By Gaurav Bhola, MSM, Managing Editor
Tuesday, August 14, 2007
The ‘Mortgage Friday’ last week saw the stock market decline, as the residue of the U.S. mortgage market infected stock markets worldwide. The ongoing concern of the subprime home loan mortgage market restricted credit and credit liquidity caused the Federal Reserve to inject $38 billion into the banking system last week.
When the markets opened on Monday, the Fed pumped another $2 billion into the banking system, surpassing the largest infusion of liquidity since September 11, 2001. The Fed’s European and Japanese counterparts added $72 billion into the banking system this Monday.
Usually the Fed buys or sells safe U.S. Treasuries but last week the Fed purchased $38 billion worth of risky subprime mortgage backed bonds. There is hardly anyone interested in buying these bonds due to the heightened risk associated with them in the current environment.
These actions by the Central Banks were taken to avoid a possible credit crunch. So far, the markets have gone up but the undercurrent of risky mortgages and tightening mortgage lending practices still exist. Most likely the markets will still be vulnerable in the coming weeks. The volatile home loan arena has made it virtually impossible for Wall Street to ascertain the market value of these risky mortgage backed securities.
Current estimates place these bonds at a third of their actual value. The recent headlines about Bear Stearns and French Bank BNP Prabis funds loosing values due to their underlying portfolio investments in subprime and other risky mortgages are just the beginning of many such stories in the coming weeks. Many investment funds, banks, and hedge funds are in possession of billions of dollars worth of such rubbish bonds. However, hedge funds are not regulated by the Fed, thus it will not be easy to assess what further damage these funds can cause to the overall stock market.
The current mortgage market contagion was a result of the last few years of the housing boom. During that time, mortgage companies, mortgage lenders, and mortgage brokers fed the home buying for investment frenzy by doling out popular mortgages and home loans: home equity loans, home equity line of credits, mortgage refinance, subprime mortgages, and adjustable rate mortgages.
Now another area of concern is looming over the horizon as millions of homeowners deal with their adjustable rate mortgages (ARMs). These “interest-only” mortgages give the borrower the flexibility to initially pay only interest on the loan balance every month, leaving the initial home loan balance intact to be paid at a later time.
For many homeowners, their ARMs have been twisting for some time now. At the moment, the main focus revolves around subprime mortgages but interest-only ARMs may soon eclipse them for the spotlight. Unlike subprime holders, most borrowers with adjustable rate mortgages have good credit. Even in the last few months people with good credit have been defaulting on their loans.
No longer is the upper echelon of credit worthiness immune from the residue of the mortgage whirlwind. As of yet, less than 4 percent of the ARMs are in default, whereas 14 percent of subprime mortgages are delinquent. Several analysts foresee the ARM bubble bursting in the next eighteen months as mortgage rates increase over time.
Mortgage lenders loaned approximately $581 billion in option ARMs during the housing market’s peak in 2005 and 2006 and $1.4 trillion in interest-only ARMs. It is forecasted that as much as $325 billion of these loans will be delinquent in the coming months compared to $212 billion subprime loans in default in the second quarter of this year.
These home loans are overdue for a correction. When the correction does occurs the excess burden will crumble the already fragile financial markets’ foundations. So far, the Fed and other global Central Banks have been able to assuage the markets. It is in doubt whether the current infusion of liquidity can improve and sustain an already precarious market, let alone handle another mortgage disaster.
