Federal Reserve Board Member Randall S. Kroszner Discusses the Challenges Facing Subprime Mortgage Borrowers
Today at the Consumer Bankers Association Fair Lending Conference in Washington, DC, Randall Kroszner discussed the challenges subprime borrowers face into 2008.
He started the meeting by reviewing the subprime market in general, and sources of the recent subprime crisis. The number of subprime mortgage loans now totals 7 and 3/4 million, or approximately 14 percent of the overall mortgage market. This large increase that happened in the 1990s was largely due to technological advances, and financial innovations that reduced the costs of lending to higher-risk borrowers. While lenders were able to better weigh subprime borrower risks, subprime loans in a whole are more likely to default. With the originate-to-distribute model many lenders have adapted many lenders had less incentives to maintain strong underwriting standards.
Kroszner narrows the increase foreclosures down to four key factors. The first of these is the increased unemployment rates in an area. States in the midwest were hit the hardest by job cuts in the auto industry, such as Michigan and Ohio. The second key factor is the slowing of house prices. We experienced double digit housing price percent increases from 2000 through 2005. This then changed to small increase if not losses in certain markets. This lowered equity makes it harder for homeowners struggling with payments to refinance. The third major factor was the loosening of underwriting standards for mortgages generated in late 2005 and 2006. Investors stopped demanding sufficient information from lenders after seeing several years where mortgages showed extremely strong performance. This lead to price discovery as discussed in his October 22nd Institute of International Bankers annual breakfast dialogue. The forth factor that affects subprime delinquencies is the substantial payment increase often experienced at the first interest rate increase. The problem with this is with the tightening of credit standards and the decreases in home values its much harder for these borrowers to refinance. On average, in each quarter from now until the end of 2008, mortgage payments for more than 400,000 subprime mortgages are scheduled to undergo their first interest rate reset.
These circumstances call for a high degree of collaboration and innovation to identify any solutions that can keep borrowers from foreclosure in their homes. The loss of a home to foreclosure causes significant financial and social difficulties with the borrowers, and financial losses to the lenders. Generally lenders and servicers can lead to a loss of as much as 40 percent to 50 percent of the unpaid mortgage balance. Several efforts that can be done to help alleviate the stress from the foreclosures. First, would be an industry collaborative effort to help borrowers modify loans on a case-by-case basis. Second, is that programs from the Federal Housing Administration should be modernized. The FHA is an administration that already has experience helping low and moderate income households obtain home financing. Lastly, to prevent these problems from reoccurring we must review the mortgage related rules to tighten lending rules.
To read Randall Kroszner’s full speech at the Consumer Bankers Association 2007 Fair Lending Conference, head on over to the Federal Reserve.
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J.P. Morgan Chase & Co. says it will modify the terms of $70 billion in troubled, mostly adjustable-rate mortgages it holds.
The New York bank inherited many of the loans as part of its September purchase of a failed competitor, Washington Mutual Inc. (NYSE:WM), and its move will cover as many as 400,000 borrowers. J.P. Morgan said Friday the borrowers will be moved into loans carrying lower interest rates, smaller principal amounts or other more-affordable terms, The Wall Street Journal reported.
The move came shortly after the bank received a $25 billion capital infusion from the U.S. Treasury’s program to strengthen financial institutions and get credit flowing.
“Our goal in doing this was to come up with something that we think will lead the industry in helping as much as possible on this issue,” said J.P. Morgan executive Charles Scharf.
John Taylor, chief executive of the National Community Reinvestment Coalition, said the action was “a gutsy move on their part. They are bending over backward to try to reach out to these people.”
November 15th, 2008 at 4:34 pm
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