Many lack rules requiring lenders to perform criminal background checks on brokers, as federal guidelines require.

Few doubt that the subprime mess was, in part, a regulatory failure. But now the mistakes have been made, the biggest risk is that populist politicians rewrite the rules hamfistedly. Fraudulent activity should be punished. The vulnerable need protection from predatory lenders. But an ill-conceived swathe of new “consumer protection” could easily make matters worse. If restrictive regulation scared investors away from the subprime market for good, that really would hurt the poor.

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Fed Accused of Encouraging Subprime Loans: 'Perfect Storm’

Fed accused of subprime ‘perfect storm’

By Eoin Callan, Edward Luce and Krishna Guha in Washington

Published: March 22 2007 18:50 | Last updated: March 23 2007 00:33

The Federal Reserve helped create a “perfect storm” in the US subprime mortgage market that could expose up to 2.2m more Americans to the threat of home foreclosure, Chris Dodd, chairman of the Senate Banking committee, said on Thursday.

Mr Dodd, who is also a Democratic Party candidate for the 2008 presidential nomination, alleged the Fed had failed in its oversight role when the growth in high-risk “adjustable rate mortgages (ARM)” to risky borrowers was exploding.

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While questioning leading mortgage lenders and federal banking regulators, Mr Dodd also promised legislation to crack down on predatory lending in the US mortgage market, where a rising level of repayment delinquency has caused global market jitters during the past month.

Mr Dodd said that US regulators had relaxed guidelines on mortgage lending at precisely the point in 2004 and 2005 when the riskiest ARM loans – which impose initially light monthly payments that escalate quickly at a later date – were increasing most rapidly. That also coincided with the start of the Fed’s consecutive 17-stage rise in rates.

“Despite those warning signals the leadership of the Federal Reserve seemed to encourage the development and use of ARMs that, today, are defaulting and going into foreclosure at record rates,” he said.

Mr Dodd, who was supported by Richard Shelby, the senior Republican on the committee, also expressed frustration at the fact the Fed had so far failed to issue promised guidance to tighten controls on the $1,200bn subprime mortgage market.

An estimated 1m subprime borrowers will have their rates adjusted sharply upwards this year and another 800,000 next. Roger Cole, a senior Fed official, said the guidance would come out by May at the earliest. But he conceded that the Fed could have done more.

Thursday’s hearing could mark the start of a backlash against leading subprime mortgage lenders. Senior executives from four of the leading lenders – HSBC, Countrywide, WMC Mortgage, First Franklin – testified. Of those invited, only New Century, the largest subprime lender, declined to send a witness.

Mr Dodd said the lenders had engaged in “unconscionable and deceptive” practices. But he also admitted that it would be hard to pass a stricter law.

The Center for Responsive Politics, a watchdog, said New Century more than doubled its Washington lobbying efforts between 2004 and 2005 and contributed $342,000 in campaign funds to candidates in last year’s mid-term congressional elections.

Mr Dodd said lenders had engaged in “unconscionable and deceptive” practices.

Copyright The Financial Times Limited 2007

US housing, mortgage woes contagion feared

ANALYSIS

By Joanne Morrison, Reuters | March 22, 2007

WASHINGTON --For months as the U.S. housing market unraveled, the Bush administration, the Federal Reserve, and most economists maintained the decline did not risk hitting the economy at large, but economists are growing increasingly concerned the broad economy may take a hit.

An abrupt exodus of more than two dozen so-called subprime lenders from the market has heightened fears other lenders may soon start choking off credit to businesses and consumers.

Economists, and the Bush administration, agree falling house prices and rising defaults by borrowers with poor credit in the subprime mortgage market may mean slower U.S. economic growth this year.

"We know that the housing market will have an impact on GDP over the next six months," Edward Lazear, chairman of the White House Council of Economic Advisers, said this week.

When asked how subprime mortgage market troubles would weigh on the economy, Lazear said the banking sector was still strong, but delinquencies are high and lenders, even outside of the subprime market, have begun to tighten up credit.

"It's clearly going to increase the cost of capital and on the margin its going to be less conducive of capital spending," said Richard DeKaser, chief economist at National City Corp. in Cleveland.

According to the Mortgage Bankers Association's most recent data, the proportion of mortgages in the initial stages of foreclosure during the fourth quarter of last year hit its highest in the 37-year history of the association's survey.

In addition, commercial banks have tightened their lending standards. According to the Federal Reserve's most recent Senior Loan Officers Survey released last month, which covered lending business at the end of last year, domestic banks reported tightening standards on all residential mortgages, the highest net fraction seen since the early 1990s.

"The extent of the tightening of credit conditions for borrowers has yet to be fully clarified, and bears continual monitoring," Citigroup economist Steven Wieting wrote in a report this week.

About 45 percent of bank loan officers in the Fed survey said they expect a deterioration in the quality of the loans they make, ranging from loans for business investment to commercial real estate loans.

--MORE--

Countrywide sees record foreclosures

The Associated Press March 22, 2007, 4:47PM EST

WASHINGTON

A top executive at Countrywide Financial Corp. said Thursday that dropping home prices could produce record-high levels of foreclosures on loans made in 2006 to people with poor credit histories.

Sandy Samuels, executive managing director and chief legal officer of the Calabasas, Calif.-based mortgage lender, said in prepared remarks to the Senate Banking Committee that foreclosure rates on high-risk, or subprime, mortgages taken out last year may approach or exceed the level for similar loans taken out in 2000, when the foreclosure rate was nearly 10 percent.

However, Samuels urged Congress not to "lose sight of the reality that more than 90 percent of Countrywide's subprime borrowers will not lose their homes to foreclosure."

Samuels also warned lawmakers not to create overly tight restrictions on high-risk mortgages, saying that could lock out many would-be homebuyers.

Over the past 10 years, Countrywide's overall foreclosure rate for adjustable rate subprime loans was 3.4 percent, Samuels said. The so-called subprime mortgage market represents 7 percent of Countrywide's home loan volume, compared with 20 percent of the overall U.S. market, he said.

Samuels' testimony came as federal regulators said they lacked authority over expanding areas of the high-risk mortgage market, and as lawmakers pressed them on whether they were lax and helped fuel the spike in delinquent payments and foreclosures.

Anxiety that a blowup among subprime mortgage lenders could spill over into the broader economy has roiled the financial markets in recent weeks. New Century Financial Corp., the nation's second-largest subprime mortgage lender, has scrambled to stay afloat as banks cut off funding because of a failure to make payments.

Earlier this week, Fremont General Corp. said it would sell $4 billion in subprime residential real estate loans at a loss. And last Friday, Accredited Home Lenders Holding Co. announced plans to sell $2.7 billion of loans at a discount to satisfy margin calls from its lenders and stave off a liquidity crisis caused by rising defaults.

Sen. Christopher Dodd, D-Conn., the banking committee's chairman, laid out what he called a "chronology of regulatory neglect" as banks and other lenders loosened their standards for making riskier mortgage loans during the housing market boom in late 2003 and early 2004.

Dodd blamed the Federal Reserve and other regulators for setting off the crisis in subprime loans, which are higher-priced home loans for people with tarnished credit or low incomes who are considered at greater risk of default. Now, some 2.2 million homeowners could lose their homes in the next few years, said Dodd, a contender for the Democratic presidential nomination in 2008.

"Our nation's financial regulators were supposed to be the cops on the beat, protecting hardworking Americans from unscrupulous financial actors," Dodd said. "Yet they were spectators for far too long. "

Foreclosures have accelerated in recent months, especially among homeowners who took out subprime loans, raising worries that many people could lose their homes as mortgage delinquencies mount.

Shares of Countrywide fell 57 cents, or 1.5 percent, to close at $36.38 on the New York Stock Exchange, where those of Fremont General dropped 83 cents, or 8 percent, to close at $9.36.

Shares of Accredited Home Lenders rose 61 cents to close at $12.57 on the Nasdaq Stock Market.

Is the U.S. economy headed for depression? : Schoen, MSNBC

And why don't we just outlaw all these risky loans?

COMMENTARY

By John W. Schoen

Senior Producer

MSNBC

Updated: 1:53 p.m. MT March 18, 2007

OK, everybody. Let’s take a deep breath.

This week, like everyone reading the headlines, Answer Desk readers are a tad nervous about this whole housing market, subprime mortgage lending debacle. Yes, it’s complicated. And even economists and other experts can’t agree on just how bad it will get.

But readers like Michael in Colorado — who see a full-blown depression coming — are getting a little ahead of themselves. And while it may seem like a good idea to just ban all these risky loans — as David in Washington suggests — that may be going a little too far. Meanwhile, subprime borrower Latrice in Detroit is looking for some tips on refinancing her loan.

At this point in time, there's nothing but a big-fat-gigantic depression coming through the front door — and everyone but the most naive and "true believers" knows it. Its gonna be very, very bad. I think the jig is up. The facade is rotting away — quickly.
— Michael A., Denver, Colo.

There are certainly plenty of indications that things may get worse before they get better.

Economists and officials like Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson are correct in saying that — at this moment, today — the U.S. economy remains healthy. The question is what happens next, which no one, not even the sagest of economists, can predict. Economies are like mobs: they can get ugly, but you really can’t tell when or if the riot will start or how long it will last.

But a little perspective is in order. Some of us watching the current mortgage meltdown and stock market gyrations remember the real estate slide and stock market crash of the 1980s. (Others, including some of the younger mortgage brokers who made all these risky loans that are now going up in smoke, apparently weren’t around then.)

The lending problems in the 1980s — both in the savings and loan mortgage market and the junk bond mania on Wall Street — were much worse that anything we've seen so far today. When it was all over, more than 1,000 thrift institutions, holding $519 billion, had been closed down in the “greatest collapse of U.S. financial institutions since the 1930s,” according to a summary report by the Federal Deposit Insurance Corporation.

At the worst of the 1980s crunch, we heard respected forecasters talk about 50 percent drops in housing prices and dire predictions of impending economic doom. Bookshelves sprouted titles like “How to Prepare for the Coming Economic Collapse” complete with advice on stocking up on canned goods.

But when the dust settled, the depression of the 1990s didn’t happen. Yes, we had a fairly nasty recession in 90-91, the housing market unraveled (home prices fell somewhat or were flat for many years in some markets), major commercial developers went bust, Congress had to write a check for over $100 billion to clean up the mess, and some S&L cowboys who wrote junk bonds that weren't worth the paper they were printed on went to jail. Within a few years, the economy was back on its feet again. Within a decade, the Fed chairman was worrying outloud about “irrational exuberance.”

It’s often said that economic cycles, and the markets that finance them, swing between fear and greed. Today, with the “fear factor” on the ascendancy, it’s useful to consider the scale of economic devastation brought by the Great Depression. Between 1929 and 1933, U.S. Gross Domestic Product fell from $103.6 billion to $56.4 billion — a 46 percent contraction that took 10 years to retrace. By contrast, the 1990-91 recession that followed the late 1980s housing collapse lasted 8 months, and GDP dropped by about 1 percent.

You can never say never again, but there are a number of reasons to believe that the odds of seeing another contraction on the scale of the Great Depression in your lifetime are pretty remote. The 1930s actually produced two back-to-back contractions; since then, historians have unearthed a number of government and businesses mistakes that actually made things worse and prolonged the agony.

Those lessons learned may help explain why modern recessions tend to be shorter and shallower than the panics and busts of earlier economic upheavals. From 1854 to 1919, for example, there were 16 downturns lasting an average of 22 months, according to the National Bureau of Economic Research. From 1919-1945, the average downturn lasted 18 months. From 1945-2001, the average recession lasted just 8 months.

While any recession is painful, recent downturns have been relatively mild by historical standards. One useful measure is the number of people who lose their jobs. In the recession of mid 1970s, the unemployment rate jumped from 4.6 percent to 9 percent. In the 1980-82 slump, the jobless rate shot up from 5.7 to 10.8 percent. In 1990-91 it went from 5.0 percent to 7.8 percent. In 2000, after falling to 3.8 percent, the jobless rate hit 6.3 percent in 2003 before dropping back to 4.5 percent today.

So before you buy a gun, fill your car with canned goods, and head for the woods – take a deep breath. The economy maybe headed for a rough patch. But it’s done so every ten years or so in our lifetime, worked out the problems that caused it to stumble, got up and dusted itself off, and went on its merry way. Your forecast is as good as mine. But, based on what’s going on today, we’re betting against a catastrophic, Hollywood-movie-style economic collapse.

Given the current situation with home loan defaults, the collapse of several major lending institutions, and the high possibility of a further decline in home values does it not seem like fair time to make ARM and Zero Interest loans illegal? These loans are not safe to the U.S. economy and allow too much risk into the capital markets. It just seems by requiring banks to charge an even rate over the term of the loan, we can secure our markets protecting both the consumer and the banking industry.
— David S. Maple Valley, Washington

Now that the damage is done, you’re going to see plenty of regulators come out of the woodwork. If anything, the risk is that they over regulate and create a “credit crunch” for worthy borrowers who aren’t overextended.

But you can't ban or eliminate risk: it's a part of every economic transaction. The purpose of the capital markets is to let everyone kick the tires of that risk, decide how much extra they're going to charge for it, and mark up the return on their investment to make up for the odds that it might blow up and go to Money Heaven.

What seems to have happened this time around is that either: 1) mortgage lenders who wrote subprime loans weren't completely forthright about the specific risks when they sold off the loans to Wall Street or 2) there was so much demand for these loans from investors that Wall Street looked the other way. (Or both.)

There’s nothing wrong with option ARMs and interest-only loans — when the circumstances are appropriate. (If you can get someone to give you a zero interest loan, by the way, you should take it.) Many of the loans now in default weren't bad products: they were just the wrong product for that borrower.

For example, a builder who plans to sell a house when it’s done can save money with an interest-only construction loan: He knows he's going to get a big check to cover the principal when he sells the house. For the lender, it makes sense because the loan is secured by the land and the house.

And there's nothing wrong with a lender giving a loan to someone with less-than-stellar credit and charging a higher rate to cover that risk. That's a good thing for people who can afford the loan who might not otherwise qualify. On the other hand, if a home buyer can’t afford a conventional monthly mortgage payment, setting them up with a loan that relies on both their income and home value rising rapidly is a risky thing to do.

Rather than banning these “exotic” mortgages, you’ll probably see more rules about disclosure. There’s is some indication that some of these loans were not properly explained to the borrowers who took them on. In some cases, this may have constituted fraud, which is a crime.

Something to think about next time you here that phrase: “Don’t worry, just sign here.”

We took out what would be considered a subprime loan at a fixed rate of nearly 11 percent. We would like to refinance to obtain a lower interest rate. We plan to remain in our home for at least another 8 to 10 years. Can you give us some helpful tips with regards to financing at a better rate?
— Latrice Detroit, Mich.

You really won’t know until you shop around: lenders are not all the same. Some may have a lot of subprime loans out and don’t want to write new ones. But there are plenty of solid lenders out there, and the mortgage market will continue to offer new loans.

“Subprime” includes a number of different circumstances. If your credit history has been spotty, make sure all your bills are current when you go for the loan. The less non-mortgage debt you’re carrying, the better. If you didn’t make a significant down payment the first time around, you may have to put up more money to refinance. And if you got one of those mortgages that was light on paperwork, be prepared to come up with tax returns, bank statements, and anything else the lender asks for.

So find a list of mortgage brokers in your area, call them up, find out if you qualify and ask them for the best rate you can get. You may be surprised how differently lenders react to the same application.

© 2007 MSNBC Interactive© 2007 MSNBC Interactive

Warning: Mortgages mess will only get worse

Contrarian Chronicles 3/19/2007 12:00 AM ET

Warning: This mess will only get worse

The inevitable demise of the subprime mortgage market leaves the entire housing market -- and with it the economy -- on the verge of collapse.

March 20, 2007 -- 13:30 ET

Bubbles have a way of masking what would otherwise be self-evident truths. And, as the credit bubble in real estate dies a dramatic, not-pretty death, a very simple truth has resurfaced: It's not a viable business when you lend money to people you know can't pay it back. If the late, "great" subprime sector had a tombstone, that would be a fitting epitaph for New Century Financial and others.

--MORE--

Blacks suffer most in U.S. foreclosure surge

Subprime lenders targeting blacks, Hispanics, analysts say
---

By Jason Szep 1 hour, 50 minutes ago

Barbara Anderson and her husband know racism. Among the first blacks to move into an Ohio neighborhood 25 years ago, she watched in horror as white neighbors burned her garage nearly to the ground.

Fast-forward to 2007 and Anderson talks of a different sort of discrimination: brokers of subprime mortgages who prey on borrowers with weak credit histories like the Andersons, who raised eight children in Cleveland's Slavic Village district.

"These subprime lenders target you to take you through disaster," said Anderson, 59, who filed for bankruptcy after a legal tussle with a subprime lender, a "nightmare" that she said ended four years ago when her home was nearly foreclosed.

"I was fortunate. I went to another bank that decided to give me a chance with a new loan. The day that happened my headache stopped, my blood pressure lowered, my sick stomach went away, and it was because now I could see some daylight."

Across the United States, blacks and Hispanics are more likely to get a high-cost, subprime mortgage when buying a home than whites, a major factor in a wave of foreclosures in poor, often black neighborhoods nationwide as a housing slowdown puts millions of "subprime" borrowers at risk of default.

Even more troubling, real-estate industry analysts say, is an alarming proportion of blacks and Hispanics who received subprime loans by predatory lenders even when their credit picture was good enough to deserve a cheaper loan.

In six major U.S. cities, black borrowers were 3.8 times more likely than whites to receive a higher-cost home loan, and Hispanic borrowers were 3.6 times more likely, according to a study released this month by a group of fair housing agencies.

"Blacks and Latinos have lower incomes and less wealth, less steady employment and lower credit ratings, so a completely neutral and fair credit-rating system would still give a higher percentage of subprime loans to minorities," said Jim Campen, a University of Massachusetts economist who contributed to the study.

"But the problem is exacerbated by a financial system which isn't fair," he said.

In greater Boston, 71 percent of blacks earning above $153,000 in 2005 took out mortgages with high interest rates, compared to just 9.4 percent of whites, while about 70 percent of black and Hispanic borrowers with incomes between $92,000 and $152,000 received high-interest rate home loans, compared to 17 percent for whites, according to his research.

"It's a huge disparity," he said. High-cost mortgages usually have interest rates at least 3 percentage points above conventional mortgages.

PREDATORY LENDERS

Predatory lenders moved aggressively into the subprime mortgage market as a housing price boom between 2000 and 2005 cut the risk of lending to people with damaged credit ratings.

Many focused on minority neighborhoods in slick sales pitches that offered the American dream: home ownership with no money down and little worry about poor credit.

"The predatory lenders reach out to those who don't really know, people with a lack of education," said Cassandra Hedges, a black 37-year-old mother of two fighting to stave off foreclosure of the Ohio home she bought three years ago.

"One of the first things my broker asked me was 'How do you know you are ready to buy a house. Have you done any research?' We said 'No'. At that point I think he realized 'Okay I got some people that don't know what the heck they are doing'."

She and her husband Andre now face a 10.75 percent interest rate on an adjustable-rate mortgage and monthly payments of $1,600 -- more than double the $650 she told her broker she could afford. Foreclosure looms after she missed a payment.

"If you're white they overlook the fact that your credit score is a little too low or you have one extra late payment," said Barbara Rice, a community organizer at the Massachusetts Affordable Housing Alliance, a nonprofit advocacy group.

Rice, who is white, and a colleague who is black took part in an experiment in Massachusetts last year to test the racial bias of mortgage brokers. They both posed as prospective home buyers in a separate meetings with several brokers.

Rice presented a worse credit rating and lower income than her black colleague to brokers but received better treatment.

"I was given more information," she said.

Many traditional banks do not run branches in poor minority neighborhoods, creating a vacuum often filled by predatory lenders and unscrupulous brokers, said Stephen Ross, a University of Connecticut economist who studies lending.

When the property market was strong, those brokers could tell borrowers that rising prices meant they could easily remortgage their properties to keep up with payments. But since the market peaked in 2005, millions are struggling to repay those loans. This year, some 1.5 million homeowners will face foreclosure, research firm RealtyTrac estimates.

The U.S. Mortgage Bankers Association said disparities by race alone in home loans do not prove unlawful discrimination but may indicate a need for closer scrutiny.