Subprime home loans: don't panic

As serious as the mortgage situation is, there are good reasons why the sky is not likely to fall.

from the April 26, 2007 edition

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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.

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