including Goldman Sachs, Morgan Stanley and Bear Stearns, also got burned.

Briefly, the subprime mortgage concept goes like this: a home purchaser, usually with blemished or no credit history whatsoever, takes out a home loan at higher interest rates from an originator, or a sub-prime mortgage firm, which then sells the loan to a bank, for example, Goldman Sachs.

The bank then repackages the loan into a security of some sort, which market players call a mortgage-backed security, and sells it to investors.

When defaults of these loans are low, it becomes a win-win-win situation among banks, subprime firms and investors as they all make nice profits and enjoy good returns from the securities.

But recent mortgage delinquencies in the United States are so high they exceeded forecasts, rising to 4.95 percent in the fourth quarter last year, up 28 ba-sis points from the third quarter and 25 basis points from the corresponding period in 2005, accord-ing to data released by the US Mortgage Bankers Association.

In the wake of rising defaults, subprime firms had to set aside more cash for bad loans, which de-voured profits.

In a worst-case scenario, subprime firms are re-quired to buy back loans from the banks under the “credit default swap” agreement. As a result, cash dries up for subprime firms, which have to cease making new loans – their only source of income.

Irvine, California-based New Century Financial is close to being broke as it indicated earlier it would

be unable to finance repayment of loans if all its creditors came barking at the door at once.

But its spokeswoman refused to confirm market rumors that New Century plans to seek bankruptcy protection. “We know there is a lot of speculation, but we do not comment on speculation,” she said.

The beleaguered mortgage-products provider is being investigated by the US Securities and Futures Commission. It is also being probed by the California attorney’s office for accounting errors and defaulting on obligations to its creditors.

Meanwhile, Accredited Home Lenders, the 15th biggest US subprime lender, said Friday it has agreed to sell US$2.7 billion of loans to pay bankers who de-manded cash to cover the risk of defaults.

The loans will be sold at a “substantial discount” to an unidentified buyer to alleviate pressure from margin calls, the firm said.

San Diego-based Accredited will take a pretax charge of US$150 million on the sale of the loans.

Ratings agency Moody’s said that “home price appreciation” and “refinancing opportunities avail-able” will have the biggest impact on the subprime industry in the next few years.

“Economic factors, such as interest rates and un-employment, will also play a significant role as will loss mitigation techniques employed by loan ser-vicers,” said Debash Chatterjee, senior analyst at Moody’s.

Mark Zandi, chief economist at Economy.com, said home prices are now falling in much of California, Florida, the US Northeast and the auto-

producing areas of the Midwest. “Lenders are much more willing to help a borrower through a credit problem if there is equity in the home, and there are good prospects that prices and equity will increase in the near future,” Zandi said.

“However, many new homeowners with an exot-ic mortgage in these areas have little or no equity, as house prices are weakening.”

Countrywide Financial, the largest mortgage pro-vider in the United States, has reported late pay-ments on nearly 20 percent of its subprime loans, but the firm’s chief financial officer Eric Sieracki in-dicated that the lender could pull through given its broad business mix. “If you’re a monoline subprime lender, this is a dark time for you,” Sieracki warned his company’s peers.

Analysts say the dark time could get darker.“Mortgage credit conditions are rapidly erod-

ing. Delinquency rates are as high as they have been since the depths of the 2001 recession, and all indi-cations are that they will rise measurably higher in 2007,” Zandi said. “This poses a threat to the san-guine consensus view that the economy will experi-ence only a very modest slowdown this year.”

Julian Jessop, chief international economist at Capital Economics, noted that so far delinquencies and defaults have remained below their peaks in 2002.

“But there are good reasons to expect both to rise further as more special deals end and the economy continues to weaken,” Jessop said.

“Although the full extent of the problem is still

not clear, at the very least the subprime crisis can be expected to worsen the downturn in the US hous-ing market.”

Housing supply will increase while demand will drop, forcing home prices to depreciate, Jessop ex-plained. “Repossessed homes will add to the supply of properties coming onto the market, while the re-duced availability of mortgage financing will under-mine demand,” he said.

And US consumers will spend less as a result.“Consumers have been relying on gains in hous-

ing wealth to take the place of regular savings, so the downturn in the housing market is likely to lead to a rebound in the personal savings rate and a corre-sponding slowdown in consumer spending,” Jessop said.

However, investment bank UBS said the sub-prime woes are actually not as bad as the media has portrayed.

“We are certainly not expecting an economy-wide crunch or recession,” UBS economists wrote in a report. “The news coverage [is] disproportionate to the implications for the economy as a whole.”

Hang Seng Bank (0011) chief executive Raymond Or Ching-fai said the subprime crisis could be a blessing in disguise as the US Federal Reserve may consider lowering interest rates earlier than the mar-ket had forecast.

“If the United States cuts its rates, homebuyers in the country may have greater power to repay their home loans,” Or said.jeffrey.tam@singtaonewscorp.com

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Monday, March 19, 200706 Monday, March 19, 2007 07

Subprime mortgage firmS in the United States, which have cornered a fifth of the home-loan market, have sudden-ly become famous – or infamous – among policymakers, regulators and

Wall Street as declining home affordability has put many of these lenders at death’s door.

At least 30 subprime mortgage companies have closed down, reduced their workforce, or sought ad-ditional capital to maintain operations. Some have been asked by the New York Stock Exchange to de-list, while others are filing for bankruptcy protection as they lack the resources to repay loans to financial institutions.

New Century Financial Corp, one of the largest subprime mortgage lenders in the United States, said it owes creditors about US$8.6 billion (HK$67.08 billion).

The troubled industry sparked concerns of a credit crunch in the world’s largest economy, send-ing the Dow Jones Industrial Average plummeting 242.66 points March 14. Contagious to the trading gloom in the United States, the Hang Seng Index fell up to 594.63 points the same day.

Former US Federal Reserve chairman Alan Greenspan said he expects fallout from the subprime mortgage crisis to spread to other parts of the econo-my, especially if residential property prices decline.

The subprime mortgage concept is much more complicated than conventional mortgages. It is also the riskiest part of the home-loan industry, which is exactly why even the big smart firms on Wall Street,

Alan Greenspan fears fallout from the subprime mortgage crisis in the United States

will spread to other parts of the economy, writes Jeffrey Tam

Housing starts in the United States may fall as mortgage defaults increase.

DEATH’S DOOR