With the national media frenzy accompanying the concerns about weakness in the subprime mortgage market, it has been difficult to discern what is actually happening. In this article, I attempt to point out a few facts that may help put things into perspective and comment on the subsequent relevance for Mississippi.
Let’s first examine the current situation. Relying solely on the national reporting on this issue would leave one with the impression that homeowners are defaulting in mass on “bad loans” made by lenders, and these defaults are putting financial institutions out of business. While there may be some truth to this, the data doesn’t support this scenario.
For example, delinquencies on one-to-four unit, residential first-lien mortgages were up .43 percentage points in the first quarter of 2007 compared to one year earlier, according to the Mortgage Bankers Association (MBA), and foreclosures for subprime adjustable rate mortgages (ARM) were up .53 percentage points. These changes are significant but by no means reflect historic highs.
Additionally, a careful read of the MBA report by economist Doug Duncan indicates that these increases are being driven by a handful of states that have experienced sharp economic downturns and are not reflective of what is happening nationwide.
In fact, the foreclosure rate on these types of loans (subprime ARM) actually declined in 26 states, and the nationwide rate would have reflected a slight decline had it not been anomalies in the states of California, Florida, Nevada and Arizona. The data also indicates that were it not for the isolated activities in a small number of states, overall foreclosure rates would be below the average for the last 10 years.
These figures suggest that the critical source of the melee is not the subprime borrower or even the lenders, but a result of the securitization of real estate. Almost universally, long-term residential (and much commercial) mortgage debt is eventually converted to some form of securities instruments and publicly traded. This means that lenders that underwrite and fund these loans are basically nothing more than intermediaries. This structure allows buyers lower monthly payments by providing lower rates and longer terms but has a consequence — Wall Street is tied to Main Street.
Wall Street has displayed a vigorous appetite for Main Street in recent years. Mortgage-backed securities have been one of the fastest-growing aspects of the debt market since 1995 with a particular emphasis on subprime mortgages in the last five years.
Wall Street is notoriously adverse to uncertainty. When reports began to emerge about potential unanticipated weaknesses in subprime mortgages coupled with a softening housing market and allegations of widespread mortgage fraud, this was more than investors could bear. Concerns about underwriting quality and adequate pricing for risk began to circulate as bond rating companies backed away from their ratings and investors retreated from anything labeled “mortgage.”
Heavily leveraged mortgage bankers, left with little or no liquidity, had no option but to close up shop. What we really have witnessed is a meltdown in the capital markets rather than the housing market.
That being said, we may not be left without some impact on our local markets.
Although the Federal Reserve and most economist do not believe that the “crisis” will translate into an effect on the broader economy, there will likely be some indirect impact. Lending standards will be (and have been) tightened in an attempt to woo investors back to the table. Government-sponsored enterprises (GSE) such as Fannie Mae and Freddie Mac began quietly raising underwriting standards and increasing rates for higher risk level-loans and 100% financing products early this year. Some hybrid and subprime loan vehicles, which have helped fuel much of the growth in the residential real estate sector will continue to be eliminated.
It is important to note, however, that of the 14% of all outstanding mortgages that are considered subprime, two-thirds were for refinance of existing mortgages. This suggests that the home purchase market may not be as deeply affected as believed.
Not as dramatic?
There are also other indicators that suggest the impact may not be as dramatic as some have predicted. The housing market has been gradually slowing for the past 12 months, which has allowed time for adjustments to be made for a slower market.
Nationwide it is estimated there is an excess inventory of 500,000 new homes, but the current state of the housing sector can still absorb a net increase of three million new homes per year. Prices of homes have been mixed over the past six months, which suggest a slowing growth in home values rather than depreciation.
In addition, Mississippi has experienced moderate appreciation in home prices compared to many other parts of the country which are now experiencing problems. Home prices have increased only slightly more than real income growth, thus lessening the concern over a precipitous drop in home values. Residential construction has also slowed this year, which should assist in clearing the market of excess inventory, and economic indicators suggest the state economy is stable.
I am not trying downplay the significance of the subprime issue, nor deny that there may be more consequences to come. However, I do see things leveling off in Mississippi sooner rather than later.
Brandon Roberts, Ph.D., serves as a consultant to the banking industry and is owner and president of Premier Insights Inc. and Brandon Roberts Realty Group. His research has been published in scientific journals such as Review of Policy Research, Health Economics, and International Journal of Bank Marketing and trade journals such as the Mississippi Banker. He holds a doctor of philosophy in public policy and political economy from the University of Texas at Dallas.