The U.S. mortgage market goes from bad to much worse

Posted on 24 July 2007 by Ray Boulger

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The biggest U.S. mortgage lender, Countrywide Financial Corp, today reported appalling figures and sharply reduced its profit forecast for 2007, following much worse than expected arrears. Their profit forecast for this year was cut by 23% from the previous forecast, which was made only 3 months ago. Such a big cut in the profit forecast in such a short space of time from the U.S.’s biggest mortgage lender is a very clear indication of the speed with which the US mortgage market is deteriorating.

The situation increasingly looks to have some similarities with the UK market in the late 80s and early 90s, in that the double whammy of rapidly rising interest rates (a 0.25% increase at 17 consecutive meetings of the Federal Reserve from 1% to 5.25% between 2004 and 2006) and falling property prices are leaving overstretched borrowers with nowhere to go.

There are also other factors peculiar to the U.S. such as very low initial teaser rates, negative amortization loans, i.e. where the monthly payments don’t even cover the interest, self certification loans to people who would never be able to afford the payments and generally loose underwriting standards. The U.S. regulator could learn a few things from the FSA about how to regulate the mortgage market. Even “treating customers fairly” would be a good start!

Although the problems in the U.S. market started with sub prime loans, Countrywide’s report makes clear that arrears on consumer loans are spreading to prime borrowers. The scale of the problems can best be demonstrated by the fact that they have increased their provision for bad debts in the 2^nd quarter of this year by 373%, compared with the same period last year ($292.9m, of which $181m is for prime mortgages, v $61.9m).

The Chief Executive commented “We are experiencing home price depreciation almost like never before, with the exception of the Great Depression.” As so often happens when a serious problem occurs in a market the effect is initially underestimated. In the space of a few months the U.S. capital markets have gone from investors being keen buyers of all types of mortgage backed securities to the market being virtually closed to new issues.

Whilst the UK market has not suffered such a fate the margin between gilt yields and swap rates has increased by about 0.15% over the last month, after being stable for a long time. This will have an effect on the cost of funds for UK lenders and hence is more bad news for UK borrowers.

The one piece of good news for U.K. borrowers from all this is that as the U.S. problems get worse the negative impact on their economy is likely to mean that the Federal Reserve will start cutting rates sooner than previously expected and this may make our MPC rather more cautious about further hikes in our Bank Rate. The MPC will no doubt take heed of what is happening in the U.S. and be careful not to risk the same problems here by pushing Bank Rate up too far.

Northern Rock’s figures are due out tomorrow at 7.00., followed by Bradford & Bingley on Thursday, Alliance & Leicester on Friday, Lloyds TSB on Tuesday and HBOS on Wednesday next week. There will probably be some reports of increases in mortgage arrears, but on nothing like the scale of what is happening in the U.S.

Category: Bank of England, House and home, Interest rates, Mortgages, Personal finance, Property market, Regulation

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