High-risk Mortgage Foreclosures Likely to Rise
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GWEN IFILL: As the housing slump continues, lenders, borrowers and investors are coping with a new worry: rising mortgage defaults, especially among high-risk homebuyers with poor credit history or heavy debt.
Many of them were able to qualify for a mortgage financing in the first place only by obtaining what are known as “subprime loans.” Here’s how it works.
A homebuyer receives a loan from a subprime mortgage lender and makes payments to that lender. The lender then arranges the mortgage and, in most cases, sells it to a commercial bank or Wall Street firm. Those companies then repackage the loan with mortgage-backed securities and sell them to investors.
The tradeoff for borrowers: interest rates often 2 to 3 percentage points higher than regular mortgages. But getting the loan is easier, with low initial “teaser” rates that adjust upward over time.
As the rates rise, the loans get tougher to repay. And when homebuyers default on these loans, the original lender has to buy back the loan from the banks and Wall Street firms.
That cycle has been exacerbated in the last few months by generally rising interest rates and falling home prices that have depressed the once-booming housing market. Last year alone, subprime loans accounted for one out of every five new mortgages.
More than two dozen subprime lenders have been forced to close or sell operations. The latest casualty: New Century Financial Corporation, the nation’s second-biggest subprime mortgage lender.
New Century stopped accepting new loan applications last week and announced today that all of the lenders that have been keeping them afloat have now cut off their financing. That could push the company closer to bankruptcy.
The numbers game
GWEN IFILL: Now, more about these loans and why they've become so problematic. For that, we're joined by Mark Zandi, chief economist at Moody's Economy.com. His firm provides economic data to a number of mortgage lenders. And Josh Rosner, managing director at Graham Fisher and Company, an independent investment research firm in New York.
Mark Zandi, how much of this market is subprime, of the mortgage market, are we talking about here?
MARK ZANDI, Chief Economist, Moody's Economy: Well, about 20 percent of origination volume in the last year was subprime, and about 15 percent of all mortgage debt outstanding is subprime. But the problems extend beyond that to so-called Alternative A loans and interest-only option ARMs.
If you include all of these so-called exotic mortgage loans, they accounted for about 40 percent of originations last year and account for about 20 percent of mortgage debt outstanding.
GWEN IFILL: And, Josh Rosner, as we're talking about the number of defaults and the number of delinquencies, what numbers are we talking about there?
JOSH ROSNER, Graham Fisher and Company: Well, it's unclear. I mean, part of the problem is that these mortgages were originated with very little empirical data, with very little historic data of these borrowers. So it's hard to estimate where it's going to. And the subprime, it could end up as high as 20 percent.
GWEN IFILL: So when, for instance, someone comes to someone who might have a spotty credit history and says, "We can get you in a house, no money down," that's the sort of thing which is leading to what we're seeing today?
JOSH ROSNER: Absolutely, and I think that it's important to remember that, through almost all of American history, homebuyers were expected to have a considerable amount of money to put down on a home. And that was generally there to give the lender comfort that that buyer had enough of an economic interest not just to walk away with it, from the asset. That's changed over the cycle materially.
GWEN IFILL: Used to be like 20 percent, and now you don't even need a fraction of that, I guess.
JOSH ROSNER: Exactly.
GWEN IFILL: So let's talk, Mark Zandi, a little bit about what the gamble was here. Presumably this gamble was supposed to pay off when the market was booming, but when the market began to soften, the deal was off.
MARK ZANDI: Yes, I mean, it's a combination of things that came together to create this problem. Many of the borrowers who got loans in the last couple of years probably shouldn't have gotten them. They were very poor credits, and that's clear now.
And, moreover, many of these folks now face resets on their mortgages. They are fixed-rate loans for two years, generally, and then they become adjustable mortgage rates, and their rate moves higher. And now most of these households face these much higher mortgage payments.
And then, on top of that, you have a very weak housing market, where house prices no longer are rising. They're actually falling in many areas. So you mix all of these things together, and you throw in a little bit of fraud, and you've got the problem that we see today.
The issue of fraud
GWEN IFILL: Josh Rosner, let's talk about that little bit of fraud. This reminds me a little bit of the savings and loan debacle of the 1990s. How much of this is outright fraud?
JOSH ROSNER: Well, I mean, I think that you have to actually separate that into a number of areas. You know, there was a story in the papers today about a poor woman who had been given a loan that she didn't understand the risks of, and I think that there is some of that.
But I think the larger problem is actually the fraud by the borrower. It's been estimated that, you know, about 50 percent of stated income loans are overstated by about 50 percent. And, in fact, there was one study last year which stated that 90 percent of stated income low-doc, no-doc loans were overstated income by at least 5 percent.
So I think that part of it is that the lenders made loans to people without appropriate verification of income, and it's coming home to roost.
GWEN IFILL: And when that happens -- I read one article today in which someone had actually not even filled out the income box on the loan application -- when that happens, then the lender is responsible for repaying all of those investors who bought the loans. Is that the way it works?
JOSH ROSNER: Absolutely. And it depends on how their contractual reps and warranties are structured. But there comes another problem, which is, even if they aren't legally on the hook to, ultimately borrowers, investors can put it back to them through what's considered implicit recourse, which is either you buy it back and make us whole, or the access to capital that you have will dry up. And so that becomes a whole other set of problems for lenders.
The ripple effect?
GWEN IFILL: Mark Zandi, does it become a whole other set of problems for borrowers, people just have to get used to the idea that maybe they're not going to be able to own homes if this part of the market collapses?
MARK ZANDI: Yes, I think many borrowers who could have gotten a loan last year certainly won't get a loan this year, so credit is not going to be as ample, not as available as it was in the recent past.
Moreover, many of those borrowers who are now in homes and face those payment resets unfortunately are not going to be able to make those higher mortgage payments. They're going to end up in foreclosure. So this is going to be a very tough period for subprime borrowers.
GWEN IFILL: And if that happens, what ripple effect -- is there a ripple effect to people who have decent credit and are still getting some sort of regular conventional loan? Does there become a ripple effect when one part of the industry collapses like this?
MARK ZANDI: It's possible, but I doubt it. I think the prime mortgage market, which is still the bulk of the mortgage market, is in good shape. Most people have jobs, have good incomes, wages are rising. Delinquencies and defaults on prime loans are low.
So, no, I think this is really the subprime market and parts of the prime market, but the bulk of the market remains healthy.
GWEN IFILL: Let me ask Josh Rosner about that. What do you think about the ripple effect potential?
JOSH ROSNER: Yes, I actually do think that there's a ripple effect potential. You know, if you end up with 20 percent foreclosure rates, obviously those properties end up back on the market. You've got less available funding to fund new mortgage loans.
And so the way it traditionally works is that home prices end up finding an equilibrium between buyers and sellers, and that does not actually end up isolated just to subprime. It ends up affecting housing prices more broadly within those markets.
GWEN IFILL: And maybe beyond housing prices, to the economy in general?
JOSH ROSNER: Well, I think it's too early to tell. I think that you've got to also remember you've got two different issues going on here. Historically, mortgage funding really was driven in the real economy, and today it's largely actually financed by the financial markets.
And so, frankly, I think a lot of it comes down to how comfortable capital market players, investors are with continuing to buy these assets, not necessarily subprime, but all-day and prime mortgage assets. And I think that will dictate the size and the follow-on effects in the real economy in the housing markets, per se.
Impact on the economy
GWEN IFILL: Mark Zandi, if all of this depended, the success of this depended on a booming economy and the fact that, if you defaulted, you could sell your house for more money, find a way to repay your lenders, and then they would turn the money over again, it seemed almost like a shell game. Why didn't this all collapse before?
MARK ZANDI: Well, just a year ago, the housing market was booming. I mean, it wasn't until this time last year that house prices really started to decline.
And, moreover, many of the new borrowers are the ones that are in trouble, the folks that borrowed back in 2005, 2006, and they're only now facing those higher mortgage payments. So the game could go on until just now when you mix these lower house prices with these higher mortgage payments. And, you know, obviously, it's created a great deal of difficulty. It's actually been quite stunning how quickly credit quality has weakened.
GWEN IFILL: Are there areas of the country, Mark Zandi, that are affected more than others because of this collapse?
MARK ZANDI: Yes, subprime lending was most prevalent in parts of California, Arizona, Florida, the northeast corridor, you know, those markets that were very, very active a year or two ago.
And, in fact, lenders had to become very aggressive, because affordability had collapsed when prices were very high. And the only way to keep the market going was to become more aggressive and extending out more credit, a la subprime loan, Alternative A loans, interest-only loans, those kinds of loans.
GWEN IFILL: And, Josh Rosner, if this does turn into the problem that it looks like right now, at least for one major company and perhaps others, is this something that -- are there regulations that can be put in place that can be tightened? Is there something government should be doing to get this back under control?
JOSH ROSNER: Well, I actually think the best answer for our capital markets and for our economy is just to accept that risk is the price that you'd never thought you would have to pay. But at this point, we've taken the risks, and I think we have to allow the capital markets and the real economy to clear these problems.
I think that regulators actually, unless they see a systemic problem, don't really have reason to step in. And I would hope that we don't go down the same path that we did during the S&L crisis, where we actually become so concerned that we just allow institutions to continue to roll bad loans forward.
I think that we should, you know, allow losses to be taken all the way around and go forward.
I would also add that, you know, there were other parts of the country, not really just the coasts, where affordability had been a problem, the Midwest, some of the rust belt, and it was for the opposite reasons. It was actually income-driven as opposed to necessarily home price appreciation-driven, that are also somewhat at risk.
And I think the reason now, as opposed to, you know, during the past few years is you saw increased competition, a race to zero by lenders to generate volumes, and that actually lead to looser and looser and looser underwriting standards.
GWEN IFILL: Very complicated, but you guys made it very clear. Josh Rosner and Mark Zandi, thank you both very much.
JOSH ROSNER: You're welcome.