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bubble land « Previous | |Next »
March 17, 2007

I see that the Australian Financial Review is beginning to take the meltdown in the US subprime market a little more seriously than before. Last Thursday its editorial said:

Jittery American investors, spooked by cracks in dodgy end of the US housing market, are casting a temporal pall on an otherwise robust local market. In reality, the impact of the US housing sector's troubles should be kept in perspective. The consequences could be more optimistically interpreted as a serendipitous pause for securities markets in a steadily growing economy.

The market will self-correct the wobbles. The AFR is like the Wall Street cheerleaders mocking as Chicken Little "sky is falling" hysteria those who interpret the bad news on the housing finance sector as a clear and present danger. But the adamant denial is no longer repudiating economic reason about the housing price 'bubble land', even if the AFR thinks in terms of mitigate the "fallout" when it occurs and easing the transition to the next expansion into a new bubble land. We have 'jitters', 'cracks', 'dodgy,' 'pall' in the one paragraph. 'Jitter's' is another word for panic.

And there is reason for panic. As Henry C K Liu says in Asia Times Online:

In the United States, when house prices have generally tripled in less than a decade, it is evidence that the value of the dollar has declined by a factor of three in the same time period. Consumer prices have not risen by the same amount because of outsourcing of manufacturing to low-wage economies overseas also acts as a depressant on domestic wages. Imbalance in the economy appears if wages and earnings have not risen proportional to prices. A homeowner whose house has increased 300% in market price while his income has risen only 30% has not become richer. He has become a victim of uneven inflation. He may enjoy a one-time joyride with cash-out financing with a new mortgage, but his income cannot sustain the new mortgage payments if interest rates rise, and he will lose his home.

It looks more like a foreclosure bloodbath to me. One that is far broader than the AFR's tacit view that it is only a sub-prime niche problem that is contained and will have no spillover and contagion effects to other mortgages, to the credit market, to the economy and to the US growth rate. Wall Street, like the AFR, continues to deny there is a serious problem, even though 30 or more subprime lenders have gone out of business since December.

| Posted by Gary Sauer-Thompson at 8:27 AM | | Comments (7)


The evidence is similar here - house price growth at unsustainable levels, while wages remain under control.

I would have to poo poo Henry's statement above about the homeowner not being richer. While it is a nifty saying i think he should look in the dictionary for the meaning of the word "richer".
Also lets not forget as we have experienced in the past here in Oz house prices have had long periods of zero growth and at times have even gone considerably back wards while incomes grew yearly.

Your statement at the end hits the nail on the head. A bloodbath is perhaps a bit mild. Bad times ahead I suggest. It will be very interesting to see the next federal budget.

if your mortgage is for $500,000 with interest rates at 6% and you bought in the boom with rising house prices and rising personal income, then you are sitting pretty.

But if your house price falls to $400,000 and interest rates rise to 7% then you are really in big trouble. What if your income cannot sustain the mortgage repayments?

That is what is happening in the subprime market in the US. It's an unfolding financial and economic wreck cos of the extent of the dodgy mortgage financing.

I guess the difference with the US is that we do not have the "innovative" mortgage instruments of the US that are in the subprime market for borrowers with sketchy credit histories ----mortgage loans that require no money down and no documentation of income to people who won't be able to afford the monthly payments if interest rates rise.

These "innovations" are a major reason the subprime mortgage market is melting down, why 1.5 million Americans may lose their homes to foreclosure and why hundreds of thousands of homes could be dumped on an already glutted market. They also represent a huge cloud hanging over Wall Street investment houses, which packaged and sold these mortgages to investors around the world....

I think when the whole thing goes POP! the mortgage brokers will have lots of blood on their hands.
I don't know if you understand the system they work under.
Lets just say Joe Bloggs walks in for a 300,000 home loan. He has a poor credit history but has a job and the first home buyers grant.
The broker then sets about trying to sell him to the financial institutions at say 7% interest rate. Ok no takers so they try 7.5% this time....and so on till someone takes up the deal. The commision to the broker on that size loan is about $2,600 straight up then monthly trailings of say $15 per month for the term of the loan.
You see there is an awful lot of people out there paying 10% interest rates and these are the people that will fail first when rates rise.

I interpret that to mean that the mortgage brokers are creating what the Americans call a sub-prime mortgage market: higher-risk people who have poor or limited credit histories.

I see that the Australian Prudential Regulatory Authority is increasing its scrutiny of bank's lending policies because of rising concerns over credit quality. Which kind of credit quality is the issue

APRA says that their antennae is twitching because mortgage arrears are rising, as are mortgagee sales in NSW and Victoria. They say that there is increasing evidence that the banks, in an attempt to raise market share in a highly competitive environment are lending to borrowers with little evidence that the borrower is able to service the loan.

I would have thought that what is going on with the nonbank lenders that is the problem. What about the vertical integration of mortgage broking, real estate investment advice, real estate sales and select real estate developers selling to those who are looking for that great Queensland investment property?

It is common for high risk clients to be charged Mortgage insurance which could be $1400 or so when the loan is set up.
In reality this amount is only insuring the amount between what the the property is sold for as Mortgagee in possession and what is owed.
In normal market conditions this figure may only be a few thousand dollars given that it may take a couple of years from when the original contract was signed to when the client struck trouble.
So you can see that the finance companies are still making money as are the Insurance companies.