The Subprime Squeeze Is Looking More Like a Hangman's Noose

A year ago, I voiced my concerns in a post entitled "The Subprime Squeeze" that the dramatic "hockey stick" growth in housing's subprime lending market was "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," I predicted, "then waves of defaults will be 'tsunami-like' in proportion."  Last Memorial Day, I echoed these sentiments in this post.

Well, "the chickens are coming home to roost," as the old saying goes, and the subprime squeeze is looking to some (such as Professor Nouriel Roubini) more like a hangman's noose.

Courtesy of the TPM Cafe Blog, here's a great read from Credit Suisse entitled "The Impact of the 2005 Bankruptcy Law on Subprime HEL [Home Equity Loans]."  Here are the conclusions of the report:

•   We believe that the new bankruptcy law introduced on October 17, 2005 has had a profound impact on subprime borrowers.  Under the new law, we find that bankrupt borrowers are riskier. Under the new law, the means test is more difficult to pass for bankruptcy petitioners, and more subprime mortgagor filers are required to enter Chapter 13 rather than Chapter 7 bankruptcy, even though they might not be able to complete the repayment plan.  Our analysis reveals that a higher percentage of borrowers are failing their bankruptcy repayment plans.


•   The stringent means test also means more delinquent loans have to go into foreclosure directly rather than into bankruptcy.  Therefore, it is directly responsible for the rising foreclosure rate since the end of 2005.

•   We believe that the cash flow from bankrupt filers is lower after the new law, and the cure rate from bankruptcy has declined.

•   The roll rate pattern since October 2005 indicates that roll rate data prior to the bankruptcy law change should be used with caution, as it overstates the cure rate and can have a non-trivial impact on delinquency and trigger projections.

Remember the old maxim, "bad cases make bad law" (cited as a "rule" in this 1845 US Supreme Court opinion)?  Well, when it comes to BAPCPA, the converse is also proving to be true, even for the hard-nosed lenders the law was designed to benefit.

I've discussed here and here the "law of unintended consequences" affecting subprime auto lenders as a result of BAPCPA's "hanging paragraph."  Looks like we can add the subprime home lenders to the list of those to whom BAPCPA's "conventional wisdoms" don't apply.  Regardless, the squeeze continues.

© Steve Jakubowski 2007

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