Wednesday, October 24, 2007

Housing Problems contained to...

First the housing credit problems were contained to a few bad subprime companies, but the safeguards and credit protections as well as tougher underwriting standards protected Alt-A, jumbo, and prime markets. Next we found out this summer that credit problems were taking down the Alt-A and jumbo markets, but we were assured that the combination of a Bernacke Put, a Super SIV, improved credit risk assessment and underwriting would protect the prime markets from seizing up. And now the Wall Street Journal via Calculated Risk is the least prime of the prime market is starting to show some serious problems:
Some loans classified as prime when they were originated are now going bad at a rapid pace.

These ... option ARMs ... typically have low introductory rates and allow minimal payments in the early years of the mortgage. Multiple payment choices include a minimum payment that covers none of the principal and only part of the interest normally due. If borrowers choose that minimum payment, their loan balances grow....

An analysis prepared for The Wall Street Journal by UBS AG shows that 3.55% of option ARMs originated by Countrywide in 2006 and packaged into securities sold to investors are at least 60 days past due. That compares with an average option-ARM delinquency rate of 2.56% for the industry as a whole....

It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS.
I am not a mortgage guy, although the ones that I talk to say that the market is frozen for anything that they prepare that does not have W-2/1099 income verification, reasonable DTI, multiple months of bank statements as well as significant cash reserves. The mortgage brokers that I know can still qualify people who would have qualified as prime borrowers ten years ago, twenty years ago and forty years ago. They can not qualify anyone else at any interest rate and conditions that are economically and cash flow reasonable right now. This is ancedotal information, so take it with a grain of sea salt.

What seems to be happening is the end result of a massive case of credit worthiness inflation, similiar to grade inflation. People at the bottom end of the credit ladder were getting bumped up one or two levels of creditworthiness and being offered loans that in normal underwriting circumstances they should have never been considered for, and this had a cumulative impact of bumping up slightly better credit risks that should have been seriously subprime to 'good subprime', and so on and so forth down the line.

Throw in a speculative frenzy, minimal real wage growth, generationally low interest rates, a bevy of teasers rates and hooks that make the first couple of years affordable and the evaporation of personal financial reserves to deal with any set back, any shock to the pre-exisiting system makes the entire system unstable. And that is what is happening now as the supply of greater fools ran out in late 2005/early 2006 and the reserves are not there to cope with personal losses.

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