Home-loan trouble spurs fears of US 'credit crunch'

Such worry is one reason that stock prices took a dive Tuesday. Could the problems affect the broader economy?

from the March 15, 2007 edition

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Worst problems in subprime market

The mortgage market woes have been worst among lenders that specialized in the subprime market. A boom in subprime lending has had benefits, analysts say, since it has opened the door to homeownership to many who could not afford it in the past.

But more of those loans are going delinquent.

On Tuesday, the New York Stock Exchange suspended trading in shares of New Century Financial, a prominent subprime lender, and began taking steps to delist its shares from the exchange, citing the company's worsening financial prospects. The company also faces an inquiry by the US Attorney's Office for the Central District of California into possible criminal activity in its bookkeeping and other matters.

But if New Century is a high-profile disaster, the loan-delinquency problem extends broadly through the banking sector.

On Tuesday, shares of many large banks saw their share prices fall, as did insurance companies exposed to home lending.

Delinquency rates have been rising for all types of loans, not just subprime, according to an analysis written Tuesday by Jan Hatzius, an economist at Goldman Sachs in New York.

But the problems are rooted more in adjustable-rate loans, rather than fixed-rate loans.

"Fixed-rate subprime delinquencies have only risen by 39 basis points [0.39 percentage points] over the past year and are still far below the levels seen in the 2001 recession," Mr. Hatzius said. "Meanwhile, prime adjustable-rate delinquencies have soared by 85 basis points or 47% and are already comparable to the levels seen in the 2001 recession."

How the mortgage process works

When banks or other lending companies issue a mortgage, their loans are then typically packaged into securities that are sold to investors. To a large extent, what banking companies are doing now is responding to new demands from investors regarding the risk of loans.

"They need to be sure that the loans ... are acceptable to the final investor," says Mike Fratantoni, a senior economist of the Mortgage Bankers Association in Washington.

This process will continue to evolve, he says, and the result is likely to be that it's harder for some borrowers to get a home loan. That's because the interest rates go higher or the borrowers may need bigger down payments.

Still, he predicts that these effects will be largely contained in the subprime sector.

Meanwhile, Congress also has its eye on lending standards.

Lawmakers are considering bills designed to crack down on predatory lending. One would require that lenders consider the ability of borrowers to pay back their loans over the entire term of the mortgage. This measure is designed to prevent lenders from issuing loans based merely on customers' ability to pay initial "teaser" interest rates.

• Material from the Associated Press was used in this report.

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