08.16.07

Subprime Crisis

Posted in Finance at 3:33 pm by Valentine

Me: “R., don’t put that cup down on the bed or it will spill. Be careful to hold the cup or it will spill.”

[I walk out of the room for a moment. Thirty seconds later…]

R.: “Baba, the juice spilled! Help! The bed is all wet!”

The “subprime crisis” continues to rock the global financial markets, pressuring everything from consumer spending (Walmart has cut their earnings outlook) to corporate bonds (reportedly the core of the Sowood Capital Management strategy). A few thoughts…

1. It is potentially much broader than the title “subprime” would have you think. Any adjustable rate mortgage written with a high loan-to-value is potentially at risk right now, including the majority of “Alt-A” loans and even some “prime” loans. There will be a rise in foreclosures across the country, particularly in those markets where speculative investment was most rampant. California is especially at risk.
2. Investors are presently spooked by the rising swell of defaults, yet the wave is not projected to peak until the middle of 2008 at the earliest (reflecting the 2004-2006 boom in riskier mortgages). If your financial situation is sufficiently stable to qualify for a “prime” mortgage, you may find some excellent housing bargains next year. Until then I imagine there will be heavy downward pressure on real-estate prices.
3. Anybody could have seen the potential for this collapse. In fact some analysts did warn us of the excesses in the mortgage market as early as the spring of 2005. As a nation, we paid them little more heed than R. does to my own warnings.

The rest of the story is perhaps best told through quotes dug out of the archives. Some of the contradictions are particularly ironic.

• February 2004: “Many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade.” — Alan Greenspan
• April 2005: “Lenders have become more lenient, but not because they are irresponsible or irrational. With the help of credit scoring, lenders have fine-tuned how they measure credit risk, he said.” — LendingTree president, Anthony Hsieh
• April 2005: “What is new today is that lenders are allowing for the layering of risks on top of one another. What we don’t know is what if we put all these risks together and put them in a rising interest rate environment, a declining housing market, or a weakening economy.” — Keith Gumbinger, vice president for HSH Associates
• April 2005: “For borrowers who are stretched thin, this leaves little equity cushion if the value of the home declines.” — Greg McBride, senior analyst for Bankrate.com
• June 2005: “The apparent froth in housing markets may have spilled over into mortgage markets. The dramatic increase in the prevalence of interest-only loans, as well as the introduction of other relatively exotic forms of adjustable-rate mortgages, are developments of particular concern.” — Alan Greenspan
• August 2005: “If you own your own home free and clear, people will often refer to you as a fool. All that money sitting there, doing nothing.” — Anthony Hsieh

Finally, let me recommend this essay by Nobel laureate Joseph Stiglitz.

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