Subprime Loan Problems, Stock Market Declines: A Result of Lax Lending Practices, Not Identity Theft and Fraud
March 14, 2007
|
William Poole, President of the St. Louis Federal Reserve remarked in February (when addressing Subprime lending problems): "Some of this lending probably involved actual fraudulence....". Some took such comments to mean that the recent problems we have witnessed in Subprime lending, and the ensuing stock market declines, have been caused primarily by mortgage lending fraud. Although mortgage lending fraud has been on the increase in recent years, and both Identity Theft and Identity Fraud are contributors to mortgage lending fraud, data suggests that such factors are a small contributor, not a major one.
|
 | In November 2006, the Financial Crimes Enforcement
Network (FinCen) Office of Regulatory Analysis released a report
titled: Mortgage Loan Fraud. In such report, FinCen analyzed SAR
(Suspicious Activity Report) data from 1996 to 2006 and isolated
records associated with Mortgage Loan Fraud:82,851 such records were
identified. Such data pointed to a substantial increase in Mortgage
Loan Fraud in recent years: 28,372 in 2006 (expected); 25,989 in 2005;
18,391 in 2004; 9,539 in 2003; 5,387 in 2002; 4,696 in 2001; 3,515 in
2000; 2,934 in 1999; 2,269 in 1998; 1,720 in 1997; 1,318 in 1996.
Despite the substantial increase in Mortgage Loan Fraud SAR, given the
substantial number of mortgage applications filed each year, the 28,372
data for 2006 is less than 0.1% of total mortgage loan applications for
2006.
Furthermore, FinCen discovered that less than 1% of all Mortgage Loan Fraud SAR were characterized by Subprime Loans.
Although the percentage of mortgage loan fraud relating to subprime
loans relevant to the total number of mortgage loan applications seems
extremely small, Identity Theft and Identity Fraud are a major
contributor to mortgage loan fraud. In a random sample of 1,054
narratives taken from the 82,851 SAR records, FinCen concluded that
3.9% were characterized by Identity Theft, and 23.12% were
characterized by Identity Fraud. Identity Theft is characterized by the
assumption of someone else's identity, while Identity Fraud is
characterized by the misrepresentation of some data underpinning one's
identity (such as using someone else's social security number, but not
someone else's name).
In conclusion, Identity Theft and Identity Fraud are a major
contributor to Mortgage Loan Fraud. However, Mortgage Loan Fraud (and
in turn Identity Theft and Identity Fraud), is not a major contributor
to the recent problems associated with Subprime loans.
Such findings should not be surprising. After all, if someone wants to
commit fraud to secure a mortgage loan, wouldn't it make sense to
secure a low |
interest loan as opposed to a high interest one? Why would
a criminal act fraudulently to secure a loan, but honestly to get a
high interest one?
The recent turmoil in Subprime lending and the ensuing stock market
declines is a function of lax lending standards, rising short term
interest rates, and non-increasing home prices. Lax lending practices
allowed lenders to qualify borrowers based on monthly payments
calculated at initially low adjustable rates. When time came for such
adjustable rates to increase, the home buyers could not afford the
higher monthly payments. When such buyers were forced to place their
properties on the market, housing inventory increased, limiting real
estate price appreciation. As a result, homeowners could not sell their
homes, they also could not make their higher monthly payments, and as a
result, subprime lenders were stuck with non-performing loans. With
non-performing loans on their books, subprime lenders could not make
interest payments on loans they have taken themselves. As a result,
they were forced to file for bankruptcy.
|
None of this should be surprising, given the substantial increase in
interest rates we have witnessed in about 2 1/2 years, coupled with
the substantial increase in adjustable rate financing. Short term
interest rates have increased from a low of 1% to 5.25%. That is an
increase of 4.25%.
Subscription Published Research (SPR), a service of Gammawealth
Strategy & Research , LLC (www.gammawealth.com),
published an extensive study/research |
 |
article in November 2005 titled:
Greenspan, Bernanke and The Fed; Productivity,
Inflation and Economic Growth. At such time Fed Funds
interest rates were 4%. Such article predicted that interest rates
would rise to at least 4.5%. Furthermore, such article stated on page
9: "if a change in the recent tightening cycle is not indicated soon,
an unecessary slowdown in the economy may ensue, resulting in the need
to aggressively lower rates further in the future". We should note that
GammaWealth also operates www.creditlock.com
Such prediction was far from the norm in November 2005, when everyone
else was predicting substantial additional increases in interest rates
and continued growth. Yet today, several analysts are starting to talk
about an imminent upcoming ease of policy.
Despite the seriousness of the current situation, considering that only
6% of outstanding mortgages are subprime mortgages with adjustable
rates, it is unlikely that a major financial shock will ensue. An
article by David Gaffen, "Be Cautious, Don't panic", published on WSJ
Online in February, illustrated such perspective. |
 |
Richard Brown, FDIC chief economist recently remarked that FDIC insured
banks hold about $2.2 Trillion in mortgages, probably with 85% to 90%
being prime mortgages. The total size of the mortgage market is about
$10.2 Trillion. About $5.5 Trillion have been securitized. The total
size of the Subprime mortgage market is about $1.3 Trillion. If 30% of
such mortgages default, and banks are only able to recoup 60% of lent
monies, that would result in losses of $156 Billion. It is estimated
that FDIC insured banks generated about $145.7 Billion in profits in
2006 alone.
|
What if the Subprime problems affect the overall mortgage market? It is
estimated by the Mortgage Bankers Association that 35% of homeowners
own their homes outright. Furthermore, an additional 47% are estimated
to hold a Fixed Rate Mortgage. Unless there is a substantial loss of
jobs, it is unlikely that the Subprime problems will cause a serious
economic shock.
Although it is unlikely that a serious economic shock will ensue, it is
very possible that an increase in real estate inventory available for
sale will cause some slowdown in the real estate sector. Such sector
slowdown will have a negative, non-shock, effect on the economy, which
might be absorbed by growth in another sector, such as increased
corporate spending. If no other sector absorbs such slowdown, then it
is possible the economy may stagnate: hence the possibility of
recession that Greenspan recently alluded to.
The Fed will most likely monitor the situation very closely, with its
finger only inches away from the interest rate ease button, in order to
prevent a liquidity crunch. The fed, or another regulatory or
government entity, may also give incentives to lenders to extend lower
rates to subprime borrowers, in order to help them avoid default. It is
ironic that those who cannot afford to make high interest payments, are
exactly those who are forced to pay higher interest rates.... because
they cannot afford it....
|
|
To Go Back to Blog, Make Comments or RSS Feeds Click Here |
|
Seed Newsvine