September 2007 - Interest Notes

Dispelling the Mortgage Meltdown Myth

By Stacey Harding, CML
Chairman of the Board

It seems that the press is determined to sell newspapers, airtime, and web space by touting the demise of the housing market and the residential real estate finance industry.  The notion that good news doesn’t sell is all too obvious when we read headlines claiming that the “Sub-prime fallout is worse than the threat of terrorist attacks”. While such headlines are meant to get your attention, most of the articles that appear under such dramatic claims eventually admit that the five-year housing outlook remains positive, despite the current pain being caused by market corrections. While some economists embrace the theory of a bursting nationwide housing bubble, 40% actually expect home prices to climb between 2 and 6 percent in the next five years (Realty Times, 8/28/07).  Both views cannot be right and I’m not one given to temporary hysteria.  Yes, there is turmoil in our current market, but the industry is not melting into oblivion.  While words such as “meltdown” and “crisis” probably sell more newspapers, I believe that we are experiencing an overdue correction toward quality, not the end of our industry.

The homeownership rate in America peaked at 69.1 percent during the first quarter of 2005, and then fell to 68.4 percent in the first quarter 2007 (U.S. Census Bureau, Housing Vacancies and Homeownership).  During the 1990’s, loosened underwriting standards and the introduction of automated underwriting systems allowed more people to qualify for home loans. At the same time, we experienced historically low mortgage interest rates as unprecedented supplies of international capital flowed into the US bond markets. Thus, the rate of homeownership rose to historic levels while the price of money was relatively low. The good news was that more people could qualify and afford to buy homes.  However, with that increased rate of homeownership came the possible risk that foreclosures would increase should interest rates begin to rise, which is exactly what happened.

Following the terrorist attacks of September 11, 2001, investment capital quickly moved away from the US stock market toward the relative safe harbor of the bond market, which is the primary source of “mortgage money”.  Though the press chronically and incorrectly attributes mortgage interest rate adjustments to the Federal Reserve Board, mortgage interest rates are primarily affected by the supply of investment dollars flowing into the bond market and consumer demand for those dollars to finance or refinance mortgage debt.  From 2001 through 2005, investors accustomed to the greater risk associated with the stock market sought opportunities for greater return in the relatively safe bond market.  The solution: sup-prime mortgage loans.  Investor capital steered toward the sub-prime market and consumer demand rose for such mortgage products.  Supply was strong, demand was growing, and property values were on the rise.  Thus, investor losses were actually lower than predicted.  The response?  Put even more money into the sub-prime market.  Then, in 2006, the US stock market began to rise rather substantially.  Investors began to steer their dollars away from the bond market and back into stocks.  As the supply of dollars flowing into the bond market began to decrease, the price for those dollars (“mortgage money”) began to rise.  The price for those dollars translates to interest rates, which also began to rise.  In turn, losses (foreclosures) began to increase, and investors began to pull back even more. Not only was the stock market becoming more attractive to investors, the bond market was offering incentive for investors to vacate that space.  Thus, the supply of “mortgage money” decreased, the price increased, and the prior exuberance over sub-prime investments became taboo.

Instead of helping consumers understand what is really happening, I’m of the opinion that the media has dedicated itself to blaming the mortgage finance industry and simply scaring consumers.  One example of miss-directed reporting has been the chronic practice of blaming foreclosures on “risky mortgage products”.  However, according to the report “Suitability – Don’t Turn Back the Clock on Fair Lending and Homeownership Gains”, published by the Mortgage Bankers Association of America, the top two causes for mortgage delinquency are unemployment/curtailment of income, followed by illness or death in the borrower’s family.  Those two factors constitute 64.3% of the homes that are being foreclosed. Those factors are not influenced by the type of product someone chose or by anyone trying to defraud people.

Rather than calling the current (and temporary) situation we’re in today a “meltdown”, I believe we’re experiencing a market correction driven primarily by a decrease in the supply of mortgage capital.  At our Convention in Vail just over a month ago, incoming MBA chairman Kieran Quinn noted that in 2003, our industry funded $3.9 Trillion dollars in residential mortgage loans - an all time high.  According to Doug Duncan, Chief Economist for MBA, our industry funded $2.5 Trillion in 2006 and is projected to hit $2.42 Trillion this year.  As for his outlook, Mr. Duncan has projected our industry to fund $2.07 Trillion in 2008.  To put that “meltdown” in perspective, for every workday next year, our industry will be funding approximately $8 Billion in residential mortgage loans per day.

While it is very difficult for those impacted by a foreclosure, it is not unusual to see an increase in foreclosures following such a peak financing period of time. For the second quarter of 2007, the National Delinquency Survey, published by MBA, reported that 5.12 percent of all outstanding loans on one-to-four-unit properties were delinquent, with only 1.11 percent reporting 90-days or more past due. It also showed the percentage of loans in the foreclosure process was 1.40 percent of all outstanding loans. Delinquency and foreclosure rates continue to be driven by what is occurring in a few large states, including California, Florida, Nevada and Arizona. Despite that, overall, 34 states had decreases in their rates of new foreclosures and the increases were very moderate in all but the four mentioned above. When all the pieces are put together to form the big picture, 98 percent of people are paying their mortgages. To me, that’s not a meltdown!

The tough reality is that the market is making adjustments. Perhaps the swinging pendulum has not yet come to rest, but the story today is not that of a mortgage meltdown. Yes, underwriting guidelines are tightening, and more careful scrutiny is occurring on every loan. The current market is primarily affecting borrowers at the lower end of the credit spectrum and those who seek higher loan amounts: sub-prime borrowers and jumbo loan amounts. But take heart, the sky is not falling – we are going through a transition period that will settle out in a healthier, more “normal” state of our industry.  I would encourage you to think of every dollar that is available to fund loans as the natural resource our industry uses to manufacture our product: closed mortgage loans.  Those who buy mortgage-backed securities, those who are looking for safe, long-term investments, are no longer in the market to buy in volume. Today, those investors want to buy loans of higher quality.  Because fewer dollars (resources) exist to make loans, we must use each of those dollars to build a higher quality product (a closed loan).  Those who can build better loans will succeed and thrive.

In the coming months, CMLA will communicate this balanced perspective to the press and all 100 members of the Colorado general assembly.  If your company is a CMLA member firm, then I would welcome your participation in our Legislator Outreach Program that will introduce mortgage professionals in Colorado to their State Representative and State Senator.  We’re not asking anyone to “lobby” for or against legislation, we’re simply asking you to meet the two people who are elected to represent you.  We want the members of the Colorado legislature to know the CMLA members who live in their respective district – and we’re asking for your help in spreading the word that the mortgage lending industry is still the greatest system of community investment ever to exist.  If you’re a CMLA member through your company’s corporate membership and you’d like to be part of our Legislator Outreach Program, please send an email to Chris Holbert at pres@cmla.com and provide your first and last name; home address, city, state, and zip code; daytime telephone number, email address, and the name of your company. CMLA staff will use that information to verify your State Representative and State Senator, and assign your follow-up to a member of the Legislator Outreach Committee (“LOC”).  I offer my thanks and appreciation to Tom Kimball, CML, who is chairman of the LOC and who has continued the exceptional level of service that earned him the 2007 Jacob Award for outstanding service by a non-lender.  Tom’s committee will make a significant impact for our industry this year and I invite all CMLA members to be a part of that effort.

Be assured that despite changing market conditions, the CMLA remains committed our mission of a world of homeownership achieved through the practice of integrity based lending. Be sure to watch your email and check our Meetings & Events page (cmla.com/meetings.html) to gain access to our networking and educational opportunities. On September 6, Erin Toll, Director of the Division of Real Estate, addressed a crowd of almost 200 industry professionals at our luncheon in Denver. Julie Piepho, Vice Chairman of the CMLA, introduced several fun new items to our agenda, including a “Question of the Day” which was “What is the best tip you would give a sales rep in today’s market?” Many people responded to that question - Click here to see the answers they gave. Through our chapter luncheons, our upcoming Holiday Party December 6, our 17th Annual Wholesale Fair January 4, and educational events throughout the state, we’re going to continue to deliver superb value to our members and friends.  Many of you have been loyal to CMLA over the years and we’re here to help you through the challenges of the current market.

On a personal note, now is a great time to take stock and to think about how you’re going to elevate yourself as a mortgage professional. Take the time each day to learn about products, communicate with business associates, and to keep your customers informed. If you are committed to doing those things then you’re likely to succeed in the forecasted $2.07 Trillion market of 2008.

Want to be more involved with the CMLA? I welcome your questions and comments! Email me at chairman@cmla.com