At issue are mortgages made to people who fall in the gray area between "prime" (borrowers considered the best credit risks) and "subprime" (borrowers considered the greatest credit risks). A record $400 billion of these midlevel loans -- which are known in the industry as "Alt-A" mortgages -- were originated last year, up from $85 billion in 2003, according to Inside Mortgage Finance, a trade publication. Alt-A loans accounted for roughly 16% of mortgage originations last year and subprime loans an additional 24%.
The catch-all Alt-A category includes many of the innovative products that helped fuel the housing boom, such as mortgages that carry little, if any, documentation of income or assets, and so-called option adjustable-rate mortgages, which give borrowers multiple payment choices but can lead to a rising loan balance. Loans taken by investors buying homes they don't plan to occupy themselves can also fall into the Alt-A category.
Let's look at those totals. Notice the four-fold increase in the totla dollar amount of alt-A loans in 4 years. Simply put, that's a ton of new debt in the system. Although these people had better credit, the large increase makes me wonder whether credit standards were relaxed a bit too much to make all those loans.
In addition, notice that subprime and alt-A loans comprise 40% of the mortgage loans. That means trouble with both of these tiers of loans could lead to problems outside of the housing market.
Data from UBS AG show that the default rate for Alt-A mortgages has doubled in the past 14 months. "The credit deterioration has been almost parallel to what's been happening in the subprime market," says UBS mortgage analyst David Liu. The UBS report contrasts with testimony Federal Reserve Board Chairman Ben Bernanke gave to Congress yesterday. "Our assessment is that there's not much indication that subprime issues have spread into the broader mortgage market," Mr. Bernanke said.
To be sure, defaults have remained very low in the prime market -- and despite the uptick in bad loans, the problems in the Alt-A sector aren't as severe as those that have roiled the subprime market. Some 2.4% of Alt-A loans are at least 60 days past due, according to UBS, which looked at mortgages that were packaged into securities and sold to investors. That is well below the 10.5% delinquency rate for subprime mortgages. (During the housing boom, delinquencies were low for all types of loans because borrowers who wound up in trouble could refinance or sell.)
OK -- we're far away from serious danger levels in the Alt-A market. however, the recent vintage of subprime loans went bad very quickly. So this situation should be closely monitored.
Thomas Gorman, a bankruptcy attorney in Alexandria, Va., says he is seeing more financially strapped borrowers who "probably bought more house than they could afford and then took on more credit-card debt" to furnish the house and pay for the move. When the housing market cooled, they were "caught in the middle," unable to sell their home or refinance and make their debt load more manageable.
Easy credit has defined this expansion. Now the bill may be coming due -- and it may not be pretty.