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Monday, November 26, 2007

Help for Subprime Reporters

by Calculated Risk on 11/26/2007 10:25:00 AM

Yesterday Tanta answered the question: What is Subprime?

Tanta covers the basics of mortgage underwriting and the three Cs:

Mortgage underwriting isn’t really that difficult, which is of course why some of us have been so shocked at the extent to which lenders have been screwing it up in the last few years. ... what it’s about is just working through the complexity of the variations on three things that have been the core of mortgage underwriting since roughly the dawn of time: the three Cs, or Credit, Capacity, and Collateral. Does the borrower’s history establish creditworthiness, or the willingness to repay debt? Does the borrower’s current income and expense situation (and likely future prospects) establish the capacity or ability to repay the debt? Does the house itself, the collateral for the loan, have sufficient value and marketability to protect the lender in the event that the debt is not repaid?

There is no New Paradigm, there was no New Paradigm, there is not going to be a New Paradigm. The Cs are the Cs. What we “innovated” was our willingness to believe that we had established the Cs with indirect or superficial measures (that are, not coincidentally, cheap and fast compared to direct measures). We looked at FICOs—scores produced by computers—instead of full credit reports and other documents to supplement them. We looked at the borrower’s statement of income or assets, not the documents; when we got docs, we looked at the last paystub or the current balance of an account, not the documentation of a long enough period to establish stability of income or source of account balances. We looked at AVMs instead of full field appraisals. We read the Cliff’s Notes.

These practices have not worked out so well, of course, but my point is that they were simply “innovative” ways of answering the three C questions, not new questions.
Later in the piece Tanta explains why "we are all subprime now":
The fact is that huge numbers of people who have “prime” mortgage loans couldn’t refi or sell right now to—literally, for some of the uninsured—save their lives. They may well still be making payments on the mortgage, but they’re rapidly approaching upside-down if they’re not there yet, they’ve spent the proceeds of the previous cash-outs that kept up the lifestyle or just kept life together, and if the truth were known about credit card balances, their current FICOs probably aren’t the envy of the neighborhood either. They are, in short, subprime. They just don’t recognize themselves in the stereotype of the deadbeat serial bankruptcy filer or the undocumented immigrant or the waitress in the McMansion or whatever extreme case you can dredge up and label “typical” for subprime. They are, increasingly, “us.”

The invisible subprimers will do okay if this blows over and they don’t lose their jobs: if and when the RE market recovers, anyone who hung onto the mortgage he has will come out “prime” again. That’s the good news. The bad news is that attributing this solely to your own prudence and good judgment and inherent worth as “not one of those subprime people” is a form of delusion. Subprime is like the weather: when it rains, everybody gets wet.
This is a key point: a large number of prime and Alt-A borrowers are - or will soon be - upside down in their homes. They cannot sell (without bringing cash to escrow). They cannot refinance. The slightest financial problem and they will be facing foreclosure. And just imagine the psychological impact of making payments on a $500K mortgage when the same house just sold for $400K down the street. Collateral is one of the three Cs, and these homeowners' collateral makes them part of a growing group of "invisible subprimers".

Check out Tanta's entire post: What is Subprime?