By Jesse Eisinger, The Wall Street Journal
Gloom aficionados -- and I count myself among them -- have worried about the health of the American consumer for years and years. And we have always been wrong.
Will this time be different? With new-home sales data strong and consumer confidence soaring this week, with gasoline prices down and Christmas off to a fairly good start, investors might just be tempted yet again to dismiss the perennial doomsday scenario about the debt-encrusted consumer crackup.
But there are some early warning signals about problems.
Despite high debt levels, consumers have been making good on their loans for the past several years. Defaults and late payments at credit-card and mortgage companies remain low. But what seems clear is that credit indicators have bottomed and started to worsen.
A rush to file for bankruptcy ahead of a new law, effective in October, that makes it harder to wipe certain debts clean will mean artificially depressed bankruptcy numbers in the coming months. It behooves investors not to be lulled into a false sense of security.
Bill Ryan, an analyst for the independent financial research firm Portales Partners, has been on the lookout. Since the home has replaced the credit card as the consumer's ATM of choice in recent years, the proper place to look for early warnings signs is from delinquent mortgages, he reasons. And the likely area for those would be the subprime sector, which caters to high-risk folks.
Mr. Ryan looked at data on delinquencies for adjustable-rate mortgages for subprime borrowers, shown in the nearby chart.
The 2005 data through September reveal that these mortgages are faring worse than in comparable periods in each of the three previous years. This year, 6.23 percent of the loans are delinquent, on average, in their first nine months, a rate not surpassed until the 20th month for 2004 mortgages. By September 2004, that year's mortgages had a delinquency rate of only 3.72 percent.
The conclusion seems obvious: These folks were among the last to get mortgages during a great boom, and laggards tend to be worse credit risks. They flocked to short-term, floating-rate mortgages, interest-only loans and loans that require little documentation.
The data display an even more ominous trend. Housing-bubble skeptics pooh-pooh us worrywarts by arguing, in part, that home prices rarely fall dramatically across the board. Maybe. But what this argument fails to address is that home prices don't need to fall a great deal to wreak havoc. They simply need to stall, and a big source of extra spending green dries up.
Keep in mind that most of these mortgages were two-year hybrids, which have a fixed rate for two years and then float for the remaining 28. If rates rise during the first two years of the mortgage, at the end of that period the monthly payments would shoot up and lead to payment shock. The only out is to refinance, but that's impossible if the home's value hasn't risen. This year, rates have risen and, predictably, home prices mostly have stalled or gone down.
To see the effects of this, look at the line representing the 2003 mortgages. At around 24 months into these mortgages, just when the popular two-year ARMs were resetting to higher rates, delinquencies shot up. At 24 months, the percentage of folks 30 days late on their payments was 10.2 percent. Six months later, the delinquencies had spiked to 16.6 percent.
What makes this so troubling is that the dollar amount of two-year ARM mortgages was much smaller in 2003 than in 2004 or this year. Mark Agah, another analyst at Portales, estimates that there were about $220 billion in two-year ARMs in 2003. That soared to about $400 billion last year and should be around $440 billion this year.
That means at the two-year point for the 2004 mortgages, we are likely going to see a lot more mortgage problems.
How worried should investors be about this?
Investors have been watching the United Kingdom closely, where interest rates bottomed out -- and risky mortgage deals were peaking -- about a year earlier than in the U.S. and where home-price appreciation rates have come back to earth.
The crackup in Britain has been mild, surprising some of the big bears, such as Grant's Interest Rate Observer. "Real-estate Armageddon," Grant's Nov. 18 edition said, "is a no-show" so far. Australia, where home prices bottomed even earlier, has been a similar story.
Home repossessions and personal bankruptcies are surging in the U.K., but the overall numbers remain low. Shares of home builders, mortgage companies and retailers have done fine. Shares of Britain's largest home-improvement company, Kingfisher, have been dinged.
Fewer miter saws getting sold -- that ain't midnight tolling for the American consumer. But it's early for the U.K., too. |
