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Perhaps Traditional Fixed Rate Mortgages Aren’t So Bad
February 2007
“American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage,” said Alan Greenspan in a speech to the Credit Union National Association in Washington three years ago.
Some lenders took his advice. Sub-prime and limited documentation loans accounted for more than 20 percent of new mortgages last year and 16.5 percent of the total home loans outstanding, according to the Mortgage Bankers Association. During 2004-2005 when home prices were increasing at double digit rates annually, sub-prime lenders thought it inconceivable that rising delinquency rates on loans made without traditional documentation could spill over into the rest of the home-loan market. In its January survey on bank lending practices, the Fed said that a net 15 percent of domestic banks reported tightening credit standards on residential mortgage loans over the past three months, the biggest net increase since the early 1990’s when banks were being saddled with bad real estate loans. More banks and thrifts failed in the early 1990’s than at any time since the Great Depression.
The Fed's survey also found that a net 37 percent of the banks reported weaker mortgage demand to purchase a home. The ripple effects of the housing slowdown aren't confined to the financial sector. Housing-related industries have dropped sharply in the past year. Production in furniture, household appliances and carpeting has fallen for five straight quarters. Housing and housing-related employment made up a little over 40 percent of all payroll employment from November 2001 to April 2005. Employment in residential construction declined in nine out of the 10 months ended January 2007, with 104,000 jobs in residential specialty trade contracting lost since the February 2006 peak, according to the Bureau of Labor Statistics.
It's too soon to know the extent of the problem from all the sub-prime and option ARM loans originated over the past couple of years. Only three years ago, former Fed Chairman Alan Greenspan said homeowners could have saved money had they chosen adjustable-rate mortgages during the past decade. The irony is that new mortgage options that were developed during the past decade, and the subsequent problems that have ensued may adversely affect financial institutions' ability to lend in the future.
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