The Subprime Credit Meltdown

Wed. Oct. 23, 2019

This page describes the credit crunch that is exacerbating the collapse of the real estate market.

What is Consumer Sentiment?

The Consumer Sentiment Index(From December 2007) is a monthly snapshot that captures how consumers feel about the current state of the economy. It is often compared with the Consumer Confidence Index, but the latter includes more information linked to the labor market.

History: In 1946, the Federal Reserve asked the University of Michigan to measure public confidence in the postwar economy. Today, researchers poll consumers and translate their answers into an index number - the higher, the better. Under President Bush, the index has averaged 89.4, compared with 97.8 under President Clinton.

Why it's important: Retailers use the index to forecast sales performance; economists use it to predict consumption; traders of fixed-income securities watch it because spending can affect interest rates. Although the index dipped in 2007, the year's mean is 88.3. (The average since 1960 is 88.1.)

The method: About 50 interviewers in a Michigan call center phone 500 randomly selected homes nationwide. The index is so up-to-date that on December 20, researchers will still be compiling data for the electronic release to subscribers the next day.

How to get it: In January 2007, the University of Michigan struck a deal with Reuters, granting the news service the right to distribute the monthly data along with a detailed analysis. Rates vary, but subscriptions average $4,800 a year. Non-subscribers get a free one-page summary.

What's asked: Interviewers pose broad questions like "Do you think now is a good time or a bad time to buy a house?" and ask for estimates of such metrics as how much prices will rise or fall in the coming months.

Losing Ground

A study by the Center for Responsible Lending ("CRL"), entitled "Losing Ground: Forclosure and the Subprime Market", is one of the first comprehensive, nationwide reviews of millions of subprime mortgages that were originated from 1998 through 2006.

The study found that, despite low interest rates and a favorable economic environment, the subprime market nonetheless experienced high foreclosure rates. They project that one out of five (19.4%) subprime loans issued during 2005-2006 will fail.

The report shows a total of 635,159 foreclosure filings on 446,726 properties nationwide during the third quarter of 2007, a 30 percent increase from the previous quarter and an increase of nearly 100 percent from the third quarter of 2006. The report also shows a foreclosure rate of one foreclosure filing for every 196 U.S. households for the quarter.

The report discusses factors that drive subprime foreclosures, including adjustable rate mortgages with steep "adjustments", allowing borrowers to "state" their income without any proof, and failing to escrow taxes and insurance. They believe that these features encouraged unreasonable borrowing, which will result in a higher default risk, regardless of the borrower's credit score.

The study goes on to find that historically high property appreciation hid these problems, and now the decrease, if not collapse, of housing values in many areas will cause loan defaults to skyrocket. California, Arizona and Nevada will be especially hard hit.

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