From HSH Associates:
Is a ‘Credit Crunch’ Coming to the Mortgage Market?
Part I: History Lessions
Like many of you, we’ve been following the issues of mortgage risks and housing bubbles for an extended period. Of late, certain of those concerns seem to have become reality, and we’ve left to wonder: Is a ‘credit crunch’ the next leg of the housing boom-and-bust cycle? The swirl of issues and speculation about them has prompted this discussion piece, which — we hasten to add — isn’t intended as any kind of authoritative examination, but rather an outline.
Let’s look at certain of the facts first. Over a period of time, we saw a strong stock market rally which ended in a substantial correction. This was followed by a very robust real estate market characterized by “risky” loans, including negatively-amortizing short-term ARMs and low- and no-documentation loans at increasingly competitive interest rates. That mortgage-fueled demand kept home prices rising strongly over a number of years, and it seems that speculative building projects cropped up everywhere. Good times were booming.
Sound familiar? We’re actually describing the period from about 1985 to roughly 1989 or so. While there are differences between then and now, there seems to be more than a passing similarity.
Sometime around 1988, lenders began to notice that certain of the loans they had made were starting to, in industry parlance, ‘underperform.’ In the ensuing years, “risky” (see footnote) lending, concentrated primarily among thrifts, was the impetus for FIRREA, the second coming of the thrift bailout-and-closure plan. (If we recall correctly, the first was the “Southwest Plan”).
At the time, delinquencies and foreclosures spiked, REO and workout specialists were born, home prices suffered in many markets, and the term ‘cramdown’ entered the mortgage lexicon.
Investors in all kinds of assets, especially real estate and mortgage paper, looked at their books, found credit- and asset- quality problems everywhere, and turned a cold shoulder. Credit conditions tightened swiftly and significantly. Loan losses were the undoing of a number of lenders, and nearly toppled two of the largest in the market at that time.
The recession which followed was ultimately deemed to have been caused by a “credit crunch”; while brief, it was a sharp and painful recession nonetheless.