The daily headlines are alarming: homeowners are falling behind on mortgage payments at an increasing rate; foreclosures are up steeply.
Over the past few years, interest rates fell to a low point that hadn't been seen in decades. Aggressive loan underwriting fueled the housing boom, helped drive the economy and opened up the American Dream to millions.
Now that dream has become a nightmare for some. The phrase "subprime mortgage crisis" has become boilerplate. Presidential candidate Hillary Clinton has proposed a freeze on foreclosures.
Has the situation ever been this bad before? Well yes, said Jay Brinkmann, chief economist of the Mortgage Bankers Association.
Speaking at the first real estate conference put on by the Center for Real Estate Theory and Practice at the W. P. Carey School of Business on February 22, Brinkmann said the downturn for the industry is in many ways a fairly typical one.
"People ask me 'Where's the real estate industry now?,'" he said. "I tell them, 'Not too far from where we crashed the last time.'"
But there is one major difference, he cautioned. Usually, rises in delinquencies and foreclosures occur during a recession. Observers fear that real estate woes will drag the country into a recession, if the economy is not already there. Economists have so far declined to state that the U.S. economy is in recession, although government statistics and other indicators show it is slowing. The data required to declare that a slowdown was a recession is not available until several months after the economy begins to contract. Often, such as in 2001-2002, the recession is over before economists make the official call.
In any case, a serious recession would make a painful situation in the real estate industry even worse, Brinkmann said.
Problems with subprime mortgages have received most of the media attention -- but they do not tell the whole story, Brinkmann said.
Adjustable rate mortgages -- or ARMs -- made to borrowers who are deemed subprime because of risk factor such as income and credit histories have resulted in a disproportionate share of problems. Subprime ARMS make up just 7 percent of the mortgage market, Mortgage Bankers Association figures show. But subprime ARMS account for 43 percent of the foreclosure starts.
Subprime fixed rates make up almost as much of the mortgage market -- 6 percent -- but contribute 12 percent of the foreclosures.
Prime ARM's are also culprits. Those mortgages make up 15 percent of the market and contribute to 19 percent of the foreclosure starts.
"Clearly the ARMs are not working as they were intended," Brinkmann said.
The 30-day delinquency rate on mortgages is lower than it has been in the past four recessionary periods. But the 90-day delinquency rate and foreclosure starts are the highest they've been since the association began.
Subprime ARMS have been criticized for their draconian terms, which, after a couple of years, extract such escalating payments that borrowers are sometimes forced to default. And, in many cases, Brinkmann said, the borrowers are defaulting before the interest rates go up.
Anthony B. Sanders, a professor of finance at the W. P. Carey School of Business, adds another point.
"There were a large number of housing speculators in the last housing boom that had the intent of refinancing their ARM before the reset date in order to earn a large capital gain on housing," he said. "When housing prices turned flat or downwards, these speculators decided to default if they could not break even on their housing sale. That is why the concept of bailing out housing speculators is met with derision by most taxpayers."
The dark picture on mortgages nationwide is colored by what is happening in California and Florida, Brinkmann said.
These are the two largest states for home mortgages, Brinkmann said. For a long time the booming real estate markets in those states were making the national numbers look better. Now California and Florida are dragging the national figures down.
Mortgage Bankers Association figures show that the two states account for about one-third of the subprime ARM foreclosure statistics nationwide, and 42.4 percent of the prime ARM foreclosure starts.
California real estate prices are generally among the tops in the continental United States. Creative financing options have been a characteristic of this market, even for borrowers with strong credit and relatively high income. About one-quarter of all prime ARMs are in California.
The day that Brinkmann spoke, Economy.com reported that 10.3 percent of homeowners with mortgages nationwide owed more on their homes than the market value. Trends such as this one are "being driven by what's happening in California and Florida, because those are such a large portion of the market," he said.
A case could be made, he added, for separating California and Florida in order to get a clear picture of what is going on in the rest of the nation.
Flip this house
Real estate speculators played a role in the mortgage mess. This was the era of the TV show "Flip that House" and a web site called condoflip.com with the motto "Bubbles are for Bathtubs." There were buyers who applied for mortgages as owner/occupant on as many as 25 homes at one time, all closing on the same day, Brinkmann said.
"I suppose you could buy up to 30 and claim you were living in each one day of the month," he said. "I don't know what you do with February."
A lender's nightmare is a scenario where speculators who realize that home appreciation no longer provides a quick profit walk away from the property.
The Mortgage Bankers Association survey shows that 22 percent of the foreclosure starts in Arizona, Florida and Nevada came from investor-owned properties. Surprisingly in California, a longtime bastion of land speculation, investor mortgages only account for 11 percent.
"Frankly, I don't believe that number," Brinkmann said, adding that a major lender did not participate in the survey.
Is there a way out of all of this? It's relatively simple in states such as Arizona, which have consistently seen population and employment grow, Brinkmann said. The local supply of housing merely outstripped the demand -- but that's a temporary problem. A recession, with the accompanying contraction in employment, would prolong and deepen the housing slump and worsen the situation for mortgages.
In a state such as Michigan, hard hit by troubles in the auto-making industry, the answer is more elusive.
"I don't know what we do about stranded supply in these states where people are leaving -- and they're not coming back," Brinkmann said.
The out-migration pattern of people with college degrees is a bellwether trend for the future of housing markets, he said. Graduates of Midwestern universities are moving to Sun Belt states, and they are the group mostly likely to become homeowners.
If there is a winner in the housing slump, it is multifamily builders and owners. From 2002-2005 they got hammered. "We were taking people out of the apartment market," Brinkmann said. But 2006 saw the first decline in the formation of the single-family owner-occupied home since the Mortgage Bankers Association began surveying it in 1990.
As for a need to rein in subprime lending, the market has taken care of that, Brinkmann said. Adjustable rate mortgages are tied to indexes such as the LIBOR. Recent cuts by the Fed means that interest rates on ARMs won't be going up. And with all the write-offs and widening credit problems from the subprime sector, lenders just aren't making the loans any more.
"It's down to about 2 percent of the market," Brinkmann said.
- The current mortgage crisis is in many ways typical for a downturn in the housing market, except that it is happening seemingly without a recession.
- Subprime mortgages -- specifically subprime adjustable rate mortgages -- are driving the increase in foreclosure starts.
- Because of their robust markets, California and Florida once lagged the nation in foreclosure starts. They've now accelerated past the rest of the nation. The size of these two states skews the national outlook somewhat.
- Brinkmann said there's little need for new regulation of the subprime market. Low interest rates will keep higher payments from kicking in with existing loans and new loans in that sector have all but disappeared.
- Sanders agrees with Brinkmann's assessment that there is little need for new regulation. In addition, Sanders argues that increased consumer education and awareness is the best preventive measure for mortgage market ills.