Unemployment: The Other Shoe Dropping

A statistics from that paper that still shocks me: roughly 28% of all mortgages defaults, and 60% of all subprime defaults, were mortgages that started with a prime mortgage.

Approximately 30 percent of the 2006 and 2007 foreclosures in Massachusetts were traced to homeowners who used a subprime mortgage to purchase their house. However, almost 44 percent of the foreclosures were of homeowners whose last mortgage was originated by a subprime lender. Of this 44 percent, approximately 60 percent initially financed their purchase with a mortgage from a prime lender. This result implies that a large factor in the crisis stemmed from borrowers who began their home ownership with a prime mortgage, but subsequently refinanced into a subprime mortgage…For ownership experiences that begin with mortgages obtained from a prime lender, subprime refinances are often a signal of financial distress, especially for borrowers that extract equity with a subprime refinance. It is likely that in the absence of a subprime market, many of those borrowers that ended up defaulting would have defaulted on their previous prime mortgages.

This point is key. There’s a real tendency to Other subprime mortgage holders. They are idiots, crooks, dupes, minorities, single mothers, easily mislead, liars and criminals, etc. But right here, 28% of all mortgage foreclosures, and 60% of subprime foreclosures, are from people who started with a prime mortgage. Those are the Us – good credit scores, 20% down, pay the bills on time. They disappear in the data – compilations of mortgage data often don’t follow the original starting point of homeowners, just of mortgages themselves (which is why I trust the Boston Fed papers, and few others) so we don’t see their story after they replace their prime mortgage with a subprime one.

I wrote about them around 2 years ago in a guest blog post when this was first unfolding. Everyone was wondering when the Alt-As, or the prime loans were going to fall apart. They didn’t in the numbers, so that lead a lot of people into the ‘soft landing’ category on housing. The fact that lots of people were missing was that the middle class that is struggling doesn’t default from a prime or Alt-A loan, but instead refinances into a subprime loan and then perhaps defaults later.

So what happened to them? We know what this is not – it isn’t “I think I want to borrow $50,000 against my house to buy a new car, redo my kitchen and maybe buy a TV.” That’s a home equity loan, and it doesn’t show up here. Though there are exceptions, general consumption based refinances don’t tend to go subprime – the rates are too high. What we expect is what the Fed finds – prime households experiencing financial distress.

If you are familiar with Jacob Hacker, and other works from the Risk Transfer literature, you know the story. Health Care costs. Rising education cost. Income volatility. The increasing tournament-style of our ‘flexible’ labor force. Outsourcing and gated communities. The dismantling of the risk-sharing social contract. All these things make our middle class less able to handle income shocks; in place of solutions to handle unemployment spells and sudden health care costs, we got subprime.

So what about the current crisis? Back in the 3-6-3 boring banker days, the unemployment rate was the determination of necessary writeoffs for bad debt. Credit card writedowns and mortgage defaults roughly tracked unemployment. Now we’ve been overwhelmed with the trillions of subprime debt that had to be written down. But
now we have to deal with the unemployment rate again. It’s going to get a lot worse before it gets better, and underneath those numbers are some terrible duration of unemployment numbers.

Now I’ve been thinking about the shocking writedowns and loss of wealth, as well as the increase in savings, and whether that could buffer the upcoming unemployment numbers effect on housing and consumer debt. Can it really get worse, or have we done all the bleeding out we need to? The short answer, as the credit card data starts to roll in, is that the upcoming losses are going to be larger than we expected on the consumer end (my underline):

The jump in likely credit-card loan losses at Capital One Financial (COF) suggests that other major consumer lenders may be facing similar losses for the first quarter. On Apr. 15, the issuer of MasterCard and Visa credit cards reported a one-month spike of 1.27% in net charge-offs for U.S. cardholders, to 9.33%, in March, surpassing the increase in unemployment by a widening margin.

The unemployment rate rose to 8.5% in March, from 8.1% in February. Historically, the bad debt rate on credit cards has lagged unemployment, but deteriorating economic conditions have spurred growing concern that the rate would start to outpace climbing unemployment, which seems to be occurring now, according to Michael Taiano, an analyst at Sandler O’Neill & Partners in New York.

It’s a much bigger concern, considering that some economists think unemployment might rise to 10%. “That would be mean a bigger drag on [issuers’] earnings in those quarters where that happens,” says Taiano, who has a hold rating on Capital One’s shares.

And:

Fitch said many large credit-card issuers pointed toward “significant worsening” in second-quarter metrics as they released their first-quarter results. Few were even willing to forecast beyond the second quarter because of the economic uncertainty. As a result, Fitch said credit-card losses would be “meaningfully higher” in the second quarter.

It aint over yet. I wonder if we are going to have to have two layers of green shoots. One for the businesses, the stock market and corporate earnings, and another for the rest of America, one for unemployment and consumer losses and writedowns. I’m hoping we are turning a corner on both these months….