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Subprime mortgages
Michael Mandel serves up a dose of common sense:
...subprime adjustable-rate mortgages, which are the heart of the problem, make up just 7% to 8% of the total home mortgage market. Still, in absolute terms the size of the defaults could be enormous. Some estimates suggest that banks and other lenders could take a hit of $300 billion or more.
But remember, the tech bust devoured about $9 trillion in corporate equity; next to that, the subprime problem looks like an insect bite—unless it spreads to the rest of the mortgage market. But at least so far that doesn't appear to be happening: Mortgage rates for good borrowers have actually been going down. In early February, for example, the average rate for 15-year fixed rate mortgages was 6.06%, according to Freddie Mac. As of Mar. 8, that was down to 5.86%.
For an alternative perspective, here is Nouriel Roubini's Who is to Blame for the Mortgage Carnage and Coming Financial Disaster? Unregulated Free Market Fundamentalism Zealotry.
In other words, I am to blame. If not me, then Alex. Blame Alex.
Posted by Tyler Cowen on March 20, 2007 at 06:40 AM in Economics | Permalink
Comments
Roubini's essay is embarrassing.
Posted by: jult52 at Mar 20, 2007 8:27:07 AM
with all due respect Tyler, when naughty nouriel sez:
"This fairy tale spinned (sic) by free market supply side voodoo fundamentalism zealots"
I'm pretty sure he's referring to me!!!!!!!!!! After all I'm typing this in a room filled with free market voudou flags!!
Posted by: kevin at Mar 20, 2007 8:51:57 AM
What concerns me is the impact of losing the marginal 7-8% of home demand will have on overal prices (they seemed to be the highest bidders for homes).
Posted by: nelsonal at Mar 20, 2007 9:15:00 AM
Anyone care to compare the impact of those potential failures with the Japan property market bust?
Posted by: Andy at Mar 20, 2007 9:37:01 AM
Has Roubini jumped the shark?
Posted by: GN at Mar 20, 2007 9:39:08 AM
As someone looking to get into the housing market in the next 18 months or so, a meltdown sounds pretty sweet to me.
Posted by: Independent George at Mar 20, 2007 9:52:11 AM
Tyler and Alex are probably also responsible for the "Bretton Woods II" China currency peg and its subsequent collapse and the global economic disaster that followed it, which according to Roubini happened three years ago, or maybe two, or maybe last year, or maybe this year, but if not, then next year for sure.
Posted by: eddie at Mar 20, 2007 11:04:35 AM
Has Roubini jumped the shark?
Yes. Though in fairness he joins a number of would-be Fonzies, not least the folks at Calculated Risk, who appear to be well on the way to gold-buggery and hoarding food & ammo in the basement in the face of the current "meltdown". Nevermind that Potter isn't selling, he's buying.
Posted by: Bernard Guerrero at Mar 20, 2007 11:04:49 AM
Yeah, 8% of home owners defaulting on mortages will have a marginal impact on the housing market. It isn't like there's already excess supply in the market or mortgage payment afforability is at historical lows. The mortgage market is perfectly compartmentalized to contain that slice of the pie charts you're all looking at.
These are the same tools who were saying that the market was perfectly healthy in 2005 and 2006 and the risks were so small that fundamentals supported market. In six months I wonder what the naysayers taking pot shots at pessimists will be saying.
Posted by: Mark at Mar 20, 2007 11:35:45 AM
So the real question to ask is this: How does the crisis in the subprime mortgage market stack up against previous meltdowns? Is this going to be the Big One?
The short answer is, not likely. In a Feb. 20 speech, Federal Reserve Governor Susan Schmidt Bies estimated that subprime adjustable-rate mortgages, which are the heart of the problem, make up just 7% to 8% of the total home mortgage market. Still, in absolute terms the size of the defaults could be enormous. Some estimates suggest that banks and other lenders could take a hit of $300 billion or more.
...
In early February, for example, the average rate for 15-year fixed rate mortgages was 6.06%, according to Freddie Mac. As of Mar. 8, that was down to 5.86%. If low rates continue, they should actually prop up most of the housing market (see BusinessWeek.com, 2/19/07, "Out of the Basement for Housing").
So what if the 15-year fixed rates were down for those with the best credit? If move-up sellers can't sell to entry-level buyers ---- looks like the subprime market's effects will definitely be felt and resonate upwards.
BTW Mark is spot-on
Posted by: Varangy at Mar 20, 2007 11:55:10 AM
In six months I wonder what the naysayers taking pot shots at pessimists will be saying.
"Hold still, darn you!" [Bang! ptwing...] "I told you, Jim, you've gotta lead 'em."
Posted by: eddie at Mar 20, 2007 11:57:24 AM
Once you've read it in Business Week it is already old news. While Mandel may be correct that the average long only investor with a well diversified portfolio may have a reasonable hope of not getting too badly hurt by such volatility, the market is more complex, and many investment strategies these days are much more dependent on shorting and leverage than historically. Private individuals are more exposed to illiquid property and less diversified.
Structured finance has not been seriously tested in a downturn, and it certainly is not clear to me that it is understood even within the risk management competency in every fin institution or regulatory environment, since some of the innovations have been so recent and rapid, and internal systems are not yet all able to produce risk assessments across the institution on the fly for catastrophic events.
Optimistically, you can say the derivatives market creates a much more efficient fin services industry, like just-in-time delivery and supply chain management, and I can buy into those arguments. But as the UK found only a few years ago a tax-driven strike by a handful of lorry drivers was enough to bring the country to a near stand-still in a matter of days because of fuel shortages.
And we should also know there are mischief makers out there who spend their time looking for vulnerabilities in the financial system and will target them.
Posted by: knackeredhack at Mar 20, 2007 12:26:15 PM
Mr. Mandel notes that the subprime market is estimated to be 7-8% of the total mortgage marker. I suspect that Mark is a bit too pessimistic in thinking that 100% of that market will default.
I read some of the permabears just to see if they have anything interesting to say, and I am always amazed at their ability to find the dark lining in the silver cloud. I think the bears are driven in part by political partisanship, but also by the feeling that they really know what danger we are all in, and the rest of us are just fools who will be dashed on the rocks by this year's coming crash.
Thanks to MR's recommendation, I am a regular reader of www.dailyspeculations.com, which is a great antidote to the doomsters.
Posted by: Rich Berger at Mar 20, 2007 12:54:08 PM
Obviously the borrowers who default will be hurt, as will those subprime specialists who suddenly have zero customers. These subprime specialists are already in the process of being "shot and killed" by the financial markets and no longer have the financing to securitize their loans. Also whoever is holding this securitized paper have some serious losses.
But the sound subprime lenders will come out ahead in this I think, as will those banks with minimal subprime business. It is true that some would be borrowers will no longer be able to borrow until they save enough to put down a reasonable down payment, but this isn't such a bad thing is it? Living in an apartment and saving money is hardly the end of the world.
There won't be a financial crisis like in the early 90's, or like in Japan's bust. Japan went bust because their banks were unsound, and they refused to recapitalize them and shoot the rest. We won't have that problem here because the market is already way ahead of the regulators and as I mentioned has been shooting the bum lenders for some time now.
The real question is how much spillover into the rest of the economy there will be from "the wealth effect", and from the "sudden" wipeout of wealth from reduced housing prices that hurts companaies that make a significant margin of their sales from people who borrow to buy at Circuit City or at their local motorsycle dealership (the non-subprime set pay "cash").
Posted by: happyjuggler0 at Mar 20, 2007 1:11:01 PM
The correct answer is that this is unchartered territory.
The key to loose lending is that it works as long as home values increase. Without the equity to tap, the loss severity potential is very high.
Everyone is focusing on subprime, but delinquencies accross all products (alt-a, other home equity and prime) have dramatically increased.
The Fed cannot lower rates to save potential defaulting borrowers because he has said that their goal is to fight inflation. By doing nothing, more floating rate borrowers, not just subprime, will be adjusting at higher rates that some cannot afford. This will increase defaults. They can only lower rates if and when this becomes a big problem.
Saying that the 15 year rate is lower is pratically irrelevant for current borrowers. Arms reset with LIBOR, a floating short rate, not the 15 year, a fixed long rate. Could they refinance into a 15 year? Yes, but more than likely their payment would be higher and they would take a hit on their house because the value has declined. Most people would not make that trade.
Let's just forget the lenders for a moment and discuss all of the other services related to housing. Using the 7-8% of all housing (the real number is actual about 15%), will builders, realtors, title companies, furniture stores, hardware stores, or any type of remodelers or home maintenance shops be negatively affected by this segement loss? Sure, now add all of the non subprime home owners as well. Yes, there will be some offsets in foreclosure related firms, but not much of an offset.
Lender have already started to become a little more conservative in their lending practices. Combine this with any idiotic plan Congress will come up with now to save future borrowers and you have a problem for current subprime borrowers who are delinquent. If they try to refinance to avoid foreclosure, they will not qualify for any loan program and will loose their house.
That is just the economic side, the fixed income side is a whole other ball of wax....
Posted by: Patinator at Mar 20, 2007 1:15:27 PM
Mr. Mandel notes that the subprime market is estimated to be 7-8% of the total mortgage marker. I suspect that Mark is a bit too pessimistic in thinking that 100% of that market will default.
Aye! :^) As to the perma-bear delusion, one need only note how often Bill Fleckenstein gets his butt handed to him, and he's one of the ones who is worth listening to. Another dose of antidote: Felix Salmon
Posted by: Bernard Guerrero at Mar 20, 2007 1:21:33 PM
Wow reading Nouriel I picked up these tidbits. Angry much Nouriel?
Also I like how Roubini goes into how he/she can look into the hearts of those that borrowed for a condo to see if they were a flipper or were duped to divine if they should get a government subsidy or not. It is good to be king.
I'm amazed at the number of "toxic wastes" ... beats out "voodoo priests and their acolytes"
a cabal of supply side voodoo ideologues -
other assorted voodoo religion priests
proof-less dogma
free market supply side voodoo fundamentalism zealots
toxic waste
voodoo religion cabal
voodoo economics religion priests
toxic waste
free market zealot and fanatics and voodoo economics ideologues
main religious dogma of this cabal
ideological zealotry
gang of voodoo economic hacks
bunch of voodoo priests of laissez-faire capitalism
the disease of a reckless patient who lived in a bubble
priests of a voodoo religion
this cancer to grow and fester.
free markets voodoo religion
voodoo priests and their acolytes
voodoo free market system of financial incentives for lenders
toxic waste
toxic waste
oligopolistic credit rating agencies
toxic waste
toxic waste
toxic waste
excesses and monstrosities
monstrous bubble to be created, to be allowed to fester
free market fundamentalist zealots
voodoo economics hacks
zealots who want low taxation of capital
free market fundamentalist zealots who love no regulation and little taxation of capital for this sorry state.
free market zealots
voodoo religion hacks and zealots
greedy cowboys
toxic waste
toxic garbage
private sector crazed mania
toxic waste
Free market fundamentalist zealotry
free market fundamentalism zealots
dogmas and free market fundamentalism
ideological zealots
Ideological supply side voodoo zealots
unregulated free markets fundamentalism
Posted by: BlogReader at Mar 20, 2007 1:35:48 PM
Roubini hates freedom :-)
Posted by: brianS at Mar 20, 2007 1:46:25 PM
Roubini does not hate seeing himself in print. :^)
Posted by: Bernard Guerrero at Mar 20, 2007 2:29:59 PM
The comparison of the $9 trillion in dot com equity to $300 billion in mortgage lending is misleading. When Cisco lost hundred of billions in market cap the economic loss wasn’t nearly that much, but some billion of dollars Cisco spent to make routers that weren’t needed. Whereas a much greater portion of the $300 billion in mortgage lending is likely to have lead to the building of uneconomical homes.
Posted by: sort_of_knowledgeable at Mar 20, 2007 6:27:07 PM
Japan did not have an influx of immigrants to stabilize its real estate bust.
Just in my block I know of several houses being lived in (rented I believe, but who knows?) by recent immigrants.
My HOA wants to try to kick them out because they are "crowded houses"...
As long as people want to move to the US, and are allowed to (in reality, versus in law), property values will rise.
Posted by: Mr. Econotarian at Mar 20, 2007 6:38:01 PM
My main concern has nothing to do with the defaults of sub-primes, but what occurs to an industry that, as MotleyFool acknolwedged in September 2006, largely looked like a "Ponzi" scheme in relation to the skyrocketing prices of homes. New lending practices encouraged rampant speculation, and the effects of the fallout will not just fall on those who took such risky propositions, but those who lived around them.
For instance, on my street, and elderly family had to sell their house because they could no longer afford the property taxes with their pensions and government benefits. Home prices have doubled in that neighborhood sine 2003.
If someone can explain how its logical and economically efficient for home prices to double in 4 years while seeing no real change to the surrounding economy, I might view the current problem different.
Posted by: Popick at Mar 21, 2007 1:45:13 PM
We all believe in markets right? That markets will swing over and below where they should rationally be from time to time (Keynes "animal spirits) and that investors have to take it on the chin when they chase deals that are too good to be true. Yes, there will be some impact on the overall economy from the sub-prime meltdown. It will not kill the economy and the pain to the average person will be minimal and short term. Some pain is the price we pay for relatively free markets. Or we can over regulate and have everybody share in a greater pain from a much less rich economy.
Posted by: Murphy at Mar 21, 2007 2:57:18 PM
Casey Serin, foreclosure expert (sic), made the economist for next week's cover story
Posted by: Popick at Mar 23, 2007 12:14:41 PM
Over a year ago, Roubini claimed there was a 70% chance the economy would be in recession by the first quarter of 2007. As a "supply side voodoo zealot" with a much better forecasting record than he has, I sometimes try to help Mr. Roubini see himself in print. Here is an example:
http://www.cato.org/pub_display.php?pub_id=8119
Posted by: Alan Reynolds at Dec 7, 2007 10:18:20 AM
