Sowhat’stheproblem?

AstheUShousingmarketslowedlastyearandthenumberofbuyersfell,lendersrelaxedtheirlendingstandardsevenfurther–acceptingloanapplicationswithoutcheckingpeople’sincomesandsellinglargernumbersofnewproducts。

Manysubprimeloansweretakenoutunderdealsthatofferedaverylowstartingrateofinterest,butthenresetafteracoupleofyearstoafarhigherrate,forexample。

Theseinitiallygotthebuyersinthedoor,butnow,asthehigherrateskickin,thesamebuyersarestruggling。

Worse,nowthathousepriceshavestartedfalling,theycan’tselluporrefinancetheirwayoutofdifficulty。

Theresultisthatmoresubprimeloansaregoingbadmorequicklythanlendersexpected:12。

6%wereinarrearsinthelastquarterof2006。

Whatdoesthismeanforlenders?

Evenduringtherecentperiodofbuoyanthouseprices,thelevelofsubprimeforeclosureswashigh,withasmanyasoneineightloansendinginforeclosurewithinfiveyears。

Butnowthathousepricesarefalling,it’sgettingworse。

Oneinfivemortgagestakenoutbyhigh-riskcreditorsintheUSinthepasttwoyearsisexpectedtoendinrepossession。

Theproblemforsub-primelendersisthatalthoughtheyhavesoldofftheirloansasMBSs,theseloanshaveaclauseinthemthatstipulatesthat“iftheydeterioratetoofar,tooquicklytheycanbereturnedtotheoriginator”,saysFelixSalmonontheRoubiniGlobalEconomicsblog。

Andtheyarebeingreturned。

MBSinvestorsaresendingasmanyloansbackaspossible。

Atthesametime,thebanksarecuttingoffthesubprimelenders’creditlines,leavingthemwithheftydebtsandnomoneyfornewloans。

Twentytwosubprimelendershavegonetothewallinthelasttwomonthsalone。

Howcanwemeasuretheextentoftheproblem?

OnewaytomeasuretheeffectsofproblemsinthesubprimemortgagesectoristolookattheCreditDefaultSwaps(CDS)market。

ACDSeffectivelyinsuresagainstadebtgoingbad,soifwechecktheCDSmarket,wecangetaviewoftheperceivedriskinthesubprimemarket。

Inthelastfewmonths,thecostofinsuringagainstthedefaultofanMBSbasedonthelowestgrade(ie,themostrisky)ofsubprimeloans(thesearegradedBBB-bylenders)hasmorethanquadrupledandtheindexthatmeasuresthechangeinthecost(theABX)hasmovedby30%sincetheendofJanuaryalone。

Worryingly,thelackoffaithinloansamonginvestorsisnowspreadingtomortgagesinthemid-rangeofcreditquality:theAlt-A,oralternativeA-ratedpaper。

Theseloansarenotsubprime,buttendtohavehigherlevelsofdebtsecuredagainstthepropertythan‘prime’mortgages。

StandardPoor’shaveincludedAlt-Apaperin18classesofsecuritiesfrom11residentialmortgagepoolsthatareonwatchforadowngrade。

Howfarwillthesubprimerotspread?

Theexpectedjumpinforeclosurescoulddeprivetwomillionpeopleoftheirhomes,saysTomBawdeninTheTimes。

Butthebigworryisthatconcernsaboutcreditriskinthesubprimesectorwillcauselenderstotightenlendingcriteriaacrossthescaleevenfurther。

Thiswouldhurtthehousingmarketmore,allowingfewernewborrowersintothemarket,puttingthebreaksonrefinancing–theonlywaymanypeoplearecurrentlykeepingtheirheadsabovewater,andforcingfurtherrepossessions。

AsfortheMBSmarket,accordingtoJoshuaRosnerofGrahamFisherCo,co-authorofastudyonthemarket,“Thedangerintheseproductsisthatinchanginghandssomanytimes,nooneknowstheirtruemake-up,andthuswhoisholdingtherisk。

”Butasthecurrentproblemsshow,theserisksaremuchmoresignificantthanthebroadermarketshadanticipated。

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