Economic Despair

Since December last year, 31 subprime lenders have gone to the wall.

The collapse of the subprime market is now gathering pace. Moreover, things are going to get much worse. The subprime mortgage market is dominated by exotic products - interest only, ARMs, no-docs. This year is when interest rate adjustments really start to kick in, and many vulnerable borrowers will start to suffer from serious cash flow difficulties. Already the default rate on subprime products is running at 13 percent. Expect that number to rise sharply, and as it goes up, it will take more and more subprime lenders down.

With perfect foresight, everyone now sees the horrible chain of events that lies before us. As the subprime market collapses, lenders stop fuelling loans to people with low credit. As these people exit the market, housing demand in the low income sector will fall off. However, the decline in prices will gradually infect the entire market. As prices come down, panic will set in. Housing equity will collapse, ending the HELOC-led consumption bubble. New home construction will fall off. This is all leading us to one place, foks - recession.

It is going to be ugly.

What do you make of this little announcement?

"Due to the current extreme market turmoil, we have temporarily suspended acceptance of loan applications in our wholesale lending division. Authorized personnel can log in below. We apologize for the inconvenience."

This is the message that confronts customers of Domestic Bank. Personally, I don't know too much about this outfit, but judging from the internet site, it looks suspiciously like another subprime lender.

Does this mean that my interest-only loan application has been turned down?

This is a somewhat surreal veiw of this week's stock market debacle. It seems like a couple of school children got hold of a cheap video-editing package and put together some charts.

1. Recently issued subprime mortgages are in a lot of trouble. For loans written in 2006 the default rates six months after mortgages were issued are two or three times higher than defaults at the same stage among loans written in 2005.

2. At least 13.5 percent of subprime borrowers were either behind on payments or in foreclosure.

3. The Federal Reserve reported yesterday that 2.11 percent of residential loans held by banks were delinquent at the end of 2006, the highest that figure has been since 2002.

4. In 2000, in the U.S., there just under $5 trillion of outstanding mortgage debt. In 2006, there was just under $10 trillion.

More market-destabilising news from a subprime lender. Fremont General Corp, one of the largest U.S. mortgage lenders for people with poor credit histories, said on Tuesday it will delay releasing fourth-quarter results. Furthermore, the company will not file its 2006 annual report by the March 1 deadline.


So why the delay? The company wouldn’t say. However, investors weren’t too happy with the lack of disclosure. Shares of Fremont sank 18 percent to their lowest level since May 2003.

Some 14 percent of all Americans have more than 10 credit cards. That is the shocking statistic uncovered by the National Score Index study by Experian Consumer Direct, a leading provider of online direct-to-consumer credit reports, scores and monitoring products.

Just think about a wallet or a purse with 10 plastic cards. Why would anyone need so many cards? One obvious reason comes to mind; each card is loaded with debt. Ten cards equals ten available credit lines to stock up on debt.

We live in an age of personal debt. No one saves; frivolous consumption is the order of the day. Spend, spend spend, and don't think about tomorow. So, no one should be suprised that at least one in eight Americans has at least as many credit cards as they have fingers.

The subprime market is rapidly moving into meltdown. Since December 2006, at least 24 mortgage lenders have hit the wall. Nowhere is the sense of panic more evident than in the cost of default insurance on subprime loans. In just a few short weeks, it has as gone from 0.5 percent over LIBOR to 12 percent.

Like in all financial panics, institutions are slow to react, and then move with lightening speed. As always, the credit rating agencies are behind the curve. However, once financial distress becomes obvious, they start downgrading. Standard and Poors has just placed 11 loan packages worth $146m on watch for a possible downgrade.The larger subprime lenders are desperately over-provisioning for bad loans. The British bank HSBC has set aside $10.5bn (£5.4bn) to cover bad loans in the US.

However, it is the Fed that is last to react. Complacency still rules. As Governor Susan Schmidt Bies casually said "I don't think there'll be a large impact on prime mortgages from the sub-prime market,"

Lets wait and see.

Another subprime mortgage company has gone bankrupt. ResMae Mortgage Corporation is about to be auctioned and it is going for pennies on the dollar. The opening bid, by Credit Suisse Group, is $19.1 million, less than half the size of an offer received by ResMae when it filed for bankruptcy protection on Feb. 13. Since December last year, over 24 subprime mortgage companies have closed. More are likely to follow as the people shoehorned into inappropriate housing loans start to run into payment difficulties.

ResMae’s problems follows hard on the liquidity problems suffered by Mortgage Lenders Network USA Inc. This subprime lender shut down most of its operations in December. It had been offering cheap loans to poor credit borrowers. However, it ran out of cash and was forced to meet collateral calls by its banks. The company has just filed for bankruptcy..

On Wednesday, shares of Kansas City based Novastar Financial Inc. tanked more than 42 percent to $10.10 per share. The subprime lender announced fourth quarter losses of $14.4 million. Company officials set aside $45 million in anticipation of defaulting mortgages and said they were "unsure Novastar would turn a profit in the next five years".

The growing problems of subprime lenders is hardly surprising. According to New York-based Bear Stearns, the level of delinquencies is rising fast, and has reached an all time high for loans contracted within the last 12 months. Bad lending practices helped fuel the housing bubble and now the party is over.

So what are we going to call this growing financial catastrophe? Better call it something sweet, so that we don’t spook investors. Why not call it an “industry consolidation”. There were too many subprime lenders anyway. Yes, that’s right, isn’t it. These recent closures and bankruptcies are bringing us to a better place. Soon we will be left with bigger, healthier subprime lenders who will know better than to issue toxic mortgages to people who can not afford them.

Nah, let’s forget “industry consolidation”, financial catastrophe sounds a lot more accurate.

This cartoon more or less says it all. I nabbed it from the DC bubble blues blog, who appear to have taken it from the Washington Post.

Let's keep this simple, no hype, no sham and no talking things up. This is what happened to the US housing market last year:

More than half the national metro areas it surveys reported deflating home prices on a year-over-year basis.

The fourth-quarter report from National Association of Realtors showed largest price decline on record as markets with price declines now outpace those with gains.

As David Lereah said "2006 was a year of contraction".