The New York Times
Tuesday 12 February 2008
The credit crisis is no longer just a subprime mortgage problem.
As home prices fall and banks tighten lending standards, people with good, or prime, credit histories are falling behind on their payments for home loans, auto loans and credit cards at a quickening pace, according to industry data and economists.
The rise in prime delinquencies, while less severe than the one in the subprime market, nonetheless poses a threat to the battered housing market and weakening economy, which some specialists say is in a recession or headed for one.
Until recently, people with good credit, who tend to pay their bills on time and manage their finances well, were viewed as a bulwark against the economic strains posed by rising defaults among borrowers with blemished, or subprime, credit.
"This collapse in housing value is sucking in all borrowers," said Mark Zandi, chief economist at Moody's Economy.com.
Like subprime mortgages, many prime loans made in recent years allowed borrowers to pay less initially and face higher adjustable payments a few years later. As long as home prices were rising, these borrowers could refinance their loans or sell their properties to pay off their mortgages. But now, with prices falling and lenders clamping down, homeowners with solid credit are starting to come under the same financial stress as those with subprime credit.
"Subprime was a symptom of the problem," said James F. Keegan, a bond portfolio manager at American Century Investments, a mutual fund company. "The problem was we had a debt or credit bubble."
The bursting of that bubble has led to steep losses across the financial industry. American International Group said on Monday that auditors found it may have understated losses on complex financial instruments linked to mortgages and corporate loans.
The running turmoil is also stirring fears that some hedge funds may run into trouble. At the end of September, nearly 4 percent of prime mortgages were past due or in foreclosure, according to the Mortgage Bankers Association.
That was the highest rate since the group started tracking prime and subprime mortgages separately in 1998. The delinquency and foreclosure rate for all mortgages, 7.3 percent, is higher than at any time since the group started tracking that data in 1979, largely as a result of the surge in subprime lending during the last few years.
An example of the spreading credit crisis is seen in Don Doyle, a computer engineer at Lockheed Martin who makes a six-figure income and had a stellar credit score in 2004, when he refinanced his home in Northern California to take cash out to pay for his daughter's college tuition.
Mr. Doyle, 52, is now worried that he will have to file for bankruptcy, because he cannot afford to make the higher variable payments on his mortgage, and he cannot sell his home for more than his $740,000 mortgage.
"The whole plan was to get out" before his rate reset, he said. "Now I am caught. I can't sell my house. I'm having a hard time refinancing. I've avoided bankruptcy for months trying to pull this out of my savings."
The default rate for prime mortgages is still far lower than for subprime loans, about 24 percent of which are delinquent or in foreclosure. Some economists note that slightly more than a third of American homeowners have paid off their mortgages completely. This group is generally more affluent and contributes more to consumer spending and the economy relative to its size.
Unlike subprime borrowers, who tend to have lower incomes and fewer assets, prime borrowers have greater means to restructure their debt if they lose jobs or encounter other financial challenges. The recent reductions in short term interest rates by the Federal Reserve should also help by reducing the reset rate for adjustable loans.
Still, economists say the rate cuts and the $168 billion fiscal stimulus package are unlikely to make a significant dent in the large debts weighing on many Americans, because banks have tightened lending standards and expected rebates from the government will not cover most house payments.
The problems are most acute in areas that experienced a big boom in housing - California, the Southwest, Florida and other coastal markets - and in the Midwest, which is suffering from job losses in the manufacturing sector.
And it is not just first-mortgage default rates that are rising. About 5.7 percent of home equity lines of credit were delinquent or in default at the end of last year, up from 4.5 percent a year earlier, according to Moody's Economy.com and Equifax, the credit bureau.
About 7.1 percent of auto loans were in trouble, up from 6.1 percent. Personal bankruptcy filings, which fell significantly after a 2005 federal law made it harder to wipe out debts in bankruptcy, are starting to inch up.
On Monday, Fitch Ratings, the debt rating firm, reported that credit card companies wrote off 5.4 percent of their prime card balances in January, up from 4.3 percent a year ago. The so-called charge-off rate is still lower than before the 2005 law went into effect.
Banks are responding to the rise in delinquencies by capping home equity lines of credit in areas with falling real estate prices. A few credit card companies have also moved to reduce the credit limits of customers they deem more risky.
Bank of America, Citigroup, Countrywide Financial, JPMorgan Chase, Washington Mutual and Wells Fargo are expected to announce on Tuesday at the Treasury Department that they will offer both prime and subprime borrowers who are more than three months behind a chance to halt foreclosure proceedings for 30 days and work out new loan terms.
In a conference call with analysts in December, Kenneth Lewis, the chief executive of Bank of America, said more borrowers appear to be giving up on their homes as prices fall, noting a "change in social attitudes toward default."
"You don't mind making a $2,000 payment when the house is going up" in value, said Steve Walsh, a mortgage broker in Scottsdale, Arizona, who has seen several clients walk away from their homes because they couldn't refinance or sell. "When it's going down, it becomes a weight around your neck, it becomes an anchor."
Home prices in the North Las Vegas neighborhood of Brenda Harris, a technology analyst at a casino company, have fallen 20 percent to 30 percent. The builder who sold her a new three-bedroom home on Pink Flamingos Place for about $392,000 in 2006 is now listing similar properties for $314,000. A larger house a block down from Ms. Harris was recently listed online for $310,000.
But Ms. Harris does not want to leave her home. She estimates that she has spent close to $40,000 on her property, about half for a down payment and much of the rest on a deck and landscaping.
"I'm not behind in my payments, but I'm trying to prevent getting behind," Ms. Harris said. "I don't want to ruin my credit."
In addition to the declining value of her home, Ms. Harris, 53, will soon be hit with a sharply higher house payment. She has an option adjustable-rate mortgage, a loan that allows borrowers to pay less than the interest and principal due every month. The unpaid interest gets added to the principal balance. She is making the minimum monthly payments due on her loan, about $2,400.
But she knows she will not be able to pay the $3,400 needed to cover her interest and principal, which she will be required to pay once her loan balance reaches 115 percent of her starting balance. And under the terms of her loan, which was made by Countrywide Financial, she would have to pay a prepayment penalty of about $40,000 if she chose to refinance or sell her home before May 2009.
She said that she now wishes she had taken a traditional fixed-rate loan when she bought the home. At the time, she asked for a loan that could be refinanced after one year without penalty. She said her broker had told her a week before the closing that the penalty would extend until May 2009 and that she reluctantly agreed because she had already started moving.
A nonprofit community group, Acorn Housing, is trying to broker a modification of Ms. Harris's loan. In a statement Friday, Countrywide said the company had been in touch with Ms. Harris and would work with her.
Credit counselors say many borrowers like Ms. Harris were cajoled or pushed into risky mortgages that they never had the ability to repay.
Others disregarded warnings about complex loans because they wanted to be a part of the housing boom, which like the technology stock bubble lured people in with seemingly instant and risk-free profits, said Mory Brenner, vice president of Financial Firebird Corporation, a company based in Pittsfield, Mass., that publishes consumer debt information and refers borrowers to credit counselors.
"I'd say, Let me tell you something, this is crazy," Mr. Brenner said. "You cannot afford this house, even if nothing happens and rates stay as low as they are today. And the response would be: I don't care."
Lenders extended credit to people without verifying their incomes and allowing them to make little or no down payments.
But borrowers like Mr. Doyle, the engineer in Northern California, say they are victims of their circumstances - housing prices collapsed and lending standards tightened just as they needed to sell or refinance.
In refinancing their home in 2004, Mr. Doyle and his wife were doing what millions of other homeowners did in the last decade - tapping into the rising value of their homes for home improvements, paying off credit card debt, college tuition and for other spending.
The Doyles took advantage of the housing boom by refinancing their home nearly every year since they bought it in 1995 for $275,000. Until their most recent loan they never had a problem making their payments. They invested much of the money in shares of companies that subsequently went bankrupt.
Still, Mr. Doyle does not regret refinancing in 2004. "My goal was clear: I wanted to help my daughter go through college," he said. "It wasn't like it was for us."
Escape From Recession
By Jared Bernstein and Lawrence Mishel
In These Times
Monday 11 February 2008
What you should know about the economic stimulus package.
We hate to fulfill the stereotype of dismal scientists, but the news is bad: The economy is slowing sharply and may be in recession. The nation's broadest measure of growth, real gross domestic product (GDP), grew a scant annual rate of 0.6 percent at the end of last year. Unemployment has risen, and job growth has slowed sharply. The housing market has yet to hit bottom, and credit markets are still deeply chilled, if not frozen.
Here's the better news: When this type of scenario develops, the case for an economic stimulus package to offset the downturn is both simple and widely accepted. But there are many ways to craft a growth package, and if we don't get this right, we risk wasting big money while failing to mitigate the pain of recession.
As In These Times went to press, both chambers of Congress had passed bills, and their ratification looked all but certain. (President Bush had signed off on the House bill, and had agreed to support the Senate's package after it had been signifcantly scaled back.) The bills spend about $150 billion this year and next on a combination of "tax rebates" (though that's really a misnomer) and business tax cuts.
Will that be good enough? Here's a Stimulus 101 primer, as well as a list of what we think is missing from the current economic recovery plan.
The Basics
Economies depend on robust demand. When folks stop buying, when investors leave the room, when governments stop building and improving public goods, growth grinds to a halt. And when that happens, the job machine stalls, unemployment rises, those with jobs work fewer hours, wages rise more slowly, and incomes decline, especially for the lowest earners and many minorities.
The last two recessions-in the early '90s and early 2000s-led to declines in the typical family's income by about $2,500 (in today's dollars). That ain't peanuts.
Such a potential income loss is especially worrisome now, as the inflation-adjusted median family income actually remains about $1,000 below where it stood in 2000. If recession is imminent, this would be the first time that real incomes at the end of a recovery have not exceeded those at the previous economic peak.
That fact might be the greatest indictment against Bushonomics and the "ownership society" he touted. It is a stark reminder that while the stimulus appropriately targets a short-term problem, the mechanisms that serve to fairly distribute income have been broken for some time. Most families in the United States have not fared nearly as well as they should have, given their contributions to the growth we've experienced. The coming slowdown will only submerge them in deeper water.
That's what makes fiscal stimulus so necessary. By fiscal stimulus, we mean a temporary infusion of expenditures into the economy by the federal government to raise demand. The infusion necessarily takes the form of some combination of a reduction in taxes and spending increases.
We've also got more time than we think. Each of the last two recessions was short (eight months) in GDP terms, but far longer in terms that matter most to most people: jobs and unemployment.
Unemployment rose for 19 months after November 2001, which was the official end of the last recession, and employment declined by another 1.1 million and did not start growing until September 2003. Had an effective stimulus package come late in the game, as officially measured, it would have helped shorten what turned out to be the longest jobless recovery on record.
Current Proposals
The president and the House agreed on a stimulus package that spends about $100 billion on personal tax rebates and $50 billion on business, by allowing them to depreciate new investments faster than usual, and thereby pay fewer taxes. (Firms can deduct the cost of depreciation from their income to lower tax liabilities.)
The package has some pluses, but it could have been much improved. Thanks to negotiations by House Democrats, $28 billion more of the rebates will reach 35 million more low-income persons than were included in the initial White House package. Under Bush's original plan, only 8 percent of the rebate made it down to the bottom 40 percent. It's now 21 percent. That gets money to folks who need it, but also helps because those folks will spend the money (rather than save it) and generate more demand.
But the bonus depreciation for businesses is a particularly ineffective form of stimulus. For each dollar of tax revenue we sacrifice in this way, we get back a measly 27 cents in new demand, according to economist Mark Zandi. Of the 13 types of stimulus Zandi tested, this one was the worst. (Making the Bush tax cuts permanent was, at $0.29, a close second.)
This package, while costing 1 percent of GDP, could boost the economy by less than 1 percent, perhaps around 0.75 percent. That's unacceptable. We should get at least 1-for-1. Any stimulus worth passing should get back at least as much in GDP terms as it costs, and even that's a low bar.
The Senate's plan is a little better in this regard. While spending about the same amount on rebates, it gets them to even more low-income people. (Seniors dependent on Social Security were left out of the House plan.) But Senate Republicans blocked its originally proposed 13-week extension to unemployment insurance (beyond the normal 26 weeks), which offered a strong bang-for-the-buck: A dollar spent here gets you $1.64 in stimulus. The reason is simple: People unemployed long-term need money and spend money. That's not always the case with rebates.
What's Missing
One thing the current stimulus package got right was making payments to individuals. But these are not "tax rebates," which implies that the government is returning taxpayers' money to people who overpaid their taxes. Rather, these are checks provided to people in the expectation that they will spend the money on goods and services.
Why is that helpful? Because as they spend these payments, they create demand. For instance, when you buy items at Costco, the store will restock its shelves and re-order goods from its suppliers, a process that maintains employment and wages being paid and spent, all of which boosts the economy. But, to energize the economy, these payments have to be spent, not saved. Better yet, they need to be spent on domestic items, as imported goods stimulate another country's economy.
When the payments are spent domestically, their impact reverberates throughout the economy. The sooner income-constrained households receive these checks, the sooner these payments will help both the recipients and the larger economy, thus achieving the dual goals of both fairness and effectiveness.
However, failing to extend unemployment insurance was a big mistake. Such payments have the greatest probability of being spent, and the unemployment insurance system needs to provide a better safety net for low-income, part-time and other workers. Temporary improvements in food stamp allocations and greater assistance for energy bills would also have a similar positive effect.
Providing payments to state and local governments (for their Medicaid costs or otherwise) would also have helped mitigate rising unemployment. Downturns cause state revenues to fall and spending to rise, especially when they originate in housing markets. That's because, as more people need assistance, public programs kick in. But when states need to balance their budgets, they often respond by raising taxes, cutting services and laying off workers-slowing down the economy even more. It's necessary for the federal government to provide relief for the states to forestall these desperate moves.
Finally, though it's received scant attention, one of the best things we could do is put Americans to work building or repairing needed infrastructure. Jobs spun off by these projects put goods in the pockets of workers who would otherwise struggle, and the improvements in roads, bridges, schools and sewage treatment facilities can lead to higher productivity, better health and better education. Given the depreciation of our public infrastructure, these efforts only accelerate what we need to do anyway. To be timely, we should invest in projects that are planned or underway, but strapped for resources due to the slowdown. Another advantage is that none of such spending is "saved": While citizens may spend less than two-thirds of the payments made to them, governments spend all the money.
Though a recession has not officially been called, polls show that most people think we're already in one. While this may be a head-scratcher for those focusing on GDP and financial markets, it's clear to us that too many families have been economically squeezed in recent years, even in good times. Imagine what they are likely to face in bad times.
Our political representatives had every reason to quickly pass a package to jumpstart our slumping economy. But they didn't get it completely right. It's up to us to make sure they do.
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Jared Bernstein is a senior economist at the Economic Policy Institute and author of the forthcoming book, Crunch: Why Do I Feel So Squeezed? (And Other Unsolved Economic Mysteries) (Berrett-Koehler, 2008). Lawrence Mishel is president of the Economic Policy Institute.
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