Subprime Tsunami Hits Wall
Newcastle Herald
Thursday September 11, 2008
IT'S been nearly two years since the troubles created by the subprime crisis began to appear.
Still the fallout continues and the data that keeps pouring in reveals the sheer size of the problem is breathtaking. The US property market alone has suffered its worst slump since the Great Depression, with 19 million homes now vacant in the US, representing 12 months' sales in a normal market. Losses written off to date by banks worldwide exceed $500 billion, but many forecasters believe this figure will top the $1 trillion mark because sub-prime loans in America are now more than $1.3 trillion a whopping 28 per cent of all home loans in that country.Already, 276 lenders in the US have gone out of business. Even our own banks, far removed from the action, have announced write-downs in excess of $2 billion due to their exposure to US securities that were rated AAA and turned out to be worthless.How did it happen? Mainly because unscrupulous mortgage brokers talked lower socio-economic people into homes they couldn't afford and then packaged up the loans and sold them off. These loans were known as liars' loans, because the information provided in the loan application was often false and the hapless borrowers were known as NINJAS no income, no job and no assets.Part of the problem was the way the loans worked. In Australia, when you borrow for a home, the bank documents include a personal guarantee as well as security over the property. So if you default on your mortgage, the bank can sell your home and then chase you for any money that is still owing. This doesn't happen in most states in America. Borrowers can simply hand the keys back to the lender and walk away. Hence the term "jingle mail", which refers to the noise made by the postman as he dumps a swag of envelopes full of keys on the lenders' doorsteps.The case of Alberto and Rosa Ramirez is typical. They were Mexican immigrants who earned about $300 a week each picking strawberries in Watsonville, California, and got together with another couple who worked as mushroom farmers earning about $500 each when there was work. The two couples decided to pool their resources and buy a house, and, after doing a budget, calculated they could afford repayments of $3000 a month. They were happy to buy in Watsonville but the real estate agent convinced them they could get a new four-bedroom home in nearby Hollister for just $720,000. They thought that was expensive but the mortgage broker, introduced by the agent, assured them that the monthly payment would be only $4800, easily affordable on their joint incomes.They were promised also that they could refinance the house in future and payments would reduce to $3000 or less. Nobody told them they would be liable for another $750 a month for rates and insurance.They were in trouble from the start. The payments went up to $5378 a month after they moved in, but they battled on and tried to survive by taking out personal loans for living expenses. Eventually they could carry on no longer and talked to a local agent about listing the house for sale. His valuation was between $560,000 and $580,000. They had no option but to hand in their keys. Anybody with a basic knowledge of finance would know that this couple were doomed from the outset, and were taking on a task that was beyond their means. But what is surprising is that it appears even the greatest financial brains in the world did not foresee that the combination of tens of thousands of bad loans like these would create a financial tsunami that would cause a massive global credit crisis and almost bring down some of our mightiest financial institutions.As Warren Buffet said, "You only find out who's been swimming naked when the tide goes out well, we found out that Wall Street has been a kind of a nudist beach."Let's hope the worst is over.Noel Whittaker is a director of Whittaker Macnaught, a division of HBOS Australia. This advice is general in nature and readers should seek their own expert advice before making financial decisions. His email is noelwhit@gmail.com
© 2008 Newcastle Herald