Subprime mortgage bonds are making a comeback

Curbed - Jeff Andrews - 30 March 2018

Subprime mortgage bond issuance has been almost nonexistent in the 10 years since those securities brought the world economy to its knees, but data from Inside Mortgage Finance show that the risky bundled loans are making a comeback in a big way.

Financial Times reports that subprime mortgage bond issuance doubled in the first quarter of 2018 compared to a year ago, going from $666 million to $1.3 billion. Furthermore, it quotes a financial analyst predicting that issuance for the year will hit $10 billion, which is more than double the $4.1 billion issued last year. For context, the value of American subprime mortgages was estimated at $1.3 trillion in March 2007.

Since the financial crisis, mortgage-backed securities have been almost entirely issued by government-sponsored mortgage facilitators Freddie Mac, Fannie Mae, and Ginny Mae. And since the financial collapse, those organizations have refused to insure subprime mortgages. The Dodd-Frank regulation passed after the collapse put tight rules around subprime lending that for awhile effectively killed the practice.

But over the last couple years, specialty firms have jumped back into the subprime market, rebranding it as “noprime.” Investors hungry for bonds with higher yields have generated enough demand for those loans to be securitized, just as they were in the run-up to the financial collapse. The result is a rapidly expanding subprime mortgage market.

That subprime mortgages would seep back into the market right now is curious, given the current state of housing. The slow pace of new home construction and few existing homes for sale has led to an inventory shortage that has pushed home prices well out of reach for many low- and middle-income prospective homebuyers.

This has led to a sellers market, where competition is fierce for the homes that are available, and moderately priced homes end up getting bid up to the point of unaffordability. Expansion of mortgage credit into subprime territory won’t alleviate the problem of an inventory shortage, but exacerbate it, as people with shaky credit might now have options to buy. This increases demand, pushes prices higher, and makes subprime lending even riskier.

That Wall Street would flirt with bad habits just 10 years after the same habits rocked the global economy is just the latest example of the United States trying to unlearn the lessons of the catastrophe.

Earlier this month, Congress deliberated a bill that would roll back parts of the Dodd-Frank regulation that sought to restrict risky lending practices and limit the impact of too-big-to-fail banks. Negotiations on the bill were interrupted by the omnibus budget that Congress has repeatedly kicked down the road.

However, with a budget deal reached to fund the government through September, Dodd-Frank repeal could become Congress’s focus once again.