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When the subprime mortgage topic turns up, a lot of people tune out.
It’s too boring, complicated and remote, they reason.
Tens of thousands of jobs have been lost as a result of this crisis, but few of us really pay attention unless our own income suffers. The stock markets have taken some deep dives, but few of us really get worked up unless we plan to sell stock or retire soon.
But if you think you’re not affected, think again.
If your monthly mortgage rate suddenly goes through the roof or you can’t qualify for a car loan or your credit cards’ interest rates skyrocket, the subprime mortgage meltdown might just turn out to be the Grinch who stole your kids’ Christmas.
So pay attention.
The Journal Gazette crafted a series of questions and then went looking for the best local and national sources to answer them:
Q. Why all the fuss?
A.
Think of the U.S. economy as a giant net made of thousands of connecting pieces of knotted rope. When a tiny part of it weakens, just the surrounding area is affected. But if that weakness becomes a hole that continues to tear, the overall net – or economy – could be damaged.
That tear can expand because some parts of the economy are directly connected to others. It can also grow because people panic over bad news and stop spending money on things such as new cars and flat screen TVs. Consumer spending is a major engine that drives the economy.
At this point, no one knows how large this tear will become or how long it will take to fix.
The weakness that started this crisis was in the mortgage sector. In recent years, lenders were approving subprime loans for people who had riskier credit histories. Lenders liked making the loans because they could collect so much more in interest than on a conventional mortgage. They were gambling that the higher interest rates would more than make up for any borrowers who weren’t able to make all their payments.
Most of those loans were adjustable-rate mortgages, meaning they offered lower payments at the beginning and then imposed higher payments after two or three years.
Significant numbers of borrowers have been unable to make the higher payments and have defaulted on their loans. The companies that own those loans had expected to keep making monthly income from them. But they’ve found themselves drawn into costly legal proceedings while the houses sit without generating income.
Q. What’s the difference between conventional, subprime and Alt A loans?
A.
Think of these loans on tiered levels with those considered the least risky on the top level and the most risky on the bottom.
Conventional loans, the most common, are the safest or top tier. They are made to borrowers with excellent credit records who can provide documents that show steady, reliable income. They include 20- and 30-year fixed loans.
Alternative A or Alt A loans are on the middle layer, although some argue they’re even riskier than subprime mortgages. They’re made to borrowers who have good credit histories that aren’t necessarily as spotless as borrowers who qualify for conventional mortgages.
Alt A loans don’t require the same amount of documentation for approval as conventional mortgage loans. A self-employed building contractor who works for various customers and who has seasonal fluctuations in income is an example of someone who can’t show proof of consistent income.
Some Alt A loans are used for vacation homes and investment properties, said Deborah Sturges, founder of Fort Wayne-based Hallmark Home Mortgage. These loans are riskier than conventional loans because fraudulent information can slip through the application process more easily when lenders don’t perform the usual documentation checks, Sturges said.
Subprime loans, the lowest level, are made to borrowers with spotty credit histories and represent most or all of the sale price. The lender is taking a higher risk that the borrower won’t repay the money, so the interest rates on these loans are higher to offset that risk.
Q. Are all adjustable-rate or variable-rate mortgages considered subprime?
A.
No. Some ARMs are approved for conventional borrowers, said Rodney Sinn, president of Fort Wayne-based Freedom Financial Mortgage Corp. His example: A borrower who was transferred by his employer and expects to be transferred to another market within about two or three years might opt for an ARM to take advantage of a lower interest rate during the first three years of the loan.
Most subprime borrowers chose ARMs for the same reason – to keep their initial payments low, Sturges said.
Q. Why is the subprime mortgage market in crisis?
A.
Part of the problem can be traced to one of the seven deadly sins.
“Greed got in the way where everybody was trying to do as many deals as they could,” Sinn said, referring to some mortgage brokers.
But borrowers’ greed is also partly to blame.
Sturges thinks many overextended themselves when they borrowed money because they were betting on a hot housing market.
“People mortgaged to the hilt with these Alt A products,” she said. “They didn’t have the income to support it, but they probably expected to turn around in a year and sell it for $50,000 more than they paid.”
Now some of these borrowers are defaulting on their mortgages. The companies that invested in bonds backed by those shaky mortgage loans – and their stockholders – are facing the losses.
Bonds are IOUs that corporations and governments sell to raise money in the short term. The entity that issues the bond promises to pay it back – with interest – in installments or a lump sum after the maturity date. Secured bonds, which are considered safer investments than unsecured bonds, are tied to collateral. The bond issuer promises to sell that collateral, if necessary, to pay off the bonds if it runs into money problems.
As homeowners started defaulting on subprime loans, their mortgages stopped generating interest income for the companies that owned the loans.
That made it hard for them to pay off the bonds they’d issued using the loans as collateral.
Investors are responding by not buying bonds that use mortgages as their collateral. This ultimately reduces the amount of money available to borrowers.
Some subprime lenders have gone out of business. And others are financially shaky. The remaining lenders are raising their requirements for borrowers. That can include denying loan applications unless the borrowers can meet a higher minimum credit score than lenders previously required. It can also include requiring borrowers to put down their own money as part of the purchase instead of borrowing all or almost all of the sale price.
If it becomes harder to qualify for a loan, more people could have to wait to enter the housing market, driving up demand for apartments and rental homes. And if demand goes up, landlords could charge higher rents.
Q. What kinds of effects are being seen from this meltdown?
A.
Job losses, for one.
In the first three weeks of August alone, financial institutions have announced almost 21,000 job cuts, according to Challenger, Gray & Christmas Inc., a Chicago-based global outplacement consulting firm.
Most of this month’s job cuts are directly related to housing market woes, which have quickly spread into the lending industry, the firm said in a new release on Tuesday. To date, the financial industry has announced 87,962 job cuts this year, 164 percent more than through the end of August last year. The mortgage and subprime lending markets are responsible for 41 percent of this year’s job losses.
“There are two big issues behind the cuts. First, demand for new mortgages and home equity loans and other forms of credit have fallen off dramatically,” Chief Executive Officer John Challenger said in a prepared statement. “The other issue is the increasing rate of defaults and foreclosures, which is leaving the lending institutions unable to meet their own financial obligations.”
HSBC said last week it will close its Carmel location by the middle of next year because of declining mortgage business. The operation just north of Indianapolis employs 600 people, who are being told at this point that they may apply to transfer to other jobs within the company.
Accredited Home Lenders Holding Co. last week announced plans to eliminate 1,600 jobs, 62 percent of its workforce. After restructuring, the San Diego-based company will employ 1,000, compared with 4,200 just nine months ago. Analysts told Reuters that the underwriting standards used by Accredited “were more prudent than those of many rivals.”
According to the Mortgage Lender Implode-O-Meter, a blog, 135 lenders have gone out of business from late 2006 to Thursday morning.
Also, more people are defaulting on their loans. With little or no money of their own invested in the homes, the borrowers feel freer to walk away and start over.
Home loans 90 days or more past due rose by $3.1 billion, or 12.6 percent, in the second quarter compared to the same period one year earlier, the Associated Press reported Wednesday.
The data, provided by the Federal Deposit Insurance Corp., also shows that banks and thrifts set aside $11.4 billion to cover loan losses during the second quarter, an increase of more than 75 percent compared to 2006. The loan loss reserves are at their highest level since the fourth quarter of 2002, the FDIC said.
According to a report released Tuesday by RealtyTrac, an online seller of foreclosure properties, almost 180,000 foreclosures were filed in the U.S. in July. That’s a 9 percent increase from June and a 93 percent increase from July 2006.
Indiana’s foreclosure rate was ranked 10th in the country, with one for every 609 households. The state’s increase was almost 35 percent over the same month last year. Michigan ranked third nationally, and Ohio ranked sixth.
Q. What are some local effects?
A.
According to Allen County Circuit and Superior court records, the number of home foreclosure filings in Allen County increased more than 34 percent from 2002 to 2006. Most of that growth was seen in one year. The number jumped from 1,906 in 2005 to 2,349 in 2006, a 23 percent increase. The first half of 2007 is on pace to repeat that 23 percent leap.
The local housing market overall has suffered.
Joyce Swartz, a real estate agent with Coldwell Banker Roth Wehrly Graber, said the local market is starting to pick up after being slow for about two years. One reason for the rebound is that builders aren’t building as many homes, reducing the number of new homes hitting the market, she said.
During the down market, some sellers who had mortgaged 100 percent of their homes’ value couldn’t afford to sell. Others who were forced to sell were left owing money on the deals because they didn’t have equity.
“We’re seeing a lot of short sales,” Swartz said.
Also, local jobs are being lost.
One of the companies on the Mortgage Lender Implode-O-Meter is American Home Mortgage Investment Corp., which employed about 155 locally until Aug. 3, when it cut more than 7,000 jobs. The mortgage lender entered the market in early 2006 when it bought Waterfield Financial Corp. and decided to keep the 100 workers in the wholesale mortgage operation. About 850 Waterfield mortgage jobs were cut last year as part of the acquisition.
Q. Why is the mortgage industry fallout having an effect on financial markets?
A.
An international business professor at Indiana University-Purdue University Fort Wayne tackled this topic.
As the homeowners begin to default on their loans, the lenders are placed in a precarious situation. They’ve borrowed that money from somewhere, said Zoher Shipchandler, associate dean of the Doermer School of Business and Management Sciences at IPFW.
Sometimes it’s from people like you and me who have savings accounts and certificates of deposit. And these lenders have to have the cash available when depositors and investors want their money back.
“This causes significant nervousness in the financial markets as to where will this ripple effect go and can we control it?” Shipchandler said.
Consumer confidence – or, in this case, anxiety – can have enormous effects on financial markets. But federal regulators have various tools to stimulate the economy, Shipchandler said, including lowering certain interest rates and suspending trading on Wall Street if stock prices fall too far too fast.
Q. Why should I care if the markets are down?
A.
If you don’t own stock in individual companies, you might think you’re not affected. But your retirement money might be riding these ups and downs if you’ve been contributing to a 401(k) or an individual retirement account. Even though market dips are scary, remember that you don’t lock in the losses unless you sell your shares. As long as you own the shares, you stand to benefit when the markets bounce back.
In addition, when banks and credit unions tighten their credit standards, you can end up paying more in interest on your credit card balances, your home equity loan balance, auto loans and other loans.
Q. How far back does this problem go?
A.
One factor that created the credit crunch was the ultralow interest rates that were available from 2002 to 2004. The Federal Reserve lowered those rates in a series of cuts after the terrorist attacks of Sept. 11, 2001, to stabilize the economy. The rates served as an entry for some people who previously would have been shut out of the housing market until they had saved some money and established a good credit history. Those are some of the same people who have defaulted on their loans.
Q. Is there any end in sight?
A.
Ilyce Glink, an author and nationally syndicated real estate and personal finance columnist, said during a conference call that her sources say the housing market won’t improve before 2009.
In the call, sponsored by the Society of American Business Editors and Writers, Daniel Wagner applied logic as he tried to forecast the end of the subprime mortgage crisis. The Newsday reporter, who covers American Home Mortgage, reasoned that the financial repercussions will continue for as long as homeowners continue to be hit with big jumps in their adjustable-rate mortgages. Those loans, with rates that readjust after two years, were made through the end of 2006, Wagner said.
“I think it’s unavoidable that the fallout will continue at least for the next 18 months,” he said.
Todd Cook, president and chief executive of Debt.com, isn’t optimistic.
“I don’t think we’ve seen the bottom yet,” he said. “I think it’s far from over.”
Q. What is the federal government doing to protect borrowers?
A.
One response is requiring lenders to give loan applicants timely, easy-to-understand information about adjustable-rate mortgage products.
The federal financial regulatory agencies, including the Board of Governors of the Federal Reserve System, on Aug. 14 released a proposal for what those statements would say. In it, the government warns borrowers that adjustable-rate mortgages have a reduced initial interest rate that makes early payments low but that automatically will increase.
Also, monthly mortgage payment projections might not include an amount to cover taxes and insurance. The loan could require a balloon payment, which forces the borrower to pay off a large portion of the loan all at once instead of gradually. And borrowers who can’t prove a steady stream of income could be charged higher interest rates and other costs.
Some members of Congress want the federal government to provide more tangible help. They support a plan to provide $100 million to non-profit housing groups to help troubled subprime borrowers.
One approach would be to allow the Federal Housing Administration to insure more mortgages.
“FHA will be an important tool in providing mortgage financing,” said Sturges, of Hallmark Home Mortgage. “They are not credit-score driven and rely on the entire loan package to make their decision rather than on a particular credit score threshold.”
Some industry insiders hope the government keeps its hands off the mortgage industry, however. They argue that markets are efficient and don’t need intervention from federal regulators.
Some consumer advocates, on the other hand, are concerned that allowing the mortgage industry to correct itself might create a scenario in which some minorities and the poor are effectively shut out of home ownership, creating a social issue.
sslater@jg.net
