2007 October

Who is to blame for this current state of affairs? The media seems to like to point the finger at the mortgage industry and specifically at mortgage brokers. As a Mortgage Broker, myself, I know that brokers had very little to do with the mess that we are currently seeing. The media (and certain regulatory bodies) say that brokers arranged the loans that are now in default, so we are to blame. However, there are far too many other players in  this game… players that stand to make a lot more money than a lowly broker. Who is to blame? The Broker? How about the Realtor that put them in the max house they could afford? What about the Mortgage Lender that offered the loan as a product for brokers to sell? They can only offer a product that they know will be backed by the investors, so ultimately the investor (the very player that has incurred the most losses) created their own “poison-pill.” They agreed to back these very high risk loans (at the advice of fund managers and bond traders), but when the foreclosures began to mount up, they were the first to pull out of the game (and file suit against the Mortgage Lenders to try to make them give back their profits in order to off-set the Investors’ losses.

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The main causes are high foreclosure rates, excessive losses to the funding sources, a decline in property values (in several large markets), a much greater number of “exotic” mortgages held by consumers, and the adjustment of many ARM loans to levels too high for homeowner’s to maintain. You may be wondering what is an “exotic mortgage”? This is the term that federal regulators have come up with to describe both Interest Only mortgages and Negative Amortization mortgages. Interest Only loans have a time period where you only pay the interest of the mortgage- The monthly payment is less than a normal mortgage, however the balance of the loan remains the same. A Negative Amortization mortgage goes a step further by offering the borrower the opportunity to make an extremely low payment each month, but the difference between that low payment and the actual amount of interest on the loan is added to the balance of the mortgage. Basically if you make the cheap payment, you end up owing more than where you started.

The Cause:             All of the causes above could really be expressed as one cause, but the media likes to break them up because it makes for better headlines, and they can talk about a different cause every day of the week. I’ll use an example to illustrate the basic chain of events that has caused a huge mess- Meet John and Jane our homebuyers/homeowners. John and Jane are shopping for a home in late 2005. They employ a real estate agent to help them. Eventually John and Jane buy the absolute biggest house that they can afford at the advice of their Realtor; they use a 100% Interest Only (Exotic) Loan to be able to afford it; they had some credit issues to start and no savings so their loan is a “non-conforming” loan; they initially got the loan with intent of refinancing it before the adjustment date; during the 3-yr fixed period on their loan, the INDEX that drives the adjustment increased over 4%; the public sees that rates are increasing, so home sales slow down; John has some bad luck and gets laid off his job; the ADJUSTMENT DATE comes… This is were it gets ugly- Their interest rate increases by 4% and there payment changes to a PRINCIPAL and Interest payment rather than an INTEREST ONLY payment. During that 3-yr period, John and Jane only paid the interest on the loan, so they own the same principal balance as when they began. Since they got a 100% loan, they, in effect, owe 100% of the market value of the home. Add to that the fact that sales have slowed in their area; houses sit on the market; sellers lower prices to get rid of them; the value of John and Jane’s home has just decreased. This scenario happened millions of times across America as every joined in the housing boom that carried our economy through out the recent recession.

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During your busy schedule, you may not have had the opportunity to keep up with everything that has occurred and that is forecasted in the housing and real estate industry. As a homeowner or potential homeowner, many of these events will affect you, be it through changes in the value of your home, or the availabilty of mortgages, or possibly your financial situation if you work in a housing industry-related field. The housing industry and its many related sub-sectors make up a huge portion of the national economy- banking, building, appliances, steel, office leasing, equipment leasing, equipment manufacturing, highway and road construction, local government, schools… the list is endless. All of these industries depend heavily on how many houses are built as well as how many houses are sold. Let’s start by looking at the mortgage industry since it has been making headlines lately.

Since late 2006 a total of 167 major U.S. lending institutions have closed their doors. These companies range from very large operations with 100+ offices across the U.S. employing over 7,500 people, all the way down to “mortgage divisions” of larger parent companies. The majority of the companies that have been forced out of the industry have been “non-conforming / sub-prime” lenders and “Alt-A” lenders. These are two classifications of lenders that basically offered mortgage products that fit consumers with either credit challenges or non-standard income or employment situations. When these companies closed their doors, the loan products that they offered disappeared as well. The types of mortgages available today are drastically different than just one short year ago. In upcoming posts we will look at some of the causes…

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