Subprime: A Genuine Crisis Or A Mere Flesh Wound?

The state of the subprime market was viewed through a pair of starkly different spectrums at the California Mortgage Bankers Association's Western Secondary Market Conference, held July 18-20 in San Francisco. During a session titled "Economic Impact on Mortgage Banking Today and Tomorrow: Views of the Industry Experts," one presentation insisted the subprime woes were regionally contained and would disappear soon, while another presentation found the market to be a national concern that would not abate for another two years.
For Douglas G. Duncan, senior vice president and chief economist for the Mortgage Bankers Association, the news of subprime's ill health was a significant misdiagnosis.
"Subprime is alive and well," said Duncan. "Subprime is not going away."
Duncan insisted the scope of the subprime market has been acutely blown out of proportion. "Subprime is a relatively small portion of the total market," he stated. "Seven-and-a-half percent of people who have mortgages have a subprime mortgage."
In Duncan's presentation, the problems facing the subprime market are not indicative of a national epidemic. Rather, he saw it as a narrow problem for a few specific locations.
"We have what I would call "A Story of Seven States,'" he said, identifying Ohio, Indiana, Michigan, Florida, Nevada, California and Arizona as the septet trouble spots. "With delinquencies and foreclosures, this is not an entire United States issue. If you strip those states out, delinquencies and foreclosures fell in most of the United States."
Duncan blamed unique problems within statewide economies, not the subprime loans, as the primary culprit affecting the housing markets. "We want to make the point that it is not the product that's driving this," he intoned. "It's the local market conditions. If you turn their state economies around, you will not see a reversal in the prospect of the housing markets in those states. In Michigan, for example, between 2001 and 2007 they lost about 296,000 payroll jobs. You cannot lose 296,000 payroll jobs out of the state economy without some of the housing markets taking a hit. And they've definitely taken a hit.’
‘Plus,’ he continued, ‘the [Michigan] pace of median income growth is about one-third that of the U.S., and you've seen house price declines as a result."
Duncan also dismissed concerns that predatory lending and fraud were fueling the woes facing the subprime market.
"The issues of predatory lending and fraud always emerge when you see a general economic decline," he said. "Those are the players that are on the fringes when the overall economic conditions are deteriorating, but they are not the prime drivers."

Duncan predicted a fast end to the rising number of delinquencies and foreclosures. "We believe we will see the peak in delinquencies in the next two-to-four quarters, and the foreclosures peak one-to-two quarters after delinquencies," he stated. "So if we're right, then you'd expect the peak in foreclosures four-to-six quarters out."

However, Duncan's opinions were not shared by Jennifer Bridwell, senior vice president and product manager for PIMCO, a fixed-income fund management company based in Newport Beach, Calif.

"This is a critical moment in the mortgage market," she said. "We're in a protracted weak housing market. We don't think the trough in housing will come until sometime in 2009. And the reason we think that is because housing markets are slow.’

Bridwell used a nautical analogy to explain her opinion. ‘We like to compare the housing markets to a supertanker,’ she said. ‘Our friends in the Navy tell us that when you throw a supertanker in full reverse, it takes them 29 miles to stop. So the Fed put the housing market in full reverse two-plus years ago, and it's just starting to come to a stop."

Unlike Duncan, Bridwell saw the a wider tapestry of problems affecting both subprime loans and the industry as a whole: tightening credit standards, downgrades by ratings agencies, pressure on Congress to address the problems relating to residential lending, and a low supply of affordable housing. The latter concern was particularly trenchant, she added, pointing out that many Americans have experienced stagnation in their incomes and thus have been unable to keep pace with the rising costs of housing.

Bridwell also observed that subprime has created a public relations and investor relations nightmare.

"We've seen tremendous media coverage of the "mortgage meltdown,'" she said, waving her fingers to mime quotation marks around the words "mortgage meltdown." "Every time I see that in a headline, I have to sigh because I know I am going to get 50 phone calls from my clients that day saying: "What do you have in the portfolio? What is my exposure to subprime?'"


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