Subprime Mortgage Markets Are in Disarray and Mortgage Lending Standards Are Firming Up
Bad news has been coming out of the subprime mortgage market since the beginning of the year, and on Feb. 27 Freddie Mac announced that it would no longer buy mortgage securities backed by subprime mortgages with features that provoke serious “payment shock.” This announcement apparently contributed to the turmoil in financial markets later that day.
There is no doubt that lending standards in the subprime mortgage market deteriorated badly during the 2004-2005 housing boom, and even into 2006, and it’s clear that neither the investment community nor the financial rating agencies fully understood the risks associated with subprime mortgage securities — particularly the subordinated tranches.
While tightening of lending standards in the subprime market inevitably will take some toll on home buying in 2007, the adjustments now underway are essential to the health of the subprime market down the line.
The biggest issue for the housing outlook relates to lending standards in the “Alt-A” and the quantitatively dominant “prime” components of the home mortgage market. The Federal Reserve’s January Senior Loan Officer Opinion Survey — the most recent survey — showed that about 15% of domestic commercial banks (net) had tightened credit standards on residential mortgage loans over the prior three months, the highest fraction since the early 1990s.
This tightening, of course, followed three years of cumulative net easing and hardly means that mortgage lending standards at banks have become overly tight!
On Feb. 28, Fed Chairman Ben Bernanke told Congress that the current problems in the subprime mortgage market are not likely to spill over into the prime market to a serious degree, suggesting that the projected stabilization of the housing market is not likely to be derailed by an abrupt firming of mortgage lending standards.
We certainly agree, although there definitely are risks on this front. [return to top]