Wednesday, March 14, 2007

Subprime: Not to worry

The Oregonian's editorial yesterday on the impending crash of the sub-prime mortgage market had an interesting dog-that-didn't-bark-in-the-night moment.
As this plays out on the business pages, it's being couched in academic terms. What's happening now, we're told, is the fallout from lenders' eagerness to extend mortgage loans to more and more borrowers a few years ago. They made "100 percent loans" for the full value of a house, they lent to borrowers with tons of debt, they lent to people with lower credit scores, they made loans without documentation and they created financing products that deferred the day of reckoning until about, oh, now.

Now the predictable is happening. Scheduled mortgage payments are jumping and more people are defaulting, sparking a round of retrenchments in the subprime and secondary lending markets. Bankers, in other words, are calling their loans.

The wreckage from this falls most heavily on people who took subprime loans and now can't keep up with their payments, which means they risk losing their houses. Those who do will emerge from this phase in worse shape than they entered it, with ravaged credit ratings that will raise their future costs to borrow money. At the same time, people who would have qualified for a home loan several months ago now find it harder to qualify.

To be fair to the O--and fairness to the O is our new watchword around here at p3--their point is that this crash is going to hurt a lot of working Americans, and it's going to hurt them bad. They write:
In academic terms, this is a rational phase of the business cycle. In human terms, it can be a disaster.

But they wrap up with this bit of finger-wagging:
The painful lesson, again, is for lenders to stop sowing the seeds of their own destruction, and for borrowers to avoid living beyond their means.

A pox on both their houses, as it were.

That throwaway line at the end is the only mention of the industry that created this situation. And yet, it's not as if lenders were sitting around clipping coupons, minding their own business, until "nontraditional borrowers" finally pestered them into creating and marketing a new suite of risky home loan products.

I was positioned to watch the banking biz from the inside during the early part of this decade, and I'm here to assure you that the lenders went after this market like a shark to chum. They pulled internal resources off of other banking divisions to beef up the sub-prime sales program, while it lasted. They spent a lot of money developing business and marketing strategies to make it happen. It was a great way to rake in a lot of cash in a fairly short period of time (just the way American business likes it), and they seized upon it with gusto, fully understanding that it couldn't last, and fully understanding what would happen when the party ended.

Forbes notes the driving force of this boom-and-bust, and be advised that it has nothing to do with the American dream of everyone in their own home--none of that drivel about "Bread... that this house may never know hunger. Salt... that life may always have flavor," and so on. No, the phrase that describes the economic engine at work here is "yield-hungry investors."

But the capitalistic enthusiasms of today's "yield-hungry investors" only go so far in the Gilded Bush Age. As far as earnings are concerned, they're all foursquare for Adam Smith. But when it comes to risk, they're the last true raving socialists.

Privatize the profits, socialize the risk.

The Oregonian gets it right when the predation happens at the level of payday loans; will they get it right here, when the stakes are even higher?

What's mostly missing from the O's editorial, and fairly difficult to find anywhere else either, is much genuine worry that the mortgage industry will be at significant risk because of this wholly foreseeable bust. Some companies, created out of the last wave of late-1990s merger-mania, will disappear because they were the last ones holding the paper on these sold-and-resold packages of subprime loans. But the ones who handled the packages earlier, and who took a cut for themselves and their investors as the market churned--will they face the chastening power of the collapsing market?

Or--as happened last year with the credit card industry--will their losses be covered by the House (and Senate)?

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