Should We Bring Back Ozzie & Harriet Loans?
It was in 2005 that Bill Dallas — then president and CEO of Ownit Mortgage Solutions, at the time on one of the 15 largest subprime mortgage lenders in the country — said “underwriting guidelines developed in the 1950s don’t address the needs of today’s homebuyers and brokers. Loans that met the needs of Ozzie and Harriet were not intended to fill the needs of the Desperate Housewives.”
I’m not so sure Ozzie and Harriet were off the mark. Ownit closed in December 2006.
Ozzie and Harriett — the Nelsons of early TV — didn’t do too badly. The Nelsons were a prototypical one-wage earner household. They no doubt financed their home with an afforable fixed-rate loan. The mortgage choices then available were pretty much limited to VA, FHA and conventional financing with 20 percent down, financing that usually came from a local savings & loan association.
Today’s mortgages might well have confused the Nelson’s — they certainly confuse a lot of current borrowers. How could one explain the joys of interest-only financing or option-ARMs to visitors from the 1950s? What would they think of such ideas as negative amortization, interest rates based on LIBOR movements (a European index that did not then exist) and monthly payments that might double in a few years?
The Nelson’s lived in a country that was the world’s largest producer of cars and steel and by far the largest producer and exporter of food, but let’s not idealize the ’50s — schools and neighborhoods were segregated; women were relegated to a second-class status; businesses and colleges openly discriminated against Jews; lenders engaged in redlining; there had never been a Catholic president; the Korean war had ended — and the Vietnam war loomed ahead. But at least in the sense of real estate and mortgages, things were understandable.
The worry at the start of 2007 is that the market for subprime loans is less stable then investors would like and perhaps not so understandable. For instance, a 2006 study by Friedman Billings Ramsey found that default rates for adjustable subprime loans originated in 2005 were “15.4% and 6.3% higher than the default rates of those originated in 2003 and 2004, respectively.” (See the June 2006 MarketPlus Report from FRB for details.)
Well sure, you might think, interest rates reached record lows in the summer of 2003. As rates have risen so have foreclosures.
Not quite. Yes, interest rates have risen since 2003 but the Friedman Billings Ramsey study found that most of the subprime loans (74.9%) were 2/28 hybrid adjustables — that is, financing where the payment stays the same for the first two years of the loan term. “Hence,” says the report, “most of the adjustable-rate subprime loans originated in January 2005 will not reset at the earliest until January 2007.”
If rising interest rates aren’t doing it, then why then the rash of subprime foreclosures?
FBR looked at subprime foreclosure rates in 361 metropolitan statistical areas and found that 95 had particularly steep default rates. The reason: slowdowns in areas dependent on auto manufacturing, weak labor markets in New England and Golf Coast areas still reeling from hurricanes Katrina and Rita.
If you remove these 95 metropolitan statistical areas from the mix you find, according to FBR, that default rates increased from 4.16% in in July 2005 to 5.84% in July 2006. An increase, but not as bad as a superficial figures suggest.
It’s just a guess, but I would suggest that those fiscally-conservative folks from the ’50s might look at the FBR survey results and map out a mortgage investment program that looks something like this:
If I’m a mortgage investor I’d look at rising subprime default rates and say more risk means I need more interest. That, of course, is a problem given that subprime rates are already steep. Can the market absorb higher subprime rates without steeper default levels?
I’d stay away from areas with especially high default rates — that would unfortunately mean less financing for the metropolitan statistical areas where the need for mortgage capital is especially accute.
I’d look ahead and wonder about areas that have high levels of interest-only and option ARM activity. FRB reports that in the first six months of 2006 more than a quarter (25.8%) of the loans in California allowed negative amortization. In the same period interest-only financing was remarkably popular (or necessary) in Charlottesville, VA (47.1%), Ventura, CA (46.3%) and Santa Cruz-Watsonville, CA (45.7%).
I’d wonder what would happen with those 2/28 hybrid adjustables, the ones that will begin resetting in big numbers in this month. Does anyone seriously think that higher interest rates will not compound subprime problems?
The Nelsons may not have had home computers, electronic games or DVDs, but each month they could easily pay their steady mortgage bill. For a growing number of homeowners, that’s not a bad deal.
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Published originally by RealtyTrac.com during January 2007 and posted with permission.
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