"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.
________________
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.
10 comments:
Mike,
You talk about the "rate" of foreclosures being in line with other previous housing downturns, and does not appear to be abnormally high relative to other storms that we have weathered. Granted. But the "number" of foreclosures is higher, perhaps because, as you say, there are now more people in the US. But with considerably higher numbers of mortgages in default multiplied by considerably higher home values and, consequently, loan amounts, does this not mean that the overall defaulted loan amount is much higher this time? Does this not constitute a greater threat to the overall economy?
On the other hand, I remember the banking (S&L?) scare of the '80s and the junk bond crisis (remember Michael Milliken?) and we seemed to weather these fairly well. Hundreds of billions of dollars were written off at those times. Can we shrug it off again? I hope so. Thanks for the interesting commentary.
Paul
Hi, Paul. Thanks for participating.
Yes -- "the overall defaulted loan amount is much higher this time" as you say. But in all matters of this kind, we get the best perspective by looking at percentages and ratios rather than actual dollars.
As you point out, we had challenges in the 1980s with the S&L crisis and the junk bond debacle that led to a 500 billion dollar (more or less) government bailout. At that time, the Gross Domestic Product was around $4.5 trillion.
Today, the GDP is over three times higher and is approaching $14 trillion. Thus, a 1.5 trillion dollar problem would be the equivalent magnitude. I don't think we are anywhere close to that with the current housing situation.
There are 112 million households in the US. Just over 31% are renters which leaves us about 70 million homeowners. About 35% of these homeowners have no mortgage. This means there are about 50 million outstanding mortgages. If the average loan was $200,000, the total outstanding loans would be about $10 trillion.
This SWAG estimate of outstanding loans is right in line with a statistic I saw last year which indicated that the value of all residential real estate in the US was $20 trillion and outstanding loans were $10 trillion.
If 1% of all loans end up in foreclosure, this is $100 billion problem for a $14,000 billion economy. Even if there was a government bailout (and I don't think this should happen), the magnitude of the problem is much smaller than what happened with S&Ls and junk bonds in the 1980s.
It is also worth noting that $100 billion in defaulted loans does not mean that there is a $100 billion dollar loss to the lenders. They sell these foreclosed properties and recoup some of their investment. Let's say that they manage to sell these properties for 60 cents for every dollar that was owed to them. The resulting loss is $40 billion.
Now $40 billion sound like a lot of money to you and me as we compare it to our annual budgets. But this is a 40 billion dollar loss against $9,900 billion in loans where payments are being made on time and as agreed. That seems like it should be manageable.
Of course, there will be particular banks and investments houses that suffer more than others. Mortgages have been turned into "mortgage backed securities" and are held as investments. Packages of sub-prime loans were good investments in 2002, 2003, 2004, 2005 and 2006 as they provided a higher rate of return than other alternatives. After 9-11, people fled the stock market and invested in real estate both directly and indirectly -- e.g. thru the purchase of mortgage backed securities.
Like all investments, these things go up and they go down. They are going down at the moment. I don't have the exact reference to quote you, but there was a big story last week about one bank or investment house that was taking a 9 billion dollar write-down on the value of their mortgage backed securities. Again, this sounds like a huge number to you and me. But this same institution had a 5 billion dollar gain on that same portfolio of loans during the previous year. That puts the whole story in a different light.
Bottom line: The dollar amounts in all these matters are huge and sound ominous. Expressing them as percentages and ratios gives us some perspective.
Thanks again for participating and advancing the discussion.
Hi Mike,
Thanks for your article. It is as much about sub-prime journalism as it is loans! Ultimately journalists need to pay their mortgages too. The journalistic scare tactics you expose here keeps people buying papers and tuning in. It also keeps their pay checks coming in so they can pay their own mortgages. There really is a connection between sub-prime journalism and mortgages!
Ohmygosh, Mike...in addition to rejecting the subprime mortgage "crisis," you also drive a SUV? In the Denver metro area, that's anathema, isn't it? I hope you keep it in the garage at night; I wouldn't want anything to happen to it!
I appreciate the time you took to research the subprime mortgage issue. Your stats are very helpful. I'll be that the presumptive Democrat nominee for president doesn't know this info (probably doesn't care to know, either). A three month moratorium on foreclosures? Give me a break!
Do you remember that you are the guy who turned me on to Rush Limbaugh many years ago? I hope you still listen. I rejected the main stream media years ago. And I have not looked back.
A little input from a student...it is not just the media that has this story a little twisted, but a good number of professors as well. In ALL of my graduate level finance and accounting courses since last fall (a total of 18 hours) the professor has referred to this so called "crisis."
I was surprised by how many of my professors simply regurgitate the things that they hear and also by how many of my peers simply take what is said as the truth. But even worse, none of the classes that I have taken include this as part of the curriculum. This means that the "sub-prime mess" has only been mentioned in passing as a general description of what the markets are doing today. This doesn't even give the students a chance to question our professors about such things. I know this blog is about journalism but I simply thought it interesting how, even in a academia setting, many things stated by the media are taken at face value by the very people who are supposed to be developing critical thinking skills in others. Of course I do not claim or believe that all professors act in this way. It is just a general observation from my experiences.
Aside note for Tom,
I meant to comment earlier and tell you of course I remember you. How could I forget "Nice, nice, naughty, naughty Uncle Tom"?!? Hope all is well
Tom -
I introduced you to Rush? I had forgotten that! I still listen to him along with Hannity and Dennis Prager and Hugh Hewitt.
I also listen to Thom Hartmann on Air America and to Ed Schultz - the progressive talker -- for the other point of view.
I'd rather get my news from known advocates than from the mythic "objective press" who disguise their bias.
I also listen to some NPR to get a left-of-center point of view although I'm sure some people would lump NPR in with the "objective" press.
About the only lefty I won't listen to is Randi Rhodes. Her intellectual engagement of the issues is about as close to absolute zero as you can get.
My generation grew up believing that journalists told the truth to the best of their ability. We believed in their honesty and objectivity. I remember watching the CBS Evening News with Walter Cronkite every evening when he was viewed as one of the most trusted men in America.
Then his successor, Dan Rather, gets caught promoting a blatantly false story about George Bush's National Guard Service. To this day Rather maintains that the basic premise of the story was true and excuses himself and others for reporting the false details (they don't matter because the premise is true, he claims).
Nowdays journalists report those things which support their own agendas and overlook stories that don't. Or they spin a story in such a way as to make it seem as though the truth is the exact opposite of the reality.
Another example is the Man-made Global Warming hoax. We have scientists who support Al Gore's agenda. They take some facts which seem to support their theory, but they ignore contrary evidence and subject fellow scientists who disagree with their program to ad hominem attacks. And it is sad to see non-scientist politicians whom we have trusted in the past (e.g. Newt Gingrich and George Bush) jumping on the bandwagon.
So here are two groups, journalists and research scientists, aided by unscrupulous or just plain ignorant politicians, whom we were taught to trust and to rely upon, but who have shown themselves to be untrustworthy and unreliable. Not all of them, to be sure, but enough from each group to obligate us to question and to doubt whatever they tell us. Unfortunately there are just too many sheeple who are willing to blindly follow their lead.
I wish I had more time to listen to Talk Radio.
I also like Jason Lewis of KTLK in Minneapolis...sometimes I download his podcast to listen to him. And then there is the "Blond Mormon" whose name I can never remember--I like him, too.
We had guest lecturers from Comerica Bank the other day in class who specialized in commercial real estate loans. This sector wasn't really part of your analysis here that focused mainly on residential real estate. I tried asking some questions to see if the commercial real estate market had similar stats (% of loans that were made to sub-prime borrowers, how many actually default, etc). But all they really said is that the sub-prime "debacle" was messing up their whole portfolio.
If there are a significantly higher amount of commercial sub prime mortgages and they were defaulting like crazy then that could be bad, and maybe the reason for some of the problem.
However, my banking friends were no help. It seems to me that lending to sub-prime borrowers would happen less with commercial real estate because they are probably much higher dollar values (I am not sure about this because I guess overall risk could be quite large or small independent of the size). So if I had to guess I wouldn't think that this would be significantly different than the situation with residential property but thought it might be something you had either looked into or might look into.
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