Tuesday, September 7, 2010

Both Prime and Subprime Mortgages are Falling into Default. Why?

Chicago Fed economists Gene Amromin and Anna Paulson have completed an empirical study that disprove some of the theories behind the causes of rising mortgage default rates. They write:

For the past several years, the news media have carried countless stories about soaring defaults among subprime mortgage borrowers. Although concern over this segment of the mortgage market is certainly justified, subprime mortgages only account for about one quarter of the total outstanding mortgages in the United States. The remaining 75 percent are prime loans that are made to borrowers with good credit, who fully document their income and make traditional down payments. While default rates on prime loans are significantly lower than those on subprime loans, they are also increasing rapidly. For example, among prime loans made in 2005, 2.2 percent were 60 days or more overdue 12 months after the loan was made (our definition of default). For loans made in 2006, this percentage nearly doubled to 4.2 percent, and for loans made in 2007 it rose by another 20 percent, reaching 4.8 percent. By comparison, the percentage of subprime loans that had defaulted after 12 months was 14.6 percent for loans made in 2005, 20.5 percent for loans made in 2006, and 21.9 percent for loans made in 2007. To put these figures in perspective, only 1.4 percent of prime loans and less than 7 percent of subprime originated in 2002 defaulted within their first 12 months.1 How do we account for these historically high default rates? How have recent trends in home prices and economic conditions affected mortgage markets? One of the things we want to consider, specifically, is whether prime and subprime loans responded similarly to home price dynamics.
Their study does indeed show that it is housing price declines that correlate most closely to housing defaults rather than the structure of loans. This then lays more of the blame of the housing defaulys at the feet of the Federal Reserve, who fueled the out-of-control boom with easy money.  The Amromin Paulson full study is here (Pdf)

1 comment:

  1. The mortgages were underwater and people are cutting their losses. So they hose their credit rating for the near-term. It's better than carrying a mortgage for another 25 years on a property that will never be worth the original loan amount again.

    What's so hard to understand?