The Homa Files

Excerpted from Heritage Foundation:”Subprime Mortgage Problems: A Quick Tour Through the Rubble”, by Ronald D. Utt, April 3, 2008

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Note: Best recap I’ve found re: the current mortgage mess.

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The collapse of the subprime mortgage market in late 2006 set in motion a chain reaction of economic and financial adversity that has since spread to nearly all sectors of the economy, as well as to global financial markets, has created depression-like conditions in the housing market, and has led the American economy to the brink of recession.

In response, many in Congress and the executive branch have proposed a number of new federal spending and credit programs that would greatly expand the role of government in the economy.

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How the Problem Started

These problems had their origin in the mid-1990s when mortgage lenders reduced the previously strict financial qualifications needed to acquire a mortgage to buy a house by offering credit-impaired households mortgage loans, albeit at higher interest rates to compensate for the greater risk. Despite the many different forms these mortgages would ultimately assume–no down payment, interest only, negative amortization, etc.–they were designated “subprime” because of the checkered credit histories of the households using them.  Despite the risk associated with these subprime mortgages, many mortgage lenders further relaxed their underwriting standards and in the process introduced even more risk into the system, some of it motivated by fraud and misrepresentation.

As a consequence, the availability of risky loans soared from the late 1990s through 2006. In 2001, newly originated subprime, Alt-A, and home equity lines (seconds) totaled $330 billion and amounted to 15 percent of all residential mortgages. Just three years later, in 2004, these mortgages accounted for almost $1.1 trillion in new loans, equal to 37 percent of the total. Their volume peaked in 2006 when they reached $1.4 trillion and 48 percent of the total. Over a similar period, the volume of mortgage-backed securities (MBS) collateralized by subprime mortgages increased from $18.5 billion in 1995 to $507.9 billion in 2005

In turn, the looser lending standards allowed previously unqualified borrowers to become homeowners, and the homeownership rate soared from the 64 percent range of the 35 years prior to 1995 to an all time high of 69 percent in 2004. While most celebrated this accomplishment, the consequence of lending to riskier borrowers under diminished underwriting standards led to an escalation in the number of loan defaults beginning in 2006, followed by an escalation in the number of foreclosures. Because many of these loans had been repackaged into mortgage-backed securities, the growing default problem soon spread to investors in the national and international financial markets where these instruments were sold.

The first to suffer was the housing market, where new construction and the sales of both new and existing homes plunged. This was soon followed by a decline in home values, which in turn worsened the financial problems in the mortgage market by reducing the value of the collateral securing these loans. As many subprime borrowers now found themselves owning a house worth less than the debt owed on it, the incentive to default increased, and by the end of 2007, more than 17 percent of subprime borrowers had fallen behind in their loan payments.

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Implications for the Economy

After reaching the more than 1.7 million new units started in 2005, single-family housing starts in February 2008 fell to a seasonally adjusted annual rate of 707,000 units, less than half the level of production two years earlier. On a year-over-year basis, the decline in starts was 40.4 percent.  Sales of new homes fell precipitously over the same period. After reaching 1,283,000 units in 2005, they fell in February 2008 to a seasonally adjusted annual rate of 590,000, less than half the level of 2005 and down 29.8 percent from February 2007. For existing homes, sales peaked in 2005 at 7,076,000 units, fell to 6.4 million in 2006, and by February 2008 had fallen to a seasonally adjusted annual rate of 5 million, nearly 30 percent below the peak levels of sales during 2005.

After two years of declining activity in the housing market, many are hopeful that the bottom has been reached and that the market will soon revive, but this seems unlikely. The subprime default and foreclosure problems first emerged at a time when the economy was healthy, most borrowers were employed, and housing values were stable or rising. In 2008, home prices and sales are falling, some borrowers may soon confront unemployment, tightened credit standards will exclude many from homeownership, and the number of subprime mortgages resetting to higher payments will be greater than the number that reset in 2006 and 2007.

As a consequence, the homeownership rate is likely to fall from its record levels near 69 percent to something closer to the long-term historic norm of 64 percent. This trend in turn implies a greater number of lost homes coming onto the market at a time when sales are depressed.

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Notwithstanding the constituent and lobbyist pressure to do something costly and do it quickly, the history of government intervention in housing markets and the economy has not been one of notable success. .

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Full article:
http://www.heritage.org/Research/Economy/wm1881.cfm

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This entry was posted on September 22, 2008 at 7:19 am and is filed under Government & Politics, Mortgage Crisis. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.