Global Housing Price Boom and its Aftermath, The

Housing Finance International, Dec 2007 by Renaud, Bertrand, Kim, Kyung-Hwan

After 2003, strong price appreciation and declining affordability had induced a rapid expansion of the use of "non-traditional mortgage" products (NTMs) designed to stretch the buying capacity of borrowers, both prime and non-prime, in metropolitan areas with the highest housing prices and also facing higher risks of a price decline. These new loans include "interest-only" or (I-O) loans with no principal payment for the first 5, 7 or 10 years and sharply higher payments thereafter. "Option ARMs" are I-O loans where the borrower has various payment choices every month. "Minimum-Payment" loans do not cover the full loan interest and lead to negative amortization. "Piggy-Back" loans or "simultaneous second lien" loans combine a "conforming" loan saleable to Government Sponsored Enterprises (GSEs) with a home-equity line of credit (HELOC) from the same or a different lender. Their goal is to maximize the LTV ratio while avoiding private mortgage insurance. Piggy-back loans are poorly reported "silent second loans" whose share doubled during the final years of the boom. The average size of these "piggy-back loan" packages was some 40% larger than single loans. Due to the current ceiling of $417,000 on conforming loans it has been the riskier and more costly HELOC second loan that has grown the fastest.

The US subprime case is a good illustration of the paradoxical deterioration of housing affordability during this long boom, as discussed earlier. What did not need to happen and is specific to the US is an almost laissez-faire regulatory framework resulting from the patchwork of federal and state regulators, and legislatures subject to various degrees of industry lobbying. This environment invited regulatory arbitrage and eventually facilitated unethical and fraudulent behavior by poorly regulated state-licensed lenders and unlicensed new mortgage brokers on a very large scale at the peak of the boom. There was also the lack of adequate consumer protection for the financially least-educated segments of the population. This environment encouraged the very visible deterioration of lending standards, flawed or fraudulent property valuations, manipulations of credit scores and income documents, and other problems. Gramlich (2007) has pointed out the irony of devoting the best federal regulatory work to the most mature and least risky part of the mortgage markets while leaving essentially unregulated critical elements of a new and much more risky market segment. The reputational impact for the entire US mortgage market on global financial markets has been very sharp.

The US subprime market has grown to 7 � million loans representing 14% of the total US mortgage debt outstanding, which was estimated at about $13 trillion at the end of 2006.12 Delinquency rates on subprime mortgages have increased sharply and tripled since 2005. Distress is concentrated among the two-third of subprime borrowers with variable-rate mortgages. Some 17% of them are already in serious delinquency including foreclosures that have amounted to 320,000 loans per quarter in 2007, a 33% increase over the previous two years. 13 Four factors are at play: unemployment is rising in middle-west states like Ohio and Michigan; stable or falling local housing prices that would prevent borrowers from refinancing even when their contracts permits it; the poor quality of loans originated in late 2005 and 2006. Most importantly, substantial payment increases at the time of the interest rate reset have been of the order of 25% to 30% for the now notorious "2/28" loans because the first two years of payments were set at interest rates below market as "teaser rates".