Subprime Mortgages: Problem for Wall Street, Main Street

Monday, March 19, 2007 | In recent weeks, many major lenders of mortgages to consumers with poor or spotty credit have gone bust, sold off bundles of loans or vowed to drastically tighten their standards in response to investors displeased with soaring levels of default.

An embattled San Diego-based subprime mortgage lender, Accredited Home Lenders, announced Friday a fire sale of nearly its entire $2.7 billion loan portfolio in response to investor pressure. The move came near the end of a volatile week on Wall Street because of turmoil in the sector. A Mortgage Bankers Association report Tuesday showed that the number of homeowners in default rose to the highest level in four years last quarter, and the report sparked the second-worst day for the stock market in 2007. Analysts warned a rising number of defaulting subprime homeowners nationwide could lead to billions of dollars in losses for lenders and their backers, many of whom invested in bits of mortgages packaged for sale on the stock market.

The subprime storm has not subsided, and analysts say it will not be contained in just one portion of the stock market, or even in the stock market itself. This is not just a Wall Street problem; this is a Main Street problem, they say. Increased foreclosures and bargain-basement home prices will drag down surrounding home values, barring some recent homebuyers from refinancing out of any risky loans they took on the assumption they could switch to a more traditional loan later. Tighter qualifying regulations will limit the pool of first-time homebuyers — the plankton of the home-buying system — which will hold homeowners looking to move up from doing so.

And many economists, including former Federal Reserve Chairman Alan Greenspan, fear the trouble will extend past the stock market, past the housing market even, into the general economy — just as the preceding housing boom helped fuel economic growth.

“I’ve heard that this is a subprime issue,” said Chris Thornberg, co-founder of Beacon Economics, former economist at the Anderson Forecast at the University of California, Los Angeles. “But it’s not just the subprime market. Wall Street supports Main Street, and when foreclosures go up, both suffer.”

The trouble in the subprime market, brewing for months but reaching a fevered pitch these last few weeks, may be what would-be homeowners and others need to realize the housing party has ended, some analysts say.

“A lot of people were buying homes they shouldn’t have, driving prices upward, and now that part of the market’s starting to implode,” Thornberg said. “The question is, how did we expect this wasn’t going to happen?”

Thornberg and other economists have argued vehemently against the notion that trouble in the housing market will not stain the rest of the economy. Their logic: As borrowers stretch to buy a home or homeowners scrimp to make their mortgage payments, they’re less likely to get a new car or buy a bottle of wine with dinner. Many homeowners considered their homes to be seemingly magic equity machines as prices bounded by double-digit percentages for several years. Now, as prices slip, their homes take on a slightly more realistic luster, and those thousands of dollars in their “home ATM” don’t look so appealing, or bona fide.

“The big issue is, what’s going to happen to these people?” Thornberg said. “The market has finally got it that these aren’t good bets. With that kind of pulling back action, that’s going to contribute to a period of slowing, whether it’s a recession or a mild slowdown. With either one, income and jobs are going to take a hit.”

An economic hit can already be seen locally, according to one index released last week.

January marked the 10th consecutive month of declines in the economic index compiled by University of San Diego economist Alan Gin. Weakness in help-wanted advertising and building permits and an uptick in the number of people applying for unemployment insurance led the index’s decline.

Gin found there were significant losses in construction and real estate-related jobs. Construction employment was down 3,800 jobs and real estate-related jobs fell by 2,200 compared to January 2006, he said. Retail employment took a 2,500-job hit, “as spending is reduced by job and income losses,” he said in the report. And gas prices jumping to nearly $3 per gallon recently will worsen the situation, Gin said, as “more buying power [is] siphoned out of the local economy.” Gin said he expects weakness in the local economy at least until June.

The activity in the subprime sphere has local mortgage brokers sorting out the new regulations for borrowers with spotty credit. Many say economists’ fears of rampant foreclosures are unfounded, and stress that recent years have demonstrated record lows for the number of homes in foreclosure. And, they say, homeowners will do just about anything to hang onto their homes.

“It’s not a totally unsolvable problem,” said Dave McDonald, president-elect of the San Diego chapter of the California Association of Mortgage Brokers. “But I don’t think we’ve seen the worst yet.”

But new underwriting guidelines in response to market pressures will tighten the pool of both first-time homebuyers and those hoping to refinance to avoid higher payments on their mortgages down the road. People in that circumstance may just walk away, Thornberg said.

“If you can’t hang onto your home and you know it, you’re not going to give up your TV and all of that,” Thornberg said. “You’re just going to say … I’m moving into an apartment.”

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