"Meltdown" is the descriptor I hear most commonly associated with the sub-prime mortgage issue. It's a highly charged word, isn't it? It conjures up images of the catastrophic failure of a nuclear power plant or the complete mental and emotional collapse of a person -- think Britney Spears getting her head shaved and going commando to LA night clubs.
"Crisis" and "mess" are the other favorite words used by the media when reporting on sub-prime mortgages. Again, these are negative, anxiety-producing words.
If you are the typical, hard-working American, you are probably going about your busy life and you know little or nothing about sup-prime mortgages. But, from the evocative words used in the popular press to describe this financial phenomenon, you'd probably conclude that:
- Sub-prime mortgages are the biggest threat to the American economic system since the stock market crash of 1929 and
- Sub-prime lenders must be a scurrilous group of scoundrels who are just slightly less evil than Attila the Hun, Vlad the Impaler and George W. Bush.
As an aside, I should note that "sub-prime" loans are loans that are made to borrowers who are worse credit risks than "prime" borrowers. I need to clarify this because of a conversation I had recently on this issue with some extended family members. After we had talked for a while, I realized that they believed that "sub-prime" loans were loans that were made to people with A+ credit.
To them, a sub-prime loan denoted a loan that had an interest rate that was below the prime rate! Obviously, only the very best borrowers get rates that are below the prime rate. Thus, if we are having a sub-prime mortgage meltdown, then we are in very deep trouble indeed since even super well-qualified buyers are not able to keep up with their home loan payments!
But "sub-prime" does not refer to the interest rate -- it refers to the quality of the borrower. Sub-prime loans are made to sub-prime borrowers who have had some credit problems in their recent past. This is why sub-prime loans are riskier loans.
At any rate, like I said, I went looking for some facts on this matter. I spent a couple hours curled up with Google but couldn't turn up any quantitative data. I found a Mortgage Bankers' Association (MBA) report that had the info I wanted but it cost $60 and it would have required a lot of number crunching to get the stats I wanted.
Then, a couple days later, I stumbled onto the gold mine I had been seeking. I found it here at the blog of Mark J. Perry, a professor of economics and finance at the University of Michigan. It turns out that he had purchased the MBA report and had done the number-crunching for me. The following chart gives the pertinent data.
Stunning! More than 4 out of 10 homeowners are prime borrowers who have fixed rate loans on their properties.
And, what is the 2nd most common mortgage for homeowners? Drum roll please ... it is NO MORTGAGE! That's right. Almost 35% of homeowners have no loan on their properties. They own their properties free and clear!
And what about the dreaded sub-prime loans? Only 8.5% of homeowners have these types of mortgages.
Which leads to an obvious question: How can this relatively small precentage be creating a massive crisis? Are these mortgages responsible for all the foreclosures?
Sub-prime loans did account for more than half of all foreclosures in a recent reporting period. However, the overall oreclosure rate is within historic norms at the moment. Of course, the actual number of foreclosures is at an all-time high. This is because the population of the nation is at an all-time high and because the rate of home ownership is at an all-time high. However, to get some feel for the magnitude of the problem, we have to look at the "rate" of foreclosure.
The current rate of foreclosure is about the same as it was during housing downturns that peaked in 1966, 1974 and 1989. I wish the rate was lower and we need to be appropriately concerned but, by any measure, it has not approached seismic or cataclysmic proportions.
Furthermore, many reports are suggesting that the reasons for foreclosure remain tied to personal factors such as job loss, illness, divorce or death and not strictly because of the type of loan selected.
And here is one more issue I'd like you to think about -- have you ever heard a single story about the benefits of sub-prime loans? I haven't.
The main stream media love the anecdotal story. They love to find someone who has lost her house and show you how this fine person was the victims of some predatory lender.
And, of course, those stories are out there. Some people have gotten very poor advice and have been tricked into taking on inappropriate loans. But this is true of everything in life. People have been talked into buying crappy cars or expensive health club memberships that go unused after the first twenty days of the new year. There are bad actors and sad stories in every industry.
The question is not whether some people have been harmed; the more appropriate question is whether sub-prime lending has been generally helpful or harmful. In this regard, we know that home ownership is the key component to wealth-building in the US. Just look at the stats above which show that 35% of homeowners own their houses free and clear.
And, more generous lending guidelines allowed more people to own a home. Lending guidelines began to loosen in the mid-1990s and sub-prime lending really got going in 2001 and 2002. Partly as a result of this change, home ownership rose from just over 65% of Americans owning their own homes in 1996 to just under 69% ownership in 2006.
More aggressive lending allowed almost 10 million more people to participate in home ownership. And 1996 to 2006 was a very good time to own real estate in most parts of the country. Home values went up substantially during that period.
So why don't we see any anecdotal stories about the people who have benefited from sub-prime lending?
I recently talked with a young couple in Arizona. Right out of school and with no real credit history and no down payment money, they were able to buy a house for $190,000. Two years later, it was worth $340,000. It has now dropped backed to about $275,000 but they are still better off financially than they would have been without the house.
In the early 1990s, this story would not have been possible. This young couple would have been frozen out of the market and would have lost out on the possibility of wealth building at a young age.
In reality, my anecdotal Arizona couple is probably more representative of what sub-prime mortgage lending has produced than the stories of tragic loss I typically see and hear in the media. But we don't hear the positive stories.
With foreclosure rates at about 1% per year right now, we can expect about 100,000 of the ten million newly empowered home owners to go through this traumatic experience in the coming year. Our hearts should go out to them. But 9.9 million people will remain in homes they would not otherwise have owned and thus have a chance to build wealth they would not otherwise have realized.
I know some of these people myself. I’ve had two or three sub-prime borrowers that I’ve helped with real estate purchases and financing over the last couple years. They are all wonderful people and are enjoying the long-term advantages of home ownership. Sub-prime lending is not an abstract issue for me – it has a personal face.
Why do the main stream media ignore the positive aspects of sub-prime lending? There are many reasons: a preference for bad news, political bias, etc. I won't make the case for all these factors right now.
Rather, I'd just like to point out how the media's reporting on this issue is quite ironic. I've heard main stream media icons like Rather and Brokaw and Evan Thomas (Newsweek) bemoan the rise of new media like talk radio and the Internet and blogging. There are no editors or fact checkers, they allege. The new media over-simplify issues and don't give "texture" and "context". The new media are not "neutral" and "objective" like the main stream press.
These main stream media moguls are just blind to their own prejudices. They are the only ones who still believe this myth of main stream media objectivity. And their reporting on the sub-prime lending issues is a prime example of how they fail to give nuanced texture and context.
So stop listening to these dinosaurs. When ever they report on issues I know something about, they almost always have it wrong. Why waste your time paying attention to unreliable sources?
And add Mark J. Perry's blog to your favorites and read it often. It is a wealth of great info on the economy and gives a perspective you won't get from network TV or radio news.
I'm concerned about sub-prime lending and we need some appropriate, measured action on this issue. But I'm a lot more concerned about the sub-prime journalism of the main stream media. Their simplistic, biased and alarmist reporting is a much greater danger to this country.
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Note: You may know that I'm a real estate agent and a mortgage broker. Thus, this whole analysis could appear self-serving or self-justifying. My profession, however, has nothing to do with this issue. I'm continually noticing how the majority of the press misses the point on economic issues and there will be many more blog postings over the next few months on this issue that have nothing to do with real estate.
As always, feel free to give your honest reactions. And feel free to dissent. I love affirmation but dissenting views are always helpful.
