The recent implosion in the subprime mortgage market (a very big story barely being covered outside the financial pages) is going to have some drastic consequences:
“Freddie Mac said Tuesday that it would stop buying those mortgages that have ‘a high likelihood of excessive payment shock and possible foreclosure.’ Freddie Mac also said it would limit the use of loans that don’t require income verification or other documentation, and will recommend that lenders collect adequate escrow for taxes and insurance payments.”
“The firm said its new requirements cover mortgages known as 2/28 and 3/27 hybrid ARMs, which currently make up about three-quarters of the subprime market. Specifically, Freddie Mac said it will require that borrowers applying for these products be underwritten at the fully indexed and amortizing rate, as opposed to the initial ‘teaser’ rate.”
“The company also will limit use of low-documentation loans, so-called ‘no income verification’ products in combination with the 2/28 and 3/27 hybrid arms. In addition, the company won’t purchase ‘no income, no asset’ documentation loans and will limit so-called ‘stated income, stated assets’ products to borrowers whose incomes derive from hard-to-verify sources, the firm said in a press release.”
“‘There will be a reasonableness standard for stated incomes,’ Freddie Mac concluded.”
….
“No-money-down loans to borrowers with low credit scores ‘are going to be a thing of the past real soon,’ says Bob Moulton, president of Americana Mortgage Group.”
“‘We’re probably reverting back to guidelines that were in place’ four years ago, NovaStar President Lance Anderson says. The new guidelines wouldn’t have allowed as many as 25 percent of last year’s loans without more documentation or bigger down payments, he added.”
I never understood the economic rationality of giving so-called “liar’s loans” (stated income loans) without a hefty downpayment, or basing mortgage qualification on teaser rates rather than the longer-term expected rate. Purportedly brilliant hedge fund managers who bought these loans obviously disagreed, but if I had my money in a hedge fund that even provided a hint that it invested in mortgage-backed securities, I’d be pulling my money out pronto. Remember Long Term Capital Management? These folks aren’t as smart as those folks.
Meanwhile, up to 25% of last year’s loans would not be viable under stricter underwriting standards this year! Wow! Assumedly, that percentage figure is higher in bubble markets. Given the huge role easy home financing and refinancing has played in the 2000s economic boom (some huge percentage of jobs created over the last several years were in construction and real estate, and consumer spending was boosted significantly by “using the house as an ATM”, what’s going to keep the economy afloat?