It's Not a Subprime Problem

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A recent Bloomberg article illustrates why people who think that foreclosures will be confined to subprime mortgages are in for a rude awakening. Says the article:

U.S. homeowners with good credit are increasingly falling behind on mortgage payments, a sign lenders have been offering "higher risk" loans outside the so-called subprime market, Standard & Poor's Corp. said today.

Rising late payments and defaults on so-called Alt A mortgages made last year are "disconcerting" and delinquent borrowers appear to be "finding it increasingly difficult to refinance" or catch up on their payments, S&P analysts said today in a statement.

I covered the distinction between subprime mortgages and what S&P calls "higher risk" loans back in March, and again in April, but the vast majority of analysts continue to act as if the problems are limited to subprime loans. So I'm going to use the latest Bloomberg piece as an excuse to revisit the topic yet again.

"Subprime" is a label that is given to borrowers with low credit scores. A borrower who has a good credit history and a track record of paying the bills on time is not considered subprime.

"High risk mortgages" are those that have features that increase the likelihood of the borrower being unable -- or unwilling -- to make the payments at some point in the future. The most notable of such features are the tendency for the loan's monthly payment to reset substantially higher in the future, limited documentation of borrower income or assets, and very low down payments. Many high risk loans contain a combination of these vulnerabilities, if not all of them.

Now, here is the essential point: many, many high-risk mortgages were granted to borrowers who were not subprime.

As a matter of fact, high-risk mortgages have accounted for a comfortable majority of all San Diego home loans in recent years.

It's true that the biggest problems have manifested themselves in the subprime loans so far. But this is because subprime borrowers have less margin for financial error and because teaser-rate subprime loans tend to reset sooner than their non-subprime counterparts. The latter aren't in the clear just yet. 2007 will see more loan resets than 2006 did, 2008 will see more than 2007, and both years will revisit many a reset upon non-subprime borrowers.

The ongoing (and, I can't help but add, inevitable) foreclosure crisis is not about credit scores. It's about borrowers of all economic stripes who took out high-risk loans with the expectation that continued home price appreciation would pay their bills for them. To dismiss it as a subprime problem is to ignore what caused the crisis in the first place.

-- RICH TOSCANO