Chuck Ponzi January 28th, 2007
The Orange County Register featured an article today about the growing subprime debacle that is unfolding in slow motion. (BTW, can you really call it slow-motion when
16 mortgage lenders have imploded since December 2006?)
Some real gems are in the article:
Perhaps most troubling, loans made by Orange County companies in 2006 were among the quickest to see defaults, data show.And many of those subprime companies – which tend to cluster here in Orange County – are in trouble.
Some time ago, I noted that Orange County could discover that the mantra “It’s different here” might have a negative connotation, that it’s worse.
17% of Orange county’s employment base is Real-estate related.This represents the highest number, and the highest share of total jobs occupied by real estate on record. We have often heard that the 1990’s bust of housing caused by job-losses in the manufacturing sector; we are more diversified out of manufacturing since then and it doesn’t represent the same risk. Pish-posh. We are out of manufacturing and much heavier in real estate.
From the OC Register article, we learn that people are overstretched here. Not only in a risky industry, but their own homes as well.
According to UBS what did they do wrong?
They didn’t scrutinize borrowers’ incomes, and they allowed subprime borrowers, who by definition have had past problems with their credit, to take on lots of risk.
Borrowers took advantage of “stated income” loan programs, where they simply tell lenders what they earn, said David Liu, director of UBS’ mortgage strategy group. And many first-time homebuyers made a small down payment or none at all. Often they took out simultaneous second mortgages to avoid paying mortgage insurance.
We in the blogger world have been fond of calling this “risk layering”. What is risk layering? It is what is called taking what a normal lender could hande for a single risk and layering several more on top of them. What are some of them we know of?
1. 100% or near 100% of value mortgages. (This includes new 80/20 Loans)
2. Low Credit Score
3. Interest Only or Negative Amortizing Loans
4. Prior Bankruptcy (even 1-day out of BK loans)
5. Multiple income Borrowers
6. Stated-income or No/Low Documentation
7. Back-pocket appraisers
The problem is not that any one of these risks exists in a vacuum, but that they often simultaneously existed on MANY loans.
An Accurate OC Fact: I have an acquaintance who has an 80/20 Negative Amortizing loan with a state income/no documentation, and he has a low credit score (and his broker had to bring in an appraiser to inflate the value so his closing costs were funded from the loan). He has absolutely zero skin in the game. Does he care if the stated rate is 8%? No, because his payment for the negative amortizing loan is about 3%, and it doesn’t reset for another 8 months. On a 1.5Mil loan… good luck with that one.
An even more onerous problem is cash-back at closing. When a lender is led to believe the value of a home is greater so that the buyer (or seller) recieves cash back, it is illegal (and yet this kind of mortgage fraud happens far more often that most believe or understand). I have heard reports of it occuring in over 25% of all loans in the past 2 years.
So, what does the future portend for home buyers… no more risk layering? Somehow I doubt that the entire industry can turn on a dime after the past 2 years of outrageous lending, but there are some margin improvements reported in the OC register:
Like Fremont,
New Century has taken further steps to make its underwriting more restrictive, according to the company.
Several of the new rules affect first-time buyers. New Century won’t lend them money if they don’t plan to live in the property they’re buying. And if first-time buyers are putting less than 10 percent down with a “stated income” loan, they need to have savings equal to six months worth of mortgage payments.
Tony Meola, executive vice president with loan production at New Century, said the company is acting more from a sense of prudent lending than from pressure by government agencies or investors in its mortgages.
We’ll just have to see how much influence “investors” will have in the future since they are the ones determining how much risk they will ultimately accept. I suspect that the problems so far are not yet systemic in scope. However, if cross-defualts occur (one default causes another) among lenders, that will change dramatically to account for borrower AND lender risk.
