Speed of subprime bust surprises lenders

Many mortgage lenders expected a subprime meltdown, but not one that came so fast and strong.

By Les Christie, CNNMoney.com staff writer - May 23 2007: 8:18 AM EDT

NEW YORK (CNNMoney.com) -- The subprime mortgage meltdown has been a shock to industry insiders, but now they say it's hitting harder and faster than expected - even to those who predicted the crisis in the first place.  That was the message Monday from a panel of leading industry executives on the state of the mortgage lending industry at the Mortgage Bankers Association's National Secondary Market Conference & Expo in New York.  Michael Marriott, a panelist and managing director for Credit Suisse, said, "Last October, I predicted the subprime market would collapse and many issuers would go out of business. But the violence and speed of the market sell-off surprised people."

David Lowman, a panelist and chief executive of JPMorgan Chase & Co.'s global mortgage business, said, "35 percent of what once could be done, can no longer be done," referring to mortgage loan products that have effectively been taken off the shelves.  And speaking separately from his Atlanta office, Duane LeGate, president of House Buyer Network, a specialist in short sales and foreclosure prevention, said one of the real estate agents he works with had six deals blow up within four days because, "The loan originator told him, 'We're not offering [these products] anymore.'"  According to LeGate, this kind of thing just started to happen in the past month or so.  Allen Hardester, director of business development for mortgage broker Guaranteed Rate, said many once-common subprime loans products are now almost impossible to find.

Mortgage lenders get creative

"Anything that smacks of no-income and no-documentation is history," he said. "Anything above 85 percent to 90 percent loan-to-value, anything non-owner occupied, anything ludicrous as to value - like someone stepping up from a $1,000 a month payment to a $6,000 a month - is history."  Lenders are also scrutinizing applications much more carefully, and many don't like what they find.

Lowman said he had recently looked at a low-documentation application for a UPS driver who earned a quarter of a million dollars last year - or so the application stated. Fictional claims, often involving outside income, are far from unusual.  "If you took into account every person with a lawn care service on the side, there wouldn't be a blade of grass left in the United States," he said.  Investors who buy and sell bonds backed by the mortgage payments of ordinary homeowners have seen bad loans rise and have told lenders and brokers they will no longer buy whole classes of securitized mortgages, which can quickly pull the plug on a prospective home buyer.

Lauren Pephens, managing principal of financial services advisory firm, Pephens & Co., called it the "push-down effect" at a session on loss mitigation at the MBA conference. She said that some buyers have gone to close the deal only to be told that their financing had fallen apart.  All the fudging, the lax underwriting, the push for loans that went on during the housing boom were facilitated by the rapid rise of home prices. Outsized increases in home equity in many U.S. housing markets covered a multitude of sins and encouraged lenders to extend loans to poor risk borrowers.  If an owner couldn't afford to pay the monthly mortgage bill when her hybrid adjustable rate mortgage reset at a much higher interest rate, well, that was just fine.

Latest home prices

Her home had gone up in value from $200,000 to $300,000 in the interim, and she could tap that extra $100,000 in home equity to pay her bills. If worse came to worse, she could sell her house at a big profit and pay off the entire bill.  But when homes became unaffordable for too many buyers starting in 2006, "The people who were driving up prices couldn't drive them up further," said Hardester.  The speculators, the flippers and rehabbers fled. Houses went on the market and just sat. Inventories lengthened, home builders started pulling back and foreclosures climbed.

A drop is seen before recovery

So far the turnaround on prices has not been huge - unless you compare it with what immediately came before. In 2006 the median U.S. home price rose 13.6 percent, and in 2005 it climbed 8.8 percent, according to the National Association of Realtors. Now the industry group has forecast a drop in home prices this year.  MBA's chief economist, Doug Duncan, who was at the conference, predicted his own housing-price decline of 2.7 percent for 2007. Factoring in inflation of about 2 percent, the decline in real dollars is between 4 percent and 5 percent.  Duncan had said a recovery would begin mid-year but he's revised that forecast, delaying his predicted rebound until the fourth quarter of 2007.  Despite their surprise at the speed and depth of the subprime meltdown, Marriott, Lowman and their fellow panelists expected a quicker recovery than Duncan.  The group, which also included Patti Cook, an executive vice president with Freddie Mac, and Thomas Lund, an executive vice president with Fannie Mae, cited a strong economy, low unemployment and favorable demographic growth for their optimistic stance that recovery will come soon.  The recovery will "play out quicker than in the past," according to Lowman, "because [the fall] happened faster than in the past."