The mortgage meltdown has been front page news for the past couple of months. I’ve tended to ignore most of the news, thinking it related mostly to subprime borrowing and overheated and overbuilt Sunbelt markets. But this past Sunday there were 2 eye opening articles in the Sunday Times. On the front page, there was an article "In a Spiraling Credit Crisis, Large Mortgages Grow Costly." That report discussed the impact of tighter credit on "jumbo" mortgages — loans above $417,000 that don’t confirm to Fannie Mae’s guidelines and therefore can’t be sold to the Federally chartered mortgage enterprises, Fannie Mae and Freddie Mac. "Jumbo" mortgages are traditionally packaged into mortgage backed securities that are sold to investors, but don’t have the government’s backing. Investors are running for the exits on these riskier, non-government backed securities. As a result, the rates on these jumbo mortgages have been climbing sharply. This week, the spread between the rate on conventional conforming mortgages and non-forming "jumbo" mortgages has risen to .75 to 1%, up from a spread of .25 to .375. And that spread could grow. And as investors are requiring much more stringent lending guidelines on these non-government backed mortgages, the spread could get much greater. If the availability of mortgage money for large home loans becomes tighter, and the rates higher, this could have a significant impact on buyers — and demand — in the upper end market, particularly in the more discretionary second home sector.
The more disturbing news was buried deeper in the paper, in the Week in Review section. An article there, "Zero Down: The Loan Comes Due" and a companion piece, "Housing Busts and hedge Fund Meltdowns" delved into the ramifications and mechanisms of mortgage backed securities. Its a sobering article about how riskier loans with little down were made to borrowers who couldn’t afford them, how Wall Street packaged those loans into mortgage backed securities, and in the cruelest turn, how Wall Street financiers repackaged the riskiest slices to resell them as higher rated "collateralized debt obligations." The big winners in this, or course, were the investment bank wizards who figured out how to do it and skimmed off huge fees for doing so. The mechanisms are too involved to detail here, and unfortunately the archived articles are in the Times Select paid section of nytimes.com, so I can’t link to them from here. But if you still have last Sunday’s Times and didn’t read the article, dig it out of your recycling bin. It will certainly make you wonder, "Where was the government and the regulators in all of this?" I expect that, in the end, the mortgage ‘crisis’ will take its place next to Enron and Worldcom as yet another poster child of the "business run amok" legacy of this laissez faire, pro business adminsitration.
(Correction Aug. 17: I just had a long talk with a friend who is very familiar with the structure of mortgage backed securities and the mechanisms of that market. He commented that the NY Times article wasn’t technically correct, that the ‘Collateralized Debt Obligations" derived from mortgage backed securities don’t whitewash the risk of subprime mortgages that are packaged into them. His take is that the purchasers of C.D.O.’s and the riskier slices of mortgage backed securities are were sophisticated investors, well aware of the risks — and were paid higher rates of return for assuming higher risk. That, frankly, is the basis of risk-based pricing, to offer higher returns for higher risk. And sometimes those riskier investments tank, like mortgage backed securities backed by subprime mortgages. And the investors in those securities knew what they were getting into, and agreed to assume that risk in exchange for a higher rate of return.)
For the past few months, I’ve looked at the real estate market through a traditional lens of supply, demand and affordability — and from that perspective things looked pretty good in New York. But this recent shift in the ground in mortgage availability and pricing adds a whole new wild card to the mix. I don’t have a crystal ball about what the ultimate impact will be. But we could end up with a very divided market — split at that magic $417,000 threshold for conventional conforming loans that come with Fannie Mae’s blessing and backing. If availability continues to tighten and money becomes more and more expensive, for larger, non-conforming "jumbo" loans, that could have a more pronounced negative impact on more expensive properties at the upper end, over $500,000.