Coping with the national mortgage: meltdown and the collapse of the shadow banking system

NATIONAL FORECLOSURES jump 93%. More than 154 U.S. lenders have "imploded." Recent figures for defaults and foreclosures are evidence of a serious threat to the American dream of home ownership for subprime and, now, prime borrowers. When RealtyTrac, the leading online marketplace for foreclosure properties, released its U.S. Foreclosure Market Report a few months back, it showed 179,599 foreclosure filings for July (including default and auction sale notices and bank repossessions). Those figures were up just nine percent from the previous month, but a whopping 93% from July 2006. That amounts to a national foreclosure rate of one filing for every 693 households.

"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," notes James J. Saccacio, chief executive officer of RealtyTrac.

From May to June, the National Association of Realtors reported the worst sales figures since November 2002. "Jumbos" (loans over $417,000) are being overpriced or not available as the secondary market dries up. The lenders that have imploded include all types--prime, subprime, and a mix of both; retail and wholesale; subsidiaries; and entire companies. According to Implode-O-Meter, lender implosion means bankruptcy filing, temporary but open-ended halting of major operations, or a "fire sale" acquisition.

Nevada came in with the nation's highest state foreclosure rate for the seventh consecutive month in July, points out RealtyTrac. That is one foreclosure filing for every 199 households, or more than three times the national average. In second place, Georgia's foreclosure rate exploded from the eighth highest in June to second highest in July with a 75% increase. That is one foreclosure filing for every 299 households, or 2.3 times the national average. In third place, Michigan stepped up from the seventh position, at one foreclosure filing for every 320 households. That is a 39% jump, month-over-month, and a 130% year-over-year increase. California, Florida, Ohio, Colorado, Arizona, Massachusetts, and Indiana also were among the nation's 10 highest.

The top 10 cities included Detroit--which is seven times over the national foreclosure average--Las Vegas, Atlanta, and Greeley, Colo. The top 10 metropolitan areas all are located in California, and include Stockton, Merced, Modesto, Vallejo-Fairfield, Riverside-San Bernardino, and Sacramento.

The markets are in the process of repricing risk. Mark Zandi, co-founder and chief economist of Moody's Economy.com Inc., predicts things will get worse before they get better. Defaults will rise to 2,500,000 over the next two years and 10% of subprime homeowners will be in foreclosure by mid 2008, up four percent. Countrywide confirmed that delinquencies have soared in the prime markets as well, from 1.8% to 4.6% at mid year. Bear Steams has filed for bankruptcy protection on at least two high-risk, high-yield, mortgage-backed funds and is bailing out another hedge fund with around $1,600,000,000.

The fallout from this lending debacle does not just affect individual borrowers. It already is taking a grave toll on the business, finance, real estate, and lending industries. Wall Street investors failed to fund $250,000,000,000 in high-risk corporate buyout or growth securities, causing junk bond yields to rise to a four-year high. The Federal Reserve injected $38,000,000,000 of liquidity (REPOS) into the markets, an amount not seen since Sept. 14, 2001. Employment has declined for the first time in years, and more than 45,000 (and counting) individuals have been laid off from mortgage lending jobs alone.

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The mortgage meltdown means that fewer subprime (and potentially prime) borrowers can buy a new home or refinance their current loan. There are three reasons: extreme credit tightening with more restrictive eligibility requirements; affordability now is tested at the fully indexed rate (not the lower teaser rate); and property values have fallen to the point where homeowners have insufficient equity to refinance or sell at a profit. In other words, most borrowers are locked into their property and loan as adjustable rate mortgages (ARMs) are resetting to higher rates, resulting in unaffordable monthly payments. Some 1.1 trillion dollars in loans are pending reset; in some cases, monthly payments will double. The 2006 so-called 2/28 ARMS will reset in 2008. Sen. Christopher Dodd (D.-Conn.) has speculated that payment-shock monthly increases could reach 300%.

Earlier this year, the debate on Wall Street was whether or not a secondary mortgage market, nonagency paper market, or commercial paper market actually existed during times of "no bids." This should be compelling evidence that the solutions, short and long term, must include private and public (government) safeguards that reduce market uncertainty. In addition to recent bankrupt Bear Steams funds, over 154 imploding lenders, a credit crunch, and a liquidity crisis, Real Estate Owned (REO) Packages held by Wall Street investment banks such as Bear Steams, Citigroup, JP Morgan Chase, Merrill Lynch, Morgan Stanley, and Lehman Brothers are rising at an alarming rate. In the last year, the rate of firms taking back ownership of property has, at times, jumped as high as 497%.