Mortgage crunch a reminder of economic cycles

Oct. 19, 2007
The US treasury secretary offered lessons all around—some related to oil and gas—in a stinging Oct. 16 speech about the meltdown of housing finance.

Bob Tippee
Editor

The US treasury secretary offered lessons all around—some related to oil and gas—in a stinging Oct. 16 speech about the meltdown of housing finance.

Henry M. Paulson Jr. had few comforting words for his audience at the Georgetown University Law Center in Washington, DC.

While the US economy remains strong, he said, it has been wounded by a housing slump caused in part by "shameful" lending practices and won't fully recover until housing starts rebound—a turn not yet in sight.

Paulson noted fragmentation of the mortgage lending industry into parts that originate, package, and invest in mortgage loans. And he regretted a proliferation of nontraditional adjustable rate mortgages (ARMs) coupled with increased lending to borrowers not qualifying for the lowest interest rates.

About one fourth of the mortgage originations in 2005 and 2005 were nontraditional ARMs, many with risky features such as low teaser rates and interest-only payments. Subprime lending grew from 2% of mortgages in 1998 to 14% in mid-2007.

"A significant percentage of the nontraditional ARMs were marketed and sold to subprime borrowers," Paulson said. At another point he called for "a higher level of integrity" in mortgage origination. "Some of the conduct and practices that I have learned about are shameful."

Still, he said, "homebuyers have a responsibility to understand their mortgages."

That's easy to overlook when words like "shameful" are being used in high places to describe an industry.

How hard is it to see the risk here? If you take out an adjustable-rate loan you can barely afford when interest rates are low, you get hammered when rates rise.

That's not "if" rates rise; it's "when" they do. In an economy, everything cycles. Most ARM borrowers surely saw the risk of an adverse interest-rate turn. They just thought it wouldn't happen.

How many Americans similarly bought sport utility vehicles or monster pickup tricks on the assumption that fuel prices would stay low forever?

Oil prices, like interest rates, cycle. They never stay low, and buyers of beamy vehicles were wrong to expect them to.

Lest anyone forget, oil prices never stay high, either.

Editor's Perspective will appear next on Nov. 2.

(Online Oct. 19, 2007; author's e-mail: [email protected])