The financial-services industry has made it possible for millions of Americans to stop thinking, “I can’t afford that.”
Now, Wall Street is beginning to wonder how many people really couldn’t afford what they bought in recent years on incredibly cheap credit.
One-percent mortgage loans, zero-percent car loans, home-equity loans for more than your property is worth–all of this has been the cushy financial reality for U.S. consumers since 2003 or so.
In the midst of any wild party, however, some people do things they come to regret. And while talk of a housing bubble has been incessant over the last year, only now are the money changers on Wall Street beginning to worry about payback: that is, how much of the credit extended won’t be paid back.
If the only issue was whether real estate was overpriced, financial-market players could treat the housing boom like a TV reality show: Isn’t it funny what people will do?
But home mortgage and equity credit-line debt has swelled to $8 trillion from $5 trillion in 2001. And there’s a lender behind every borrower.
Richard Bove, a banking industry analyst at Punk, Ziegel & Co. in New York, last week sent clients a research report with a chilling title: “This Powder Keg is Going to Blow.”
Bove notes that the number of variations of adjustable-rate mortgages with low teaser rates has mushroomed over the last few years, leading up to the newest twist: the so-called option ARM, in which the buyer chooses among several payment options, including paying only the loan interest each month.
We’re reliving the 1920s, Bove said. In those boom years, interest-only loans were standard, and lenders usually had the right to demand full payment on home loans after five years. When the Great Depression arrived in the 1930s, and incomes and asset values dived, home repossessions soared.
Bove believes the lending industry has taken a step backward with option ARMs.
“They are an outrage,” he said. “The consumer simply does not understand what this loan is” in terms of the risks it poses, not the least of which is that the loan principal amount can rise, instead of shrinking as it would under a full-payment loan.
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The extent to which people have stretched to buy houses at ever-rising prices shows up in a recent report by SMR Research Corp., a Hackettstown, N.J.-based financial research firm.
An increasing number of home buyers have been “piggybacking,” SMR said. These buyers have needed two loans rather than one to complete their purchase: a first mortgage typically for 80 percent of the home’s value, and a home equity loan to finance the rest.
SMR found that piggyback deals comprised 19.9 percent of home-purchase mortgage dollars in 2001. That figure jumped to 48.2 percent in the first half of 2005, the firm said.
If those loans have adjustable rates, the payment burden on the buyers is guaranteed to rise, as the Federal Reserve continues to boost short-term interest rates.
And if home prices stop rising or decline? That could seal the fate of home buyers who figured that, if their income couldn’t keep pace with their payment obligations, they could simply sell their home at a profit and pay off what they owe.
But don’t most people make their house payment, no matter what? Historically, they have.
For Wall Street, however, just the scent of a significant homeowner delinquency problem could be enough to spark a vicious reaction. Hedge funds and other trigger-finger investors won’t wait to find out how bad things might get.
Worth noting is that financial-services stocks comprise the biggest single chunk of market value in the blue-chip Standard & Poor’s 500 index, at nearly 20 percent.
Recent weeks have brought a taste of what might occur on a much larger scale if housing worries mount. Shares of Downey Financial Corp., the parent of a California savings and loan that does a big business in option ARM loans, have plummeted 23 percent.
Another stock sector that has been hammered: real estate investment trusts that buy mortgages and mortgage-backed securities. A Bloomberg News index of 27 REIT stocks has fallen 12 percent since July 20.
The biggest threat of upheaval is in the mortgage-backed securities market itself.
That market, worth nearly $3 trillion, has provided much of the capital for the housing boom. Instead of holding on to the loans they make, many lenders package them and sell them to investors via mortgage-backed bonds.
If the mortgage-backed securities market were to seize up because of a pullback by nervous investors, the ripples would be felt across Wall Street and around the globe.
The question is, will it take a full-blown financial crisis to get the lending industry, and those who supply it with capital, to admit the truth to people whose homeownership ambitions far exceed their means: “No, you really can’t afford that.”