Wilberne Persaud, Financial Gleaner Columnist
The exterior of the Countrywide home loans office in San Mateo, California, Friday, August. 17. It's never been tougher to close a deal than during the past few weeks as lenders have gone bankrupt and the skittish survivors become more discriminating to avoid further trouble. - AP
The United States real estate market has been booming for the past seven years at least.
As real estate prices kept rising, homeowners found themselves richer in equity. Encouraged to take some of the cash out of their homes, borrowers, lenders and investors all did well in the game.
Today, however, with the credit crunch and falling housing market, what is being revealed as normal behaviour of many lenders is troubling. The subprime market is now in disarray.
A subprime borrower is one who does not fit the characteristics of an 'A' grade client with significant assets, a high credit score and verifiable income to cover loan servicing.
On a recent airing of the Daily Show with Jon Stewart, one of the comedians pointed out that the definition of subprime borrowers was simple - blacks.
Beyond the joke, the subprime market does exist. Such loans were extremely profitable hence attractive to lenders while being onerous on borrowers.
Among lenders, Countrywide Financial Corporation is big - making US$470 billion in loans last year. Its stock price rose more than 500 per cent in the last decade. Its operations apart from the mortgage lending business include a bank, securities brokerage selling packages of mortgage-backed securities, a unit that services mortgages by collecting and disbursing payments, insurance, and what is termed in the United States (U.S.) a 'real estate closing service'.
Paper profits
The latter operation handles what lawyers in Jamaica would do - overseeing document signing, registering liens on titles and the like. Finally, the corporation has what are called 'special-purpose' vehicles that issue short-term commercial paper with underlying value being its own mortgages.
Does all of this sound familiar? Before its collapse in 2001, ENRON had special purpose vehicles that created nothing but paper profits to keep its share price on the rise. Jamaica's 1990s indigenous financial institutions had very similar structures to Countrywide.
These structurescreate a catchment area of control for profits. When a boom stalls, however, they present problems.
Mortgage delinquency rates - the extent to which borrowers are late in making payments on their loans - are on the increase.
Countrywide had more than 20 per cent of its subprime mortgages delinquent at the end of June, compared to 15 per cent for the same period last year.
Up to six months ago, with all fees and brokerage charges collected, Countrywide could then re-package these mortgages for resale to enthusiastic investors happy to buy.
There were two features of this type of loan that made them so attractive. There is usually a pre-payment penalty. If a borrower for whatever reason wishes to pay off the loan early, a penalty payment is required.
Second, they were usually 'ARMs' - adjustable rate mortgages, which essentially meant an interest rate increase clause.
On the other hand, a prime borrower would usually have a fixed interest rate loan with no pre-payment clause. Investors stood to gain much more in the subprime market and it flourished.
Hostile takeover
A few weeks ago, Countrywide activated more than US$11 billion in a credit line with a consortium of banks. There were no longer willing buyer/investors for its repackaged loans. Shortly after, in what some speculate was an attempt to stave off a crash and/or a hostile takeover, Bank of America purchased 16 per cent of its stock for $2 billion.
The Federal Reserve (U.S. central bank) stepped in to try to calm things.
It is actually now less turbulent, but the worst has not yet passed. There are arguments about whether the housing market decline will feed its way back into the overall economy. Consumers suffer reduced wealth as home prices fall and equity declines. Construction of new houses stalls. Mortgage delinquency rates climb. All of these are negative in their impact on the economy as a whole.
We have focused on Countrywide because of its size and importance, but the general picture in the market is not muchdifferent. As a result, there may yet have to be a rescue operation.
The only question if this must occur is whether it will be a rescue of the companies and investors or the troubled borrowers through a 'work-out' scheme of some sort. We shall not be unaffected in all this.
Will Jamaican international debt seem more attractive after all this?
wilbe65@yahoo.com
