Interest Rate Roundup

Friday, January 26, 2007

The NY Times tackles the subprime fiasco

Perusing the morning headlines, I couldn't help but notice the New York Times' coverage of the fiasco in the subprime lending sector. A few choice bits ...

--"The once booming market for home loans to people with weak credit — known as subprime mortgages and made largely to minorities, the poor and first-time buyers stretching to afford a home — is coming under greater pressure. The evidence can be seen in rising default rates, increasingly strained finances at mortgage lenders and growing doubts among investors."

-- "Wall Street firms were attracted to such lenders because they helped feed a pipeline of securities backed by the mortgages, a market bigger than the one for United States Treasury bonds and notes. Merrill Lynch, for example, securitized $67.8 billion in residential mortgages in the first nine months of 2006, up 58.4 percent from the period a year earlier.

But an increasing number of borrowers are defaulting on subprime loans earlier now than they did a year ago, often within six months of having taken the loan out, shaking Wall Street’s confidence in its subprime partners."

-- "Across the industry, 2.6 percent of the subprime loans securitized in the second quarter of 2006 had been foreclosed on or repossessed within six months. That is up from 1 percent for loans securitized in the second quarter of 2005, according to Moody’s Investors Service, the ratings agency."

How severe will the subprime shakeout get? That's the key question. I think it'll be worse than people expect simply because of the amount of fraud, misrepresentation of income, shoddy appraisals, and other junk lending practices that went on during the boom. Credit "bulls" say you can't have real mortgage lending trouble with unemployment low, the economy performing well, etc. I would ask them, "If that's true, why are delinquencies and foreclosures skyrocketing? By your logic, this 'can't' happen."

We're already seeing foreclosures in some states, like Massachusetts and California, surge to multi-year highs. I think we'll see more of that over time. And it's something we should watch closely. Subprime is no longer some small corner of the mortgage market -- it accounts for about a fifth of overall loan volume, up from a tenth a few years back. Even Congress is getting involved -- Senate Banking Committee Chairman Christopher Dodd has announced plans to investigate recent lending practices.


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