Mortgage-industry shakeout is really a return to normal

NEW YORK — While the disruption roiling the mortgage-financing industry may seem like panic, some market veterans say it is actually a return to normal after a period of excess.

Without trillions of dollars in easy money pouring into bonds backed by mortgages in the last few years, many of the lenders going bankrupt this year would never have thrived. And the U.S. consumer never would have grown accustomed to a market where someone with a spotty credit history and no verifiable income could borrow lavishly with little or no down payment.

"There is a little bit of rationality returning to the markets," said Richard Bookstaber, a former risk manager at a number of Wall Street investment banks.

Bookstaber, author of "A Demon of Our Own Design," which argues crises like this are inevitable because of the way markets are structured, said this newfound aversion to risk — though painful — is ultimately good for the economy.

That can be hard to explain, though, to the tens of thousands of people who have lost their jobs at bankrupt lenders like New Century Financial and American Home Mortgage.

Anyone who owned mortgage-lending stocks has lost a lot of money in the past six months, and the shakeout in the industry prevents some people from buying a home.

People and lenders had borrowed "to the hilt," Bookstaber said. It is better for this industry to return to earth before it grows even bigger on borrowed money, he said.

"It is better to fall off the ladder when you are just four rungs up than when you are 20 rungs up," he said. "Every month that nothing goes wrong, people think the market is all the less risky so they borrow more."

Flight to safety

Most of the credit problems that ignited this flight to safety sprouted from "exotic" mortgages, including loans with cheap teaser rates that reset higher in two years, loans that are not backed by enough collateral, and loans where borrowers do not have to document their income.

These loans are becoming more difficult or sometimes impossible to obtain as lenders become pickier about the risks they are willing to take. If this shakeout seems drastic, consider that some of these loans were practically nonexistent at the turn of the century.

The worst may be yet to come, though. Many adjustable-rate loans still being paid at a teaser rate are scheduled to reset higher within the next year.

Decaying credit

And Countrywide Financial, the nation's biggest home lender, has reported decaying credit quality even among borrowers with prime credit quality. In the meantime, standards are tightening.

"The industry has returned to what it was doing 10 years ago," said Frank Bowersox, president of the Pennsylvania Association of Mortgage Brokers.

The permissive underwriting standards and exotic products of the past few years "were directed at people who normally would not have been able to buy a home," he said.

That means people with good credit who can verify their incomes still have mortgage loans readily available to them, Bowersox said. In fact, interest rates for prime home loans are at some of the most attractive levels in 20 years, he said.