mortgage default rates

In class, someone asked about the current default rate in the subprime market. I didn’t
know at the time, so I looked around a little more. Here’s what Credit & Collections
World says:

“The default rate of subprime mortgage loans jumped to a five-year high during
November. The rate rose to 10.09% in November, from 6.62% a year earlier and
101 basis points from October 2006, reports Friedman Billings Ramsey (FBR),
an investment bank that tracks mortgage credit performance.

The subprime default rate fell in 45 metropolitan statistical areas (MSAs) but
grew in 316 of them.

According to FBR, the default rate began to rise briskly after August 2005. The
November rate represents the highest number of defaults in the subprime
mortgage market since November 2001’s 10.05%.” (C&CW 2008).

Note that the “November” they are talking about is Nov. 2007.

Historically, the subprime foreclosure rate declined from 2000 & 2001 as the economy
recovered from recession and did well. (Foreclosure rate may not be exactly default
rate as some talk about it, but it provides a rough guide.) The foreclosure rate on
subprime loans was as low as 3.8 % in 2004 and 3.3 % in 2005 when the economy was
good, so the 4 % default rate used in my spreadsheet example is reasonable for
calculations made on transactions in those years. The US Census Bureau gives the
following data on foreclosure rates:

2000 2006
Total Mortgage obligations $1.14 trillion $2.82 trillion

overall foreclosure rate 1.2 % 1.2 %

foreclosure on prime conventional loans 0.4 % 0.5 %
foreclosure on subprime loans 9.4 % 4.5 %

Source: US Census Bureau. 2008. Table 1163. Mortgage Originations and Delinquency and Foreclosure
Rates: 1990 to 2006 http://www.census.gov/compendia/statab/tables/08s1163.pdf

Now, in September 2008, the overall default rate on mortgages seems to be up to

about 9 % (e.g., West 2008). In the subprime market, it isn’t clear exactly what the
default rate is now, but it is much higher. Here’s what one observer says about how
bad it might get:
 “As seen by the ABX index above, mid quality subprime debts are now selling at
10-20cents on the dollar. Those mortgage debts are being sold as if they are
worth nothing.

Let’s not forget those notes have houses as collaterals. The index is implying that
9 out of 10 subprime mortgages are expected to default, with investors getting
zero back from foreclosures.” (Lee 2008)

It also isn’t easy to figure the exact proportion of mortgages that are subprime, but some
observers put it at about 20 % (e.g., Pieterse 2008). If there are roughly 50 million
home mortgages in the USA (48 million in 2005; US Census Bureau 2008, American
Housing Survey), that means roughly 10 million are subprime.

There was roughly $10 trillion in home mortgages outstanding in 2006. (US Census
Bureau. 2008. Table 1161. Mortgage Debt Outstanding by Type of Property and Holder:
1990 to 2006 http://www.census.gov/compendia/statab/tables/08s1161.pdf ). On
average, a mortgage would be roughly $200,000 by these figures; but we can leave
$125,000 in the spreadsheet if we want since subprime mortgages are likely to be
smaller than average. (Anyway, it is only the expected payout that matters, not the
original loan, for our rough calculations here.)

We won’t even figure out the expected loss (or payout for an insurer), since those
figures are even harder to find. It might be more than we have in our spreadsheet.

You can put the numbers for default rate into the lower part of the spreadsheet to see
what happens if we have about 10 million of these subprime loans out there in the
market, and the default rate keeps rising. What if it actually does go to 80 – 90 %?

Then, this is only the subprime market. There are 40 million or so normal home
mortgages out there, for which the pricing would have been based on a much lower
default rate. Now, the economy is bad and default rates are rising in the main part of
the market, too. Hmmm …

By the way, as I said in class, this crisis isn’t really a surprise to people who have been
paying attention. Here’s an example from the mortgage industry in 2006: NMNO
(2006). ;

*****

Credit & Collections World (C&CW). 2008. Subprime Default Rate Exceeded 10% in November.
http://www.creditcollectionsworld.com/article.html?id=200702056DZUM6S3

Lee, John. 2008. US SUBPRIME BOTTOM: Resumption of Equity bulls, and Gold as new money.
Financial Sense Editorials, April 21, 2008. http://www.financialsense.com/editorials/lee/2008/0421.html

National Mortgage News Online (NMNO). October 23, 2006. Report: Default Rate on Lower Credit
Quality Loans Rises Sharply. http://www.nationalmortgagenews.com/premium/archive/?id=154204
Pieterse , Jan Nederveen. February 2008. Subprime and the World Economy. global-e: A Global Studies
Journal 1(3) http://global-ejournal.org/2008/02/15/nederveen-pieterse/

US Census Bureau. 2008. Banking, Finance, & Insurance: Payment Systems, Consumer Credit,
Mortgage Debt.
http://www.census.gov/compendia/statab/cats/banking_finance_insurance/payment_systems_consumer_
credit_mortgage_debt.html

US Census Bureau. 2008. American Housing Survey 2005. Table 3-15. Mortgage Characteristics--
Owner Occupied Units http://www.census.gov/hhes/www/housing/ahs/ahs05/tab3-15.pdf

West, Michael. September 10, 2008. 'Frannie' bailout heavy with irony. Business Day (Australia),
September 10, 2008
http://business.theage.com.au/business/frannie-bailout-heavy-with-irony-20080909-4cij.html\