The idea that the sub-prime market “walloped Manhattan with a vengeance” this
summer, as the New
York Post put it, has lead to a kind of hysteria and confusion. To back up
the reports of impending doom, the paper cites figures from Realty Trac, an industry
group. In issuing such pronouncements, though, the reports conflate some very
important, and different, issues and so provide a misleading picture.
First, take the discussion of foreclosures in general. The Post account does
not differentiate between foreclosures on sub-prime loans, those made to risky
borrowers, versus those on more conventional loans. A difference is strongly
suggested, but never specified.
Borough by Borough
To illustrate, foreclosures in Manhattan changed by only a small amount from
July 2006 to July 2007. They increased from 225 to 253, a difference of 28. It's
true that the foreclosures rose by 12 percent but the number of foreclosures
was small to begin with.
A huge amount of apartments have been bought and sold over the past year. Everyone
would agree that the housing market has not slowed in
Manhattan, and more transactions means more foreclosures. To find out if a growing
problem exists, it would be useful to know the number of housing units bought
and sold and the average foreclosure rate â€“ the percentage of transactions
that lead to a foreclosure â€“ over time.
Staten Island actually recorded a decline in foreclosures of 5.7 percent for
the year - dropping from 244 to 230 cases.
The number of foreclosures for Manhattan and Staten Island are nearly equal.
However, since more homes are sold in Manhattan than in Staten Island, Staten
Island actually has a higher foreclosure rate than Manhattan.
As for Queens: Foreclosures there have increased to 882 from 390. That is a huge
change. The borough has seen a robust increase in housing sales, but foreclosures
have increased by a far greater percentage.
This could be explained by a greater number of sub-prime borrowers in Queens
than in Manhattan. The Queens changes are consistent with the changes in the
sub-prime market. The sub-prime mortgage borrower has relatively poor credit,
took out a loan of 90 percent or more of the purchase price of the property and
has a "riskier" loan. This could be, for example, an
80/10/10, which involves a 10 percent down payment, a mortgage for 80 percent
of the price and a 10 percent home equity loan for the rest. It could be an ARM
(adjustable rate mortgage) that features lower interest rate payments at the
beginning of loan. Some borrowers may find it difficult to make payments as monthly
rates rise when the adjustable rate is reset to an annual percentage rate, based
on the prime lending rate plus some additional payment.
The Queens case raises some interesting questions:
-- Were there a handful of "predatory" sub-prime lenders in the area,
leading to concentration of foreclosures by certain lenders?
-- Are there concentrations of foreclosures by neighborhood?
-- Where will the people affected by the foreclosures go to live? Rental markets
are tight, and the sub-prime population, the group most in need of credit, will
be the least likely to have access to it.
Big Loans, Big Crunch
Lenders are tightening credit standards across the board. This is why: Typically
the mortgage lender or bank has been able to make the loans to Joe Smith on Main
Street then sell them to an intermediary. This provides the lender with more
money to make more loans and also allows it to transfer the risk, meaning the
bank no longer has the loans "on its books.” The intermediary then
packages these loans to sell to the secondary market or Wall Street. But if Wall
Street isn't buying, then the intermediary isn't buying, and if the intermediary
isn't buying, then the loan originator (the bank) has less money to lend and
less incentive to loan money to anyone - sub-prime or not.
This is especially true for the jumbo loans, that is, those greater than $417,000.
Given current housing costs, people in Manhattan and parts of Queens and Brooklyn
typically require such loans. Loans for less than this amount are secured by
the government-sponsored entities, Fannie
Mae and Freddie Mac. So, when the banks make loans
of up to $417,000 they can sell them to Fannie Mae/Freddie Mac. In return, the
bank receives money to make more loans. Meanwhile, Fannie Mae and Freddie Mac
issue securities backed by this pool of loans and sell them to Wall Street.
Jumbo loans offer no such guarantee. The intermediaries purchasing these larger
loans from the original lender are insurance companies, private equity firms,
hedge funds and other banks. The intermediary buys these loans, divides them
up according to risk profile (the likelihood that borrowers will pay back the
loan) and then issues securities. As sub-prime borrowers default on their payments,
Wall Street doesn’t want securities backed by sub-prime loans. And if Wall
Street doesn’t want securities backed by sub-prime loans, then the intermediaries
cannot sell their loans to Wall Street. If the intermediaries cannot sell their
loans to Wall Street, then they cannot buy new loans. And if they cannot buy
new loans, then loan originators will not be able to sell their loans to the
intermediaries and receive funds to make new ones. Hence, the so-called credit
So even though it doesn't seem "rational" to decline to grant a loan
to a person with a high income and decent credit score, it doesn't matter. The
market may be acting "irrationally" but in doing so it is avoiding
perceived housing/mortgage risk.
So far New York City has largely avoided the housing slump and will likely be
hit later than other parts of the country and less severely. One factor driving
the hearty housing market in New York City is the infamous Wall Street bonus.
But that bonus is contingent on the performance of the stock market. If the stock
market is down for an extended period of time, bonuses will go down. If bonuses
are down, especially for a few years in a row, then people will likely sell and
there may be less demand for housing. That could lead prices to decrease.
could still have some level of protection. If sales slow in Manhattan
and prices decline, the number of foreign purchasers of property could increase
because of the weak dollar. Manhattan is still a "bargain" to those
outside the U.S. Using London as an indication, a sizeable number of people from
the Middle East and Asia will want property here.
So what’s the bottom line? In terms of a foreclosure crisis, Queens is
the real story here. Manhattan is not.
Rebecca Jones is a credit risk analyst based in New York City.Â
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