Rising U.S. Mortgage Defaults Forecasts Danger

From the June 2007 Trumpet Print Edition

U.S. mortgage default rates hit an all-time high in the first quarter of 2007, which is sure to add additional pressure to a slowing housing market and cause lenders to tighten their credit conditions.

According to Equifax, the percentage of mortgages in default rose to 2.87 percent—eclipsing the worst levels following the 2001 recession. Defaults in many categories—first mortgages, second mortgages and home equity loans—were significantly up (cnbc, April 10).

Mississippi and Texas led a nationwide increase in the number of defaults; conditions deteriorated in all but six of the nation’s 50 states.

“The news is unremittingly bad,” said cnbc’s senior economic correspondent.

So far, most of the carnage has been confined to sub-prime borrowers. As long as defaults do not spread to the general mortgage market, many economists feel the economy should be able to weather the storm.

However, the biggest threat to the housing market—and subsequently the economy—is not the rising number of sub-prime defaults. The real threat to the economy is the tightening of credit conditions that are in large part a result of those sub-prime mortgage losses. With rising default rates and soaring investment losses, sub-prime lenders have tightened up their loan standards. The days of “anyone and his dog” being able to walk in off the street and receive a no-documentation, self-certified income loan are just about over.

Over the past few years, sub-prime loans have grown to take up one quarter of the U.S. mortgage market. In other words, a quarter of the nation’s home demand may be about to evaporate as sub-prime mortgage lenders continue to go bankrupt and lending standards are tightened.

Without that demand, housing prices, along with new construction, will probably continue to fall—two big challenges for an economy that has become dependent on a rising housing market.