Saturday, August 11, 2007

Summary of the Mortgage Mess in the US

Below is a summary of the mortgage mess in the US as summarized by the WSJ. The article has some good graphs and some interesting factoids. The article is excellent for those that do not follow the news on this market closely.

Wall Street swooned this past week, as growing turmoil in the U.S. subprime-mortgage sector spread around the world, prompting intervention by central banks.

Problems have been growing all summer. Skyrocketing defaults of subprime mortgages have caused losses for hedge funds and other buyers of securities backed by those mortgages. Lenders have responded by tightening credit, making it more difficult and expensive for businesses to borrow money.

On Thursday, market jitters escalated after French bank BNP Paribas SA said it would freeze some $2.2 billion in three funds because the market for mortgage-backed securities had practically evaporated. That made it impossible for BNP's funds to sell those securities or determine what they were worth.

BNP's move ricocheted around the globe, sending stock markets down in the U.S. on Thursday and Asia and Europe on Friday. The Federal Reserve and other central banks pumped billions of dollars into money markets, in an effort to stabilize interest rates and make borrowing easier.
Here's a closer look:

What's causing the credit crunch? Growing delinquencies in "subprime" loans, those made to borrowers with poor credit, have hit hedge funds and investors. Lenders in the past few years had been packaging these loans into securities and selling them to investors eager for bigger returns. Delinquencies stayed low at first because U.S. home prices were rising at a rapid clip, and borrowers who fell behind on payments were able to simply refinance their mortgages. But that ended as home prices peaked in most markets in 2006, leading more homeowners to fall behind on payments.

The sale of securitized loans by Wall Street was intended to distribute risk more broadly. But because the final owner of those securities often had little idea what their investment was worth, or how much risk it carried, investors are now wondering if that securitization might have instead spread a virus by making it too easy for investors to buy complex investments. Last month, Moody's Investors Service downgraded 399 residential mortgage-backed securities, about $5.2 billion of bonds.

Could more Americans feel economic pain? While it already has become much harder for subprime borrowers to get a loan, nervous home-mortgage lenders have also begun raising rates or cutting off credit for other types of loans, including Alt-A loans, a grade between prime and subprime. Standard & Poor's said this past week it would downgrade 207 classes of Alt-A mortgage-backed securities.

Rates have also increased over the past few months on jumbo mortgages, which exceed the $417,000 limit for loans offered by government-backed mortgage houses Fannie Mae and Freddie Mac. That could squeeze middle-class families in cities like San Francisco, New York, and Washington, D.C., where middle-class home prices have risen above $500,000.
Alt-A loans accounted for about 13% of home loans last year and subprime loans accounted for about 20%, according to Inside Mortgage Finance. Jumbo loans account for about 16% of the market.

Will the government get involved? The Federal Reserve issued a statement Friday, saying it would provide liquidity "to facilitate the orderly functioning of financial markets," and injected $38 billion on top of Thursday's $24 billion. This week, the ECB injected €155.85 billion ($213.2 billion) into the market, more than the €109.6 billion it injected in the two days after Sept. 11, 2001.

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