Era of Easy Credit Ends as Subprime Troubles, Mortgage Costs Increase

In matters of the heart, they say it is better to have loved and lost than to have never loved at all. We’re not sure the same can be said for matters of the wallet. After all, “money borrowed” does, at some point, demand a dutiful transformation into the more painful form of “money returned”. This is the crux of the financial fine print that got so many of those subprime pushers and junkies into such trouble in the first place. Across the US, foreclosure rates are at frightening levels, especially in “sunbelt states” like Florida and California.

RealtyTrac, a group that maintains a national database on US real estate, tells the grim tale.

“While 43 states experienced year-over-year increases in foreclosure activity, just five states – California, Florida, Michigan, Ohio and Georgia – accounted for more than half of the nation’s total foreclosure filings.”

How did so many folks get themselves hooked on the subprime junk?

The whole mess brings to mind an experience I had recently, while living in the UK. A friend of mine and I were killing time in the waiting room of a British bank that, along with decidedly sub-par coffee, also featured a limited reading selection. “How do first-time homebuyers afford these kinds of prices?” asked my no-time homebuyer friend, while flicking through the property pages of a London newspaper.

“Don’t ask me,” I replied, reminding my friend that sky-high property prices had chased me out of Laguna Beach, California. “I couldn’t even afford to rent a doghouse there. The thought of actually BUYING a home was very far from my mind.”

A young lady in a suit approached the waiting area. “Ticket 24b,” she announced in a chipper tone. She led us to her cubical and politely inquired as to how she may be of assistance today. My friend began, sheepishly, “I wanted to see about extending my overdraft line of credit.”

“We can certainly take care of that,” replied the teller before adding, without hesitation, “How much would you like?”

“Well, I just started at my new job and they only pay monthly,” the friend offered, “so I’m kind of between paycheques.” This information seemed to be of little relevance to the teller. She repeated her question, “How much would you like?”

After considerably fattening our friend’s line of credit – and declining her offer to provide proof of employment – our helpful bank teller effortlessly segued into a special deal the bank is running at the moment. The deal was for a credit card.

After our little sojourn to the local bank, we learned just how easy it is to secure “no documentation” credit…and we also realised where all the “money” has been coming from to buy these ridiculously priced homes. If we were bankers instead of borrowers, we wouldn’t be extending any credit in our direction…That’s just common sense.

But common sense rarely intrudes upon the banking industry…except when defaults and foreclosures are on the rise. And now, today, defaults and foreclosures are most definitely on the rise from Seattle to Sarasota, which means the EZ money era is over and the tight money era has arrived.

British banks may still be extending credit to marginally employed college kids, but US banks are no longer so accommodating. Tired of filing bankruptcy claims, the lending industry has tightened its belt…and sales have begun to cool as a result. For evidence of the new lending regime, look no further than the websites of America’s largest mortgage lenders. Over recent weeks, several American mortgage lenders began offering 30-year mortgages at interest rates above 8%. They might as well have just hung out a sign that said, “Closed: On Vacation”.

That’s to say nothing of the dire straights of Countrywide Financial.

Therefore, the few home loans that do manage to emerge from the constipated mortgage lending industry are carrying much higher rates of interest than prevailed six months ago. Monthly mortgage payments are jumping much higher.

Lawrence Yun, Senior economist for the National Association of Realtors, recently opined, “We’ve been anticipating slower home sales because many subprime loan products are no longer available.” Mr. Yun then went on to add, “In addition, increased scrutiny by lenders is stopping risky mortgage origination.”

What does this messy subprime kafuffle prognosticate for the days to come? Could this be the end of easy money?

Last Friday’s capitulation of Northern Rock, Britons fifth largest mortgage lender, may be a harbinger of things to come. The subprime conundrum in the US has precipitated an unusually parsimonious relationship between banks. Currently, the rate at which UK banks lend to each other is a full percent above the base rate of 5.75%, set by the Bank of England. That means less quick cash available for the likes of Northern Rock. The aforementioned bank is acutely susceptible to the downside of tightening credit, as it relies heavily on funding from the capital markets – 85% of net funding obtained in the first six months of this year.

The financial phlebotomy continued for Northern Rock in yesterday’s trading. Shares of the beleaguered bank resumed their bloodletting the minute the London Stock Exchange markets opened for business – tumbling another 35%. That was on top of the 31% loss the shares suffered last Friday, when Northern Rock first announced it would seek emergency funding from the Bank of England.

The scenes on the streets in London are eerily reminiscent of textbook photos from the Great Depression. Hordes of frantic customers line the City’s streets, clamoring to withdraw any savings they have with the bank. An estimated 2 billion pounds (US$4 billion) literally walked out the door on Friday.

For now, only a few frightened Brits are making a run on their bank. But you never know which nervous depositors might start queuing up next. So as my good friend, Dan Denning likes to say, “Panic now. Avoid the rush.”

Joel Bowman
Markets and Money

Joel Bowman
Joel Bowman is managing editor of Markets and Money. After completing his degree in media communications and journalism in his home country of Australia, Joel moved to Baltimore to join the Agora Financial team. His keen interest in travel and macroeconomics first took him to New York where he regularly reported from Wall Street, and he now writes from and lives all over the world.

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