Thursday, May 18, 2006

Strained Finances
I have seen three articles this week on the rise in defaults on mortgages. All three articles are quick to point out the default rates are below historic standards, but the point remains that the default rate is on the rise. Adjustable rate mortgages are seeing the most defaults. These are the nifty mortgages that let people buy more home than they can afford. Rising short-term interest rates make monthly payments higher when the adjustable rates reset. Jesse Eisinger, who writes the Wall Street Journal’s excellent Long & Short column, had this take-away point in Wednesday’s Journal:

“As demand wanes, there's been an unsurprising but troubling response from banks: They are making it easier to take out a mortgage. According to this week's survey of bank loan officers by the Fed, more than 11% lowered their credit standards in the past three months, while fewer than 2% tightened. And mortgage-payment performance has begun deteriorating. Though absolute levels are still historically low, late payments are rising. “

Eye-opening stuff. When my wife and I bought our house in 1993 the lenders required that the loan payment had to be less than 30% of our combined gross income, if I remember correctly. Those days are gone. The banks have no one to blame but themselves for the defaults and, like a group of lemmings, will all tighten credit in unison. Of course this will be after the housing prices decline and become more affordable.

My guess is that one of the small, high-flying mortgage companies that specialize in the most exotic loans will fail. The rise in short-term rates will accelerate the fall of a company in trouble. Annaly Mortgage, once a Wall Street darling, has cut its dividend to $.11 a quarter from $.50 a quarter at the end of 2004. Its stock has dropped from $20 to $12.50 over the same period.

I have bored many people with my theories on the false run-up in housing caused by silly mortgages people can’t afford and the dire consequences these mortgages may cause. The economy can’t withstand a housing implosion caused, in part, by lender greed and negligence.

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