Think-3 Investment Idea Sharing Platform

Risky Mortgage Business

New York Times Editorial
July 6, 2005

By any measure, the housing boom - now almost four years old - is one for the record books. A recent study by The Wall Street Journal found that in 55 places, housing prices had risen by at least 30 percent in three years, after inflation. Together, those 55 markets now account for an unprecedented 40 percent of all housing value in the United States.
What makes this boom particularly unnerving is that it owes much of its longevity to the explosion in the number of risky mortgages. Many borrowers are likely to be pinched, if not creamed, when interest rates rise or housing cools, leaving them unable to make payments, refinance on favorable terms or sell at a profit. Lenders may be even more vulnerable than borrowers, which may mean an economywide disruption if - or when - housing prices stagnate or decline.
The traditional mortgage - 20 percent down with a fixed interest rate - is being eclipsed by loans with low down payments or none at all, many with adjustable interest rates. These inherently risky mortgages are now routinely offered with features that allow a borrower to pay only the interest due for an extended period, or, even more dicey, with the "option" to pay less than the interest due each month while adding the unpaid portion to the loan balance. One-fourth of all home buyers - including 42 percent of first-time buyers - made no down payment in 2004, according to the National Association of Realtors. Nearly one-third of all new mortgages this year call for interest-only payments (in California, it's almost half), according to Loan Performance, a mortgage data firm.
Another risky aspect of these sorts of mortgages is that they attract relatively hard-pressed borrowers. Egged on by lenders where mortgage-making has been the one consistent profit center, they tend to be people who can't afford a traditional fixed-rate loan - even at the current low rates.
It's a safe bet that lenders wouldn't be so freewheeling if they had to worry about being paid back in full. But it's unusual for lenders to bear the entire risk of the loans they make: they sell many mortgages to private investment banks, which slice and dice them into various securities - an interest-only portion, say, and a principal-only portion. Those securities are then sold to other investors, like mutual funds, pension funds, hedge funds, European insurance companies and the central bank of China, to name a few. Investors now hold $4.6 trillion in mortgage-backed securities. That's more than the outstanding value of United States Treasuries.
So far, the mortgage-backed market has generated cash and profits galore. Someday, however, someone will lose money. No one knows who, when or how much because housing has never been so frothy, risky mortgages so ubiquitous or the market in which they trade so vast. Also unknowable is the quality of lenders' and investors' hedges, the complex investing strategies that are supposed to cover losses in the event of turmoil, like a default-inducing spike in interest rates. Many of the players in this market are not subject to government regulation, and those that are haven't exactly been under the microscope. Last May, federal banking regulators announced that they planned to issue new guidelines for mortgage lenders - as soon as early next year.
The lack of transparency, meanwhile, is a growing risk in its own right. Lenders and investors know they are interdependent, but they don't know which ones may be a weak link or which may be left holding the bag when economic conditions change. Such uncertainty could make lenders skittish about giving mortgages to either good or bad borrowers.
The rates on half of all adjustable-rate mortgages reset within three years of being issued, suggesting that trouble may be just around the corner. It's high time for Congress to focus on the implications for the entire economy of boom-time mortgage lending - and for regulators to pay more attention.

posted by Henry @ 10:34 AM