Will Subprime Bite the Financials Again?

Today I saw an INGDirect ad for adjustable rate mortgages that struck a chord. A week or two ago I read an article at the WSJ Deal Journal Blog that said many of the mega banks were looking at ARM's and subprime again as a way to increase returns. While the article didn't say that the banking giants were getting bank into the fold originating subprime loans, the banks are eyeing the acquisition of "distressed mortgage assets."

I'm not an MBA or finance wiz, but I'm wondering if there aren't practical considerations the big banks are overlooking. We all know that the subprime meltdown was caused by lenders extending too much credit to borrowers that had questionable credit qualifications and with too little equity. The big mortgage lenders have paid a price taking write downs on a good chunk of those loans. Since the number of delinquent borrowers has increased, the risk and corresponding value of the loans has decreased in the secondary market.

If we take it as a fact that home values have decreased (or at least stagnated) due to demand in many areas, the amount of equity that lenders hold has stayed about the stayed about the same (or increased slightly as a percentage). That would normally be fine for lenders because even if they had to forclose on the borrower they would have sufficient collateral. However, there will almost assuredly be a backlash and tightening of lendering standards. This will likely lead to a shrinking pool of qualified buyers and demand sticks lenders with different problems. Reports have quoted Freddie Mac as stating a foreclosure costs it $60,000. While that figure seems misstated to me, banks are undoubtedly better off if foreclosures never happen.

Banks know more about the time value of money than anybody else. The last thing they want to be is in the business of managing real estate. Even if they can find someone to buy the property quickly after a foreclosure, the lender will undoubtedly rack up some fairly significant legal fees in the process of removing the borrower. I'm not sure there is an easy solution, but think that the industry is much more complex than it was in the past. This is compounded by the fact that most big traditional lenders are restricted in the types of investments they can make . Hedge funds and other alternative investment organizations are more flexible and can play both sides of the market.

In the end banks need to shore up their lending standards and re-evalute the risks each borrower poses. Many of the ARM loans already originated have murky credit standards and were securitized into the secondary market with purchasers not exactly sure what they are buying. I hope the banks now moving on the discounted subprime loans have done their research so they won't need to be bailed out down the road after writing down more loans.

Foreclosure Laws for Dummies

When I was looking for the foreclosure laws in my home state of tonight I stumbled accross Foreclosures.com which has a handy list that summarizes the foreclosure laws and procedure for each state. Might be helpful for any of you out there looking to snap up a property or two that has been a victim of the subprime fallout. You can check out some of my old posts about where the hottest areas for subprime are, the subprime fallout, and why the lenders aren't to blame this time, but people shouldn't feel sorry for them either.

Links:
Foreclosures.com

Morning Round-up: What's Hot in the PFBlog-o-sphere this week?

The Consumerist has an article about a person who emailed Progressive after their credit score had improved (apparently the company checks your credit every 3 years by default) and the company dropped his premium about $70 for the 6 mo period. Not too shabby.

Frugal for Life has a nice run down of common renting laws and tips to prevent you from getting screwed by the landlord.

If you want to see the problem of overspending perpetuated in America check out the new version of the "Life" board game being co-sponsored by Visa called "Twists & Turns" over at the Consumerist.

Free stuff is always good, especially if it's good free stuff. The Five Cent Nickel is giving away iPods and well boxes of bricks in celebration of it's two year anniversary. Everyone can use a free iPod. You just need to make a comment on the page.

The Washington Post has a thorough article about how to fight back against the subprime fallout and keep your house (I know it's not a blog, but hey - it's relevant).

Subprime, Foreclosures and Second Chances

Home foreclosures are up dramatically across the country as part of the subprime fallout, but has spiked especially high in certain areas (see my post on subprime data and heat maps). If you are one of these people who is getting close to foreclosure and wondering what to do, Clark Howard (Clark Howard - Wikipedia) is suggesting that you call your lender and try to work out a deal. He reporting that to avoid foreclosures some lenders have recently began agreeing to extend loans to 40 years. While not a huge amount of relief (usually about 5%) it may be enough to help you ride things out for a little bit. Clark is saying that foreclosures rates have risen astronomically and are up 1,100% in Ventura Co. California, 900% in Orange Co., and 700% in most other Southern California counties and speculative areas in the southwest. Knowing that your lender likely has a lot of other people in the same situation might give you a little big of leverage when negotiating.

Links
Clark Howard - Apr 17, 2007 Foreclosures Up

Subprime Shakeout and Where it is Happening

The fallout from subprime lending defaults and other risky lending ventures made big news a few weeks ago, but now we are starting to get a clearer picture of the extent of the damage. Some resourceful bloggers have put the data into graphical form. The data floating around out there shows where the most subprime loans were made and also the locations where most are now in foreclosure.

For the most part the data isn't earth-shattering, because it seems that the most subprime loans were made around the major metro areas. I would guess this is because there are typically very wealth and poor people in these areas (or maybe just people in general). My theory is then that there were plenty of people buying more house than they could afford or investment property and also those who probably shouldn't have been offered a loan in the first place. However, that doesn't seem to always be the case if the maps are any indication. I'm not really sure what to make of these, but here they are...

Links
Dinocrat has some nice maps of subprime lending and subprime foreclosures

The Big Picture has a state by state subprime heat map that shows which states have the most subprime loans out there.

Subprime: The Business Falling Faster Than Britney Spear's Career

Subprime lending has received a considerable amount of attention from the major media lately. While I think that some of the negative attention is deserved, like everything the media needs a scandalous story and evil character to go after in stories. These lenders aren't without fault, but people are looking past the real issue.

Land contracts with balloon payments have been around for years in the lending biz. While I think excessively large increasing payments are ethically questionable. The biggest problems are 1) the lack of basic financial skills we possess as Americans, 2) people borrowing beyond their means and buying more house than they need, 3) eager lenders with relaxed lending standards.

Cheap, easy to attain financing is a great thing and one of the keys to people living the "American Dream." The problem recently has been that companies have extended this financing to people who were buying "investment property" or homes that their cash flow would not support. While the economy was growing fast and property values growing faster this generally wasn't an issue. As housing inventory increased the problems began. The subprime lenders had a problem in two respects first many people receiving loans were less than qualified and as the housing market turned and payments increased they were on the hook for payments they couldn't afford.

So why don't I think the problems going on now aren't the fault of lenders?

• Whether at subprime rates or market rates, unqualified people will receive loans -- they may just pay extra for the risk associated.
  
  
• Basic finance skills aren't taught in the U.S. Schools have a vested interest in teaching for tests which determines their funding. The vast majority of U.S. households are buried in "Bad Debt" with no signs of changing soon. Teaching fiscal responsibility needs to start at an early age. Americans do bestow the glory on those who take risks, but there are many more risk takers to fail than succeed.
  
  
• People need to educate themselves. There are a slew of resources online, some better than others, they can help you learn about any number of topics. Personal finance is no different. Banks are required to disclose in plain English the payments and interest rate of a loan. If you are taking out a loan and can't determine if the monthly payments outpace your monthly revenues you need to seek assistance or not take out the loan.

There are always cases of predatory lending companies, but I'm talking merely about companies that lend to borderline individuals. Not those that make loans to people who are clearly incapable of ever repaying. I am also not trying to imply that bad things don't happen to good people. Real life happens and people can lose a job, fall into bad health, or fall on hard times. I think people need to be accountable for their own actions. Too often in the society we live in people are quick to point the finger rather than look in the mirror.

What do you think? Am I way off base?