Mortgage jitters

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Major stock indexes quickly dropped 2 percent of their value Tuesday after a mere wisp of evidence suggested that the evolving meltdown in the subprime mortgage market might be spilling over into the broader home-mortgage industry. Imagine what might happen if the spillover evidence mounts in the coming months, perhaps leading to a full-blown credit crunch sufficient to tip the slowing U.S. economy into a recession. At that point, with unemployment rising, the housing crisis could begin feeding on itself. Indeed, as the sober-minded Morgan Stanley economist Richard Berner recently warned: "The subprime loan meltdown is still in full swing, and fears persist that it will usher in a broader credit crunch, spreading first to prime mortgages and ultimately to corporate credit."

The subprime mortgage market serves clients with poor (or nonexistent) credit histories or with insufficient financial resources (income, net worth, etc.) to qualify for prime mortgages, which carry a lower interest-rate structure, smaller fees and less onerous prepayment and other penalties. As the share of households owning their own home has increased in recent years from 65 percent to 69 percent, the number and proportion of subprime loans have increased significantly. According to Inside Mortgage Finance, a trade publication, new subprime loans increased from $120 billion in 2001 (about 5 percent of the total mortgage market that year) to more than $600 billion in 2006 (more than 20 percent of the total). Including both adjustable-rate mortgages (ARM) and fixed-rate loans, Inside Mortgage Finance calculates that subprime mortgages totaled $1.28 trillion in the third quarter and comprised 13 percent of the $10 trillion in total household mortgages outstanding.

Tuesday's mortgage-delinquency and home-foreclosure report, issued by the Mortgage Bankers Association, revealed that 13.3 percent of subprime loans were delinquent during the fourth quarter. That represented an increase of 6.1 percent over the third quarter. But it was what happened in the prime-mortgage area that spooked the financial markets. For prime ARMs, delinquency increased by 10.8 percent; for prime fixed-rate loans, delinquency increased 8.1 percent. The report also revealed that the "rate of [all] loans entering the foreclosure process was 0.54 percent, [17.4 percent] higher than the previous quarter and a record high." Things could get very interesting in the months to come.