The Prime Problem

Yesterday, I reported on the Mortgage Bankers Association's grim report on mortgage delinquencies and foreclosures. In doing so, I mentioned that prime mortgages continue to replace subprime mortgages as the problem. The Wall Street Journal has an article about this today, which includes this really great chart:

prime problem wsj.gif

I would note a few things about this. In the fist graph, note that the vertical axis is percentage of delinquencies for that type of mortgage, not number or percentage of all delinquencies. Subprime mortgages actually account for a very tiny proportion of all mortgages out there (see data in chart on bottom right for proportions). As a result, the rise you're seeing in prime mortgages, both adjustable rate and fixed rate, is a lot more significant in comparison to that high subprime percentage that the graph implies. In fact, looking at the shaded "All" trend shows how closely all delinquencies correlate to the prime fixed rate mortgages, which account for by far the largest portion of the market.

That same graph also demonstrates a pretty obvious point: adjustable rate mortgages, whether prime or subprime, are clearly a problem. Many homeowners likely took these mortgages because they had low teaser rates, and they figured they would just refinance before the mortgage reset. Of course, now that the housing market has tanked, they have no such opportunity: their mortgages are largely underwater, and banks have tightened lending. I am as cynical as anyone about regulating in an attempt to protect consumers from financial products, but I can't think of a very compelling reason why we need to keep adjustable rate mortgages around. This chart shows just how dangerous they can be.

Next, let's look at the chart in the bottom right-hand corner. This one shows that subprime loans are really no longer the problem. I think the subprime market may be beginning to bottom out in terms of the effect they're having on the foreclosure problem. Prime mortgages will continue to dominate delinquencies and foreclosures for as long as unemployment remains high.

Finally, the WSJ article makes a good point about the troubling direction of prime mortgages, in conjunction with Washington's attempts at foreclosure prevention:

But modification programs may not be able to help the growing number of borrowers who are falling behind on their payments because they are losing their jobs. Most loan-modification programs have been designed to help borrowers with loans that reset to higher payments or with high debt-to-income ratios.

That's right. If someone has no income, there's no way to modify a mortgage that will suddenly enable him to pay. The only way to do that would be if you allowed the borrower to defer payments until employed again. The current modification plans don't allow for that. Doing so would be a new precedent for how the government grapples with recessions, as credit delinquencies always increase during a recession due to unemployment. But prime borrowers will be the bigger part of the problem going forward, so it will be interesting to see if Washington responds.