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Politics : Sioux Nation -- Ignore unavailable to you. Want to Upgrade?

To: Wharf Rat who wrote (64666)	4/19/2006 1:14:07 PM
From: stockman_scott	Respond to of 361439

No Exposure to Mortgages? Think Again By Caroline Baum April 17 (Bloomberg) -- Every time the subject of banks making risky home loans to bad credit risks -- no money down, no questions asked -- the usual retort is that banks sell the mortgages. They aren't at risk. It doesn't matter if the loan stops performing because they don't own it. That's not exactly true. According to the Federal Reserve's Flow of Funds report for the fourth quarter of 2005, mortgages accounted for 32 percent of commercial banks' financial assets. Throw in agency- and mortgage-backed securities, and the exposure to outright and securitized mortgage loans is 44 percent. What happens to housing matters to the economy -- and not just because of the effect that reduced equity extraction would have on consumer spending if home prices were to stabilize or decline. It matters because mortgages are the big kahuna on banks' balance sheets. If enough of these loans go bad, as they did in the late 1980s and early 1990s, it could impair the banking system's ability to extend credit, with all that implies for the economy. If history is any guide -- if this time isn't different -- when the banking system is broken, the economy doesn't work. The Great Depression, the savings-and-loan crisis in the U.S. in the early 1990s, and the lost decade-plus (1990s and early 2000s) in Japan all saw an extended period of bank balance-sheet contraction, which hampered economic growth. Speculation Shift In the early 1990s, which saw the biggest number of U.S. bank failures since the 1930s, it took an extended period of low interest rates for the economy to regain its footing. In the 1980s housing boom, the villain was speculative building. After the bust, regulators clipped builders' wings. This time around, it's been speculative buyers who have provided the tailwind to the housing boom. ``We've outsourced the speculation,'' says economist Michael Carliner of the National Association of Home Builders in Washington. ``The non-owner-occupied share of mortgages has been rising since the mid 1990s.'' According to LoanPerformance, a unit of First American Corp. that maintains the two largest databases of mortgage information in the country, 17.1 percent of purchase loans were investor or second-home loans. As recently as 2000, that share was 7.7 percent. Of course, there's an incentive to lie about the nature of a home purchase, claiming primary residence rather than second or investment home to avoid the higher interest rate. While the premium for a mortgage on a non-owner-occupied home has come down over time, encouraging buyers to be more truthful, the statistics probably understate the number of homes bought for investment. Increasingly Exotic Turning to the type of loans used to finance home purchases, interest-only and negative amortization ARMs were almost 42 percent of the market last year, up from 32.6 percent in 2004, according to LoanPerformance's asset- and mortgage-backed database, which does not include Fannie Mae and Freddie Mac securities. As recently at 2001, only 1.9 percent of purchases were financed with so-called exotic mortgages. The good news is that to date, the delinquency rates for loans on owner-occupied homes and second/investment homes are almost the same, according to LoanPerformance. That doesn't mean there's nothing to worry about, according to Andy Laperriere, a political economist with International Strategy & Investment in Washington. In an article in the April 10 issue of the Weekly Standard, Laperriere outlined some potential ``Housing Bubble Trouble.'' First-Time Risk Takers -- 43 percent of first-time home buyers made no down payment last year, according to a study by First American Corp. -- 22 percent of the borrowers with initial interest payments of 2.5 percent or less have negative equity in their homes (the market value is less than the size of the loan); 40 percent have less than 10 percent equity. -- About one-quarter of the jobs created since the 2001 recession have been in construction, real estate and mortgage finance. The press has been filled with stories of folks buying houses for the sole purpose of flipping them in a year for a 25 percent profit. Even if the idea of buying a home for the steady rental income had crossed their minds, they would have been disappointed to see how divorced prices were from rents, Laperriere writes. When prices stop appreciating, the speculative tailwind behind the housing market will abate. At that point, the true measure of outright speculation versus good old-fashioned home ownership should become apparent. The froth in the housing market finally caught the attention of the regulators last December. The Office of the Comptroller of the Currency, the Fed and the other financial regulatory agencies issued ``guidance'' on ``non-traditional mortgage products,'' highlighting the potential risks and recommending banks perform due diligence on borrowers' ability to repay their loans. It would certainly be a first if regulators got into the act before any fallout occurred.