The Subprime Squeeze
The Wall Street Journal's James Haggerty wrote thi$ 3/11/06 article entitled "Millions Are Facing Monthly Squeeze On House Payments." In it, he provides some disturbing data regarding the subprime lending industry, including a graph showing subprime lending originations increasing from $150 billion in 2000 to $650 billion in 2005. Haggerty writes:
In the hot housing market of recent years, many households took advantage of "affordability" mortgage loans -- heavily promoted by lenders -- that hold down payments for an initial period. Now the initial periods are coming to an end on many of these loans, leaving borrowers to face resets of their interest rates that can cause monthly payments to shoot up between 10% and 50%.
More than $2 trillion of U.S. mortgage debt, or about a quarter of all mortgage loans outstanding, comes up for interest-rate resets in 2006 and 2007, estimates Moody's Economy.com, a research firm in West Chester, Pa....
A recent study by First American Real Estate Solutions, a unit of title insurer First American Corp., projects that about one in eight households with adjustable-rate mortgages that originated in 2004 and 2005 will default on those loans....
For a study released in February, Dr. Cagan examined adjustable-rate first mortgage loans made in 2004 and 2005, including refinancings. He figures about 7.7 million of these loans are outstanding, representing $1.888 trillion of debt.
About 1.4 million of those households face a jump of 50% or more in their monthly payments once their initial low-payment periods run out, Dr. Cagan says, and an additional 1.6 million face smaller increases that are still likely to strain their finances.
Assuming that home prices stay around current levels and interest rates don't rise sharply, Dr. Cagan figures about one million households eventually will default and lose their homes to foreclosure. That would cause about $110 billion of losses for lenders, he says.
Lenders and the economy as a whole could easily cope with such losses, Dr. Cagan says, though it would be devastating for some families and painful for some investors who bought securities backed by the riskiest loans. "It won't happen all at once," Dr. Cagan says. "It will be spread out over several years."
History has shown that "hockey stick" growth patterns in the subprime industry are more likely caused by looser adherence to underwriting standards than by increased demand for subprime products among qualified borrowers. If, in fact, looser credit standards have driven the current exponential growth since 2000 in subprime lending, then waves of defaults will be "tsunami-like" in proportion. That's what happened to the subprime auto lenders of the 1993 - 1997 era (e.g., Mercury Finance, First Merchants Acceptance Corp., National Auto Financial, Reliance Acceptance). Let's hope it's not the case here, but don't hold your breath that its not. Either way, the squeeze continues.
3/22/2007 Update:: See my latest update on the subprime squeeze here.
© Steve Jakubowski 2006
Great reading, keep up the great posts.
Subprime borrowers are toast when those 2/28's expire.