CIAO DATE: 10/2008
October 2007
U.S. stock markets are gyrating on news of an apparent credit crunch generated by defaults among subprime home mortgage loans. Such frenzy has spurred Wall Street to cry capital crisis. However, there is no shortage of capital – only a shortage of confidence in some of the instruments Wall Street has invented. Much financial capital is still out there looking for a home.
As this brief describes, the facts hardly indicate a credit crisis. As of mid-2007, data show that prices of existing homes are not collapsing. Despite large declines in new home production and existing home sales, home prices are only slightly falling overall but are still rising in many markets. Default rates are rising on subprime mortgages, but these mortgages—which offer loans to borrowers with poor credit at higher interest rates—form a relatively small part of all mortgage originations. About 87 percent of residential mortgages are not subprime loans, according to the Mortgage Bankers Association’s delinquency studies.
Subprime delinquency rates will most likely rise more in 2008 as mortgages are reset to higher levels as interest-only periods end or adjustable rates are driven upward. Unless the U.S. economy dips dramatically, however, the vast majority of subprime mortgages will be paid. And, because there is no basic shortage of money, investors still have a tremendous amount of financial capital they must put to work somewhere.
On the immediate problem of mortgage defaults, some aid to the subprime borrowers might be justified, but bailing out the lenders even more than we have up to now would create a moral hazard by merely encouraging them to do it again.
Resource link: Credit Crisis: The Sky is not Falling [PDF] - 78K