I’ve had a couple of very enjoyable chats this week with Red Symons, on the ABC Breakfast Show in Melbourne, and some friends have been trying to get me to throw some old Skyhooks song lines into the conversation–such as “Horror Movie” and the like (for any non-Australian and/or non-“Living in the Seventies” readers, Red was a guitarist–and played drums on the one occasion I saw them live, at Sydney University’s Union Building in the early ’70s–and lyricist; here is a link for the lyrics).
Though they’re definitely apt, the piece of 70’s music that most came to mind when I spotted this new feature on the US Federal Reserve’s website this morning was from The Carpenters (which in contrast to The Skyhooks, was not one of my favourite bands): “We’ve only just begun”.
It’s an interactive map of the subprime and alt‑A mortgage catastrophe in the United States. The numbers, which are also available for download as Excel spreadsheets, are simply staggering.
The scariest part of the data relates to what are known as ARMs (“Adjustable Rate Mortgages”)–fixed rate mortgages that began with a “teaser” low rate, and then reset after a number of years to a higher rate (the standard US mortgage is a fixed rater, unlike Australia where variable rate mortgages are the norm).
Of the almost 3 million subprime loans (the precise number is 2,919,604, representing 2.5% of America’s 115,904,641 housing units), almost 2/3rds are ARMs (the national average is 62.9%), and just over 30% of them will reset to the higher rate in the next 12 months (with another 10% to follow over the next two years).
That’s why this crisis has “only just begun”. There are two sides to this catastrophe, and whatever is done about it, one side or the other is bankrupt.
IF the ARMs go ahead, then the number of American households that will go bankrupt is at the minimum 1 million–because there’s no way these borrowers can pay the higher rate. At the simplest scale, this is because the rates will rise from an already high average rate of 8.8% to a usurious 14.8%. But on top of this, the effective rate for the loans throughout has been the higher rate–and the gap between this and the initial teaser rate was capitalised onto the debt.
So a borrower who took out a loan in 2006 of $183,900 (the average subprime loan size–note by the way how small this is compared to median Australian housing loans), and whose loan resets to the higher rate next year, will go from paying 8.8% on 183,900 to paying 14.8% on $219,200–a doubling of annual interest payment commitments, from $16,180 to $32,440.
This for a cohort of borrowers who are already massively behind on their payments–though not as massive as it will get (currently 10% are behind 30–60 days, 5% 60–90 days, 10% 90 days plus, and 11% are in foreclosure). There’s no way they can manage this: they are, as the Americans put it, “toast”.
But what if they are freed from this obviously onerous burden by legislative fiat? Then the people and institutions who bought the residential mortgage-backed securities (RMBSs) that these mortgages finance are “toast”: the bonds will be next to worthless.
And it won’t end there. After the subprimes come the “Alt‑A” mortgages–ones not high enough grade to qualify as prime, but above subprime in past credit history. There are roughly 2 1/4 million of them, with much higher debt levels (average of US$321,000), lower average interest rates (6.6%), currently lower default rates (5.6%–half as many in foreclosure as the subprimes), and lower levels of arrears (just over 10% behind, versus 25% of the subprimes).
But just over half of them also have ARMs, and about half of them are scheduled to reset to a 3% higher rate in 2010 or later. By then, economic conditions will have deteriorated so much that their own finances will be “subprime” at the time, and the snowball will continue rolling down the Highway to Hell.
So We’ve Only Just Begun. And it is a Horror Movie, though not “right there on your TV”–if you’re American, you’re living in it.
And if you’re not American, then it’s still almost guaranteed that some of your investments will suffer–whether indirectly if you own shares or property, or directly if you or an agency that affects you purchased the RMBSs that funded the subprime scam. You may well wish that you were still “Living in the Seventies”.