Gotham Gazette

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The Real Foreclosure Crisis

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 – the percentage of transactions that lead to a foreclosure – 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 crunch.

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.

The Outlook

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.

That said Manhattan 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. 

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