How did subprime investment problems develop?
A Thumbnail Sketch of How We Got Here
Between 1994 and 2006, there was a dramatic increase in amount of subprime related investments sold to investors. The amount of subprime mortgage issues shot up from $35 billion in 1994 to $625 billion in 2005.
During the same period, observers have concluded that there was rampant overbuilding of homes. For example, Forbes columnist, Gary Shilling, says there were 2,000,000 excess homes built in the 1995-2005 realty boom and predicts at least a 20% decline in the median sale price of single family houses (which he contends wouldn't bring prices back to historical norms).
Between 2000 and 2007, there was a dramatic increase in the number of “exotic” mortgage loans made to borrowers. These loans were structured in various exotic ways including: option adjustable rate mortgage loans (loans which permit the borrower to pay less than is owed with the unpaid amount being added to the principal), interest only adjustable rate mortgage loans (loans which permit the borrower to pay on interest without any reduction of principal), “teaser” adjustable rate mortgage loans (loans with very low interest rates for the first several years which reset to higher interest rates), “piggyback” mortgage loans (loans which allow the borrower to finance most, if not all, of the purchase price of a home with no down payment), and home equity loans (loans which tap the equity a borrower has in his home).
Between 2000 and 2007, there was also a dramatic increase in Wall Street investment firms assisting in securitizing and selling mortgage related securities including both mortgage backed securities, collateralized debt obligations, structured investment vehicles and conduits.
In 2001, Wall Street firms issued $217 billion in mortgage related securities. In 2006, Wall Street firms issued $773 billion in mortgage related securities. These securities were sold to investors.
56% of all mortgage loans outstanding, $5.7 trillion worth, have been pooled into mortgage backed securities and sold to investors.
Homeowners tapped $900 billion in home equity loans from 2000 to 2005. Many of these loans have been securitized and sold to investors. These loans have reduced the equity that many borrowers have in their homes.
$1.5 trillion of subprime mortgage bonds were sold between 2003 and 2006.
Subprime mortgages reached a record $805 billion in 2005 according to JP Morgan. In 2006, 38% of all subprime loans required no money down. Some 60% of subprime loans required no or low documentation.
Alt-A loans made up 13% of all mortgages in 2006. Alt-A loans and subprime loans accounted for about 1/3 of the mortgage market in 2006.
In 2006, Wall Street took in at least $27 billion in revenues selling and trading asset backed securities.
Lenders made an estimated $581 billion in option ARM loans during 2005 and 2006 while doling out nearly $1.4 trillion in interest-only ARMs. A recent study estimated that about $315 billion of these loans will default leading to more than 1 million homeowners relinquishing their property to lenders. The trouble with option and interest only ARMs appears to still be in its early stages. Many observers suspect that the biggest problems will emerge during the next 16 months.
In 2007, Moody's economy.com (Mark Zandi) reported:
- there is $10 trillion in mortgage debt outstanding
- home prices should bottom out in the second half of 2008 with price declines about 10% off their peak
- there were 800,000 defaults in 2005 and 900,000 in 2006; he estimates 1,200,000 defaults in 2007 and 1,300,000 in 2008
- hedge funds investors will lose between $100 billion and $125 billion.
More than $800 billion of subprime mortgage bonds ($600 billion being ARMs loans) and $700 billion of Alt-A bonds ($450 billion being ARM loans) were outstanding as of March 2007.
1,800,000 hybrid adjustable rate mortgages will reset within the next 2 years.
About $1 trillion of payments on adjustable rate mortgages are scheduled to rise in 2007 and 2008 hitting a peak in October, 2007.
Homeowners owing about $515 billion in adjustable rate home loans will reset this year and about $680 billion worth of mortgages are also to reset next year (70% is subprime).
From July to the end of 2007, $220 billion in subprime adjustable rate mortgages will reset upwards with many monthly payments increasing by 40% to 50%. Since many subprime borrowers already spend about 40% of after tax income on housing many can't afford the increases.
An estimated 2,000,000 subprime borrowers are expected to lose their homes.
Top
