Monday, March 5, 2007

Sub Prime lenders paying for their sins

It’s no secret now, mainstream media outlets are on this story. Six months ago not many were talking about it. The truth is there are a lot of people who got into exotic loans for various reasons. Some thought if they didn’t get into the market in the last couple of years they would be forever priced out. They did what they had to to get into that house.

Some speculators took out exotic ARM loans and are now trapped in them as the anticipated market rise is not happening, which would have allowed them to sell for a profit before their rates adjusted. Still others saw their home equity rising and wanted to benefit from it. So they took out HELOCs, bought cars, boats, flat screens and Hawaiian vacations. Sure some will switch to fixed rate mortgages but a number of those borrowers are stuck for two or more years before they can switch out of their ARMs. You can bet that they pulled as much cash equity out as they could, ‘what the heck, if things don’t work out I got the money I’ll just walk away’.
Not so fast...
New laws went into effect last year making second mortgages actionable. In other words you can’t declare bankruptcy and walk from them. It seems the banking industry and Congress saw this one coming.

What does it all mean?

We will all pay the price for this one, be it through a receding economy or some government structured bailout of banks who simply won’t be able to absorb the sub-prime defaults, or who take large hits from short selling the rest, or all of the above.

Already US consumer spending is down. Look at China’s lack of orders to produce durable goods this week. A lot of what they make is sold in the US. It’s no longer a matter of if or when the pinch happens, it’s a matter of how bad it will hurt.

From Reuters.
“U.S. homeowners who bought using 100 percent financing, and those who took out ‘home equity’ loans against the value of their properties, even though they have good credit ratings, could be the next to cause problems in the U.S. housing market.”

“Many recent home buyers bought through 100 percent financing programs known as ‘piggyback’ loans, which relied on one mortgage for 80 percent of purchase price and other financing for the remaining 20 percent.”

“‘Piggyback loans could be the next skeleton to fall out of the mortgage industry closet,’ said Howard Glaser, an independent mortgage analyst. ‘These 80-20 loans give the borrower the illusion of being able to afford more house than they really have the funds for.”

“From mid-2005 to mid-2006, 29 percent of new mortgages involved no deposit by the purchaser to create some equity in the property, according to the National Association of Realtors. ‘When we went out to visit our clients on the West Coast, this was a prime area of concern,’ said Frederick Cannon, a mortgage industry analyst.”

“Another type of financing which could cause problems in the housing sector is the ‘home equity’ loan, taken out by a homeowner against the net value of the property to finance home improvements or other consumer spending. Home equity lines of credit, or HELOCs, grew from $151 billion to $559 billion from 2000 to 2005, according to the FDIC.”

“In a regulatory filing Thursday, Countrywide said 2.9 percent of its prime home-equity loans were at least 30 days late at the end of 2006, up from 1.6 percent a year earlier and 0.8 percent at the end of 2004.”

“‘Second lien holders and second lien HELOC lenders to prime borrowers are in as much of an ‘at risk’ position as subprime mortgage lenders,’ said said Josh Rosner, a housing analyst. ‘The recognition of their problems is just ahead of us as they will default more slowly.’”


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