More Pain From Avalanche of Mortgage Defaults

One year into the Aug 2007 subprime crisis, and the financial sector is still reeling from the after-effects. Billions of dollars were injected into the money markets and interest rates slashed but the deleveraging journey remains arduous.

In fact, investors must prepare for more pain from the looming avalanche of housing mortgage defaults. It seems that the malaise has spread to prime mortgages which are now defaulting at an alarming rate.

Prime loans are supposed to be the last man standing, after the tanking of subprime mortgages and Alt-A loans (less risky than subprime loans but doesn’t require strict documentation of assets or income). Their failure to shore up the housing market could spell a lengthy recovery from plummeting prices and weak investors’ sentiment.

A vicious cycle for lower sales could also result as borrowers find it harder to get loans, in spite of low interest rates. Lending standards have been tightened which will be even more conservative if if prime loans look shaky too.

As it is, more US homeowners are selling their properties at a loss, pushing the real estate market deeper into the quagmire. Nearly a third who bought since 2003 are in negative equity, meaning their homes are worth less than their mortgage loans.

Because of limited risks as purchasers bought houses with “nothing down” or minimal capital outlay, most of them are likely to conduct short sales or simply abandon their homes in foreclosures. A short sale occurs when a lender accepts a sale price less than what is owed on a mortgage and forfeit the remaining debt.

Banks and mortgage lenders suffer as investors walk away from their homes rather than be saddled with mounting mortgage payments. Just carry a black mark on their credit report which nobody will take a second look in the next bull market.

After all, banks never change, they will fall all over themselves to lend you money if you show them a good deal, subprime borrower or not.

Here is some choice bites from Charles McKay.

Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper. Men, it has been well said, think in herds; it will be seen that they go mad in herds, while they only recover their senses slowly, and one by one.

Such classic words ring true in today’s context and possibly apply in any generation. We are animals when caught in the throes of greed and speculation. And those who partake and encouraged this orgy must pay the price.

I believe, over time, our wounds from this subprime crisis will be healed. Low prices will attract investors back into the residential property market and absorb the oversupply. Once demand is back and inventories decline, we are ready for the next boom.

Meantime, more hardships await and it is a long way off from the end of the tunnel.

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