The consensus of opinion is that today’s stock market correction was due to continued worries about sub prime mortgages, particularly after Countrywide Financial, the nation’s largest mortgage loan broker, reported earnings significantly less than Wall Street expected, or the company itself had projected. It is important to bear in mind, though, that Countrywide is reporting earnings, not losses. Given that Countrywide’s primary source of revenue is origination fees on mortgage loans, that they are making as much money as they are strikes me as a good thing, and not in any way indicative of wide scale problems in either the mortgage industry or the housing industry generally. Presumably, if Countrywide is still reporting earnings, they are still originating, and remarketing, mortgage loans.
In fact, what people overlook is that so many sub prime mortgages, those ‘no qualifier’ and stated-income loans, were made to home buyers whose large size of loan and income stream makes mortgage loan underwriting difficult. The primary underwriting basis for many of these loans, simple as it sounds, is a significant cash down payment from the buyer, usually at least 30% of the purchase price of the property or its appraisal value, whichever is more. Consequently, in spite of some contraction of real estate values in some markets, the almost all sub prime mortgages remain very well collateralized. Moreover, much of what we read about how sub prime mortgages are effecting financial markets has to do with hedge funds and derivative investments that are in some way composed of sub prime mortgages. Assuming some kind of Moody’s or Standard and Poor’s down grade to the fund, the par value declines- in spite of the fact that the underlying debt instruments may still be as money good as they ever were!
Further, home builders themselves do not have massive inventories of unsold homes. Home builders, however, have to build and sell homes to make money. Consequently, those companies that expanded in order to meet the unprecedented demand for new housing units over the last 6 years, are naturally showing a large amount of red ink while they contract their overheads to match reduced demand for their product. Did I say that home builders do not have massive inventories of unsold homes? It bears repeating, as the purchasing slowdown happened so quickly it is difficult to imagine that suddenly, all demand for new housing had been met. In fact, what home builders tell me, the pundits who predicted a slowdown for at least a year before the slowdown began late in 2005 began to influence buyers who began to think that, if they waited, housing prices would decline. Did demand slacken? No- what replaced demand amongst buyers was fear of overpaying. At some point in the not too distant future, buyers will cotton on to the fact that houses continue to be a safe investment, and, with pent up consumer demand and no inventories of new housing, demand will quickly outstrip supply and prices will go through the roof.
‘Safe as houses’ as the old saying goes, certainly once consumer confidence overcomes fear in the financial markets. And sub prime mortgages? Safer than you’d think.