Subprime Problems Isolated

“We admit to being somewhat spooked,” Levkovich said. “However, we also suspect that concerns about weakening within the subprime sector have been somewhat overblown.

“We don’t think that an uptick in consumer loan delinquencies, from residential mortgage or other sources, will be enough to trigger a major economic meltdown,” he said. “In the past, an upturn in consumer delinquency rates from very low levels did not signal an imminent recession, and is unlikely to crater consumer spending again.”

Levkovich points out that, according to the Mortgage Bankers Association, only about six percent of homeowners are nonprime borrowers with adjustable rate loans.

“Subprime loans account for a fairly small share of overall mortgages, and should not necessarily be viewed as a lens into the general health of the U.S. consumer,” he said.

Striking a similar tone was Richard Berner, a managing director and chief U.S. economist for Morgan Stanley.

Berner wrote in an investment note that “soaring defaults signal that the long-awaited meltdown is subprime mortgage lending is now underway, and it likely has further to go.”

“I’ll concede that subprime spreads may widen some more, more subprime lenders may fold, and the supply of subprime credit likely will tighten further,” he said. “(But) worries about a wider credit crunch are dramatically overblown, in my view.

“The balance sheets of most prime lenders are strong, investors are differentiating among rungs of the mortgage credit ladder, and a limited incipient spillover into prime loans and other asset classes signals that a credit crunch is remote,” Bender said.

Bender reports that subprime loans account for $605 billion, or 11% of the $5.5 trillion in outstanding securitized mortgages.

Early payment defaults are hurting the sector now, “forcing some originators to take back dud paper they thought they had successfully packaged off their balance sheets into asset-backed securities,” Bender said.

“The rise in such defaults is hardly surprising,” he said. “Eager lenders fueled rapid growth in lending during a period of low rates and strongly rising home prices.”

It is those “eager” lenders who are now feeling the pain while more “disciplined” lenders should be able to weather the industry’s storm, Bender said.

“Early payment defaults are symptomatic of and confined to aggressive lenders that stretched to maintain origination volume to cover a high fixed-cost business model,” he said. “In contrast, disciplined industry leaders have experienced almost no early payment defaults, in line with the modest deterioration in overall mortgage credit quality.”

Bender does not expect Congress or federal regulators to respond with regulatory action; instead, he thinks the industry will mainly police itself with overly aggressive lenders going under or taking heavy losses while more disciplined lenders reduce exposure to bad loans.

“Legitimate lenders understand that appropriate lending standards and better financial education will improve their profitability by reducing the role of abusive lenders and limiting foreclosures,” he said, “and they and regulators are working to find the right balance.”

Patrick Crowley is a feature journalist and blogger for MortgageDaily.com. He is also a reporter, blogger and columnist for The Cincinnati Enquirer.
e-mail Patrick at: PatCrowley@MortgageDaily.com