Kass: Subprime's Siren Call

During the 1990s, mortgage equity withdrawals averaged between $20 billion to $80 billion per year, or only about 0.50% of GDP. By contrast, average yearly mortgage equity withdrawals climbed to about $230 billion, or 2% of GDP, over the last five years and peaked at nearly 3% of GDP in the second quarter of 2006 -- or at an annualized yearly rate of almost $400 billion!

Several months ago, Freddie Mac(FRE Quote) forecast that mortgage equity withdrawals will drop by 20% this year and by another 30% in 2008. These projections were done before the subprime fungus spread, and I think its estimates are too high.

In 2006, subprime mortgage loans trebled (to 36%) as a percentage of all mortgages issued. "Liar loans," or non- and low-documented loans that relied on the candor of homebuyers (never an intelligent loan strategy!) doubled (to 40%) over the same time frame. Creative loans, characterized by teaser rates, negative amortization and interest-only, among others, became the New Big Thing in real estate and dominated the mortgages issued in 2006. Refinancing cashouts proliferated, and, according to BankAmerica Securities, the average loan to a subprime borrower rose from 48% of the property's value in 2000 to 82% last year.

While the media have been focused on the D.R. Horton(DHI Quote) CEO's bleak forecast, every quarterly conference call with leading homebuilders last quarter confirmed the mounting restrictions of credit by mortgage lender. Stated simply, it is growing harder and harder to get mortgages. In the interim interval, the subprime market's health has worsened and so has, on a daily basis, the availability of mortgage credit (the lifeblood of our economy's well being).