Just Like Al, Only Honest

MANIFESTO

When it comes to cocktail-party chatter (at least where I live) the housing market ranks up there with abortion as a topic of conversation likely to split the group in two, uncomfortably. Lately, it’s been difficult to turn on the news, or open the paper, and not find one opinion or another on the explosion of sub-prime mortgages. In an era of extremely low interest rates, sub-prime mortgages were hailed as a way to “democratize” credit, and have pushed the rate of home ownership in the US to a record 69%. According to former Fed Chair Allen Greenspan:

“Where once more-marginal applicants would simply have been denied credit, lenders are now able to quite efficiently judge the risk posed by individual applicants and to price that risk appropriately. These improvements have led to rapid growth in sub-prime mortgage lending . . . fostering constructive innovation that is both responsive to market demand and beneficial to consumers."

So what’s the downside? None, it’s win-win. Constructive, responsive, and beneficial to consumers means more families can partake in the American Dream; and when risks are efficiently judged and appropriately priced markets function efficiently. Keep lending, keep spending! Yet fast forward a couple of years and the numbers look quite different:

“Many more U.S. homeowners were unable to keep up with their mortgage payments in the fourth quarter, the Mortgage Bankers Association said Tuesday, with the rate of homes entering the foreclosure process hitting a record 0.54% and the delinquency rate on U.S. home loans leaping to 4.95% from 4.67% three months earlier…. The rise was led by sub-prime mortgages, where delinquencies increased to 13.33% from 12.56%, and FHA loans, which saw a record-high delinquency rate of 13.46%. Trouble in sub-prime mortgages, made to borrowers with the riskiest credit, has roiled lenders and the stock market in recent days."

Stock markets have certainly been “roiled” and more than one noted investor is predicting financial apocalypse. The Center for Responsible Lending predicts 2.2 million sub-prime barrowers could end-up in foreclosure and notes that this type of efficient judgment and pricing of risk means “"in the sub-prime sector, the most vulnerable borrowers are sold the most dangerous loans."

To all but the cynical why the Maestro himself would have failed to see or react to these risks is a mystery. But at least Al’s English counterpart is a bit more honest. To paraphrase Lord George, former head of the Bank of England, in his confession to a committee of MPs: in the post 9-11 world low interest rates were used to stimulate a weak economy by encouraging consumer spending at the expense of increased consumer debt loads, and the nasty side-effect was rapidly rising home prices, witch further added to the level of personal debt. According to Lord George “we had pushed it up to levels which couldn't possibly be sustained into the medium and long term... my legacy…if you like has been 'sort that out’." Although I doubt we’ll here a similar confession on our side of the Atlantic, considering the similar trajectory of English and American interest rates it’s not a stretch to posit we’re owed one.

So it looks like the democratization of credit has gone as smoothly as the democratization of the Middle East and 2.2 million Americans seem poised to pay the price. Not to worry, the Fed wants to make sure the work-out process on your failed loan is just as efficient as the approval:

"Working together, the federal regulatory agencies will continue to use their supervisory authority to ensure that regulated institutions have policies and procedures designed to treat borrowers fairly, both when seeking new credit and when working through financial difficulties."