Subprime home loans: don't panic

Amid anxiety over subprime mortgages, perspective is sorely needed. There is no denying, of course, that subprime defaults and delinquencies carry risks that will hang over the economy and its financial markets until well into 2008. But there is also no denying that there is much in the situation to blunt the subprime impact. Serious as the mortgage situation is, probabilities still suggest that the sky will not fall.

The mortgage statistics are certainly striking. According to the Mortgage Bankers Association, delinquencies on mortgages of all types rose to 4.95 percent of outstanding mortgages during the fourth quarter of 2006, the latest period for which complete data is available. That rate is up from 4.67 percent in the third quarter and is the highest rate since the second quarter of 2003. Also during the fourth quarter of 2006, actual foreclosures on all mortgages rose to about 1 percent of all outstanding mortgages, an all-time high and up from about 0.9 percent during the previous quarter. In the naturally more vulnerable subprime area, delinquency rates climbed to 13.33 percent in that period, up from 12.56 percent in the previous quarter. Foreclosures in this area rose to 4.53 percent of such loans outstanding, up from 4.35 percent during the third quarter.

In the financial sphere, these reports have raised fears that the problems of mortgage lenders will spread to those institutions that lend to subprime lenders and to those individuals and institutions who own mortgage-backed bonds that include subprime exposure. Compounding these financial considerations are fears that foreclosures will depress the housing market even more than it is by adding to an already large inventory of unsold houses, which the National Association of Realtors estimates at already 4 million dwellings, up almost 20 percent from a year ago. Combined, these potential problems threaten to create a situation in which problems in finance and the housing market feed each other and drag down both areas in a kind of vicious cycle.

While it's tempting to amplify these understandable concerns, as so many did during last month's panic, investors can gain much from a look beyond the river of fearful adjectives and innuendo that has flowed so freely over this subject.

It might help, for instance, to note that few delinquent mortgages ever see foreclosure. According to the National Association of Realtors, a mortgage is delinquent if it is 30 days overdue. History shows that most of those whose payments are 30, 60, or even 90 days overdue will eventually pay up and never see foreclosure.

What is more, mortgage bankers are more reluctant to foreclose than ever before. They claim to have learned their lesson during the last real estate crunch in the early 1990s. Back then, they found themselves stuck with properties on which the best they could do was break even. Better, they say today, to rewrite terms so that the original borrower can stay in the property and keep making payments – at least of a sort.

What is more, subprime mortgages remain a relatively small part of the overall mortgage market. To be sure, subprime lending amounted to more than 13 percent of all new mortgages issued in 2005 and 2006, but still, even according to the most pessimistic of calculations, these lesser credits fall short of 10 percent of the dollar value of all outstanding mortgages in the United States.

Even in the unlikely event that all the overdue subprime loans go into foreclosure, the overall loss would still amount to barely 1 percent of the dollar value of all outstanding mortgages in the country, hardly the stuff that could on its own drag down either the housing market or the nation's financial markets.

A comparison with past experience also suggests that matters are not as dire as some suggest. In 2000, for instance, default rates actually rose faster than they are rising now, and none of that trouble stopped the economic recovery that coincidentally began at about that time.

Back in 1997 and 1998, subprime was an even bigger share of total new mortgages than it is now, and yet, when that larger surge broke, neither the economy nor financial markets collapsed or even faltered much. Of course, there was a market collapse in 2000 and a recession of sorts in 2001, but it would be a stretch to connect either event to the subprime problems of three or four years earlier.

The risks are evident. Housing is clearly the economy's weak spot, and mortgage problems are clearly a financial threat. Both issues will persist into 2008. But an economic drag is different from an economic disaster, and financial risks are different from a financial debacle. Meanwhile, with interest and mortgage rates no longer rising, the intensity of the pressure on the housing and mortgage markets is more likely to dissipate going forward than intensify.

In these circumstances, policymakers would do well to avoid panic and hold their fire. There are ample regulations to stop careless or predatory lending. New rules will do little to generate a more diligent application. Before moving to restrict lending, they should recall that the vast majority of subprime borrowers meet their obligations and that such lending has given mortgage financing to a whole class of Americans who otherwise would have had no opportunity for home ownership.

• Milton Ezrati is senior economic strategist at Lord Abbett, a money management firm.