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Prime Home Loans

Written By Brian Hicks

Posted June 2, 2009

Calling an end to our current bear market is as premature as Jim Cramer’s calling an end to the depression fears.

Unemployment will continue to climb. Consumer spending will suffer. And housing is only expected to worsen as more resets rear their ugly heads.

Just ask Meredith Whitney. . .

Whitney recently reiterated her bearish position on the financial sector and the overall economy. While some are forecasting recovery in 2009 or 2010, she (and we) believes banks have still not "properly reserved against greater than expected losses in home prices."

Still, if the "geniuses" of Wall Street want to draw this "end of crisis" conclusion, that’s just great. We can then stop the bailouts, stop flooding the market with cheap money, and leave banks to live or die. Sounds great to me.

And if you believe the worst is over, that’s fine. But be warned, the next leg of the crisis is upon us.

Prime Loan Defaults Have Only Begun to Mount

Truth be told, when it comes to an "improving" housing market, ignore the mainstream press and Wall Street hot shots that would have you believing in a bottom or the illusion of strength. We’re still nowhere near the bottom.

Yep, with surging unemployment, the foreclosure crisis can no longer be blamed on ARM loans, particularly subprime. For the first time, fixed-rate prime loans — those given to people with good credit — accounted for the largest share of foreclosures in Q1, according to the Mortgage Bankers Association.

Nationally, about 29% of the foreclosure proceedings that began in the first three months of the year involved prime loans. That’s up from 25% in Q4 2008 and 19% about a year ago.

And it’ll only get worse before improving.


Yep, after suffering through subprime fiascos, we’re now left to deal with Option ARM resets and prime loan defaults that have only begun to mount.

Here’s what we still have to look forward to:


Prime Borrower Chart

We can’t just worry about subprime and Alt-A anymore. We have to worry about prime, too.

Morris A. Davis, a real estate expert at the University of Wisconsin just may have hit the nail on the head with his comment, "Foreclosures were bad last year? It’s going to get worse."

Just as we’ve been warning, the next phase of the real estate disaster is upon us. It’s only shifted from subprime to Alt-A to prime. And with many economists (including the New York Times) predicting unemployment’s rise from 8.9% into the double digits, foreclosures will only accelerate. . . which will add to bank losses. . . which will add pressure to the financial system and broader economy.

Here’s more from the New York Times article:

"We’re right in the middle of this third wave, and it’s intensifying," said Mark Zandi, chief economist at Moody’s, according to the article. "That loss of jobs and loss of overtime hours and being forced from a full-time to part-time job is resulting in defaults. They’re coast to coast."

"From November to February, the number of prime mortgages that were delinquent at least 90 days, were in foreclosure or had deteriorated to the point that the lender took possession of the home increased more than 473,000, exceeding 1.5 million, according to a New York Times analysis of data provided by First American CoreLogic, a real estate research group. Those loans totaled more than $224 billion.

During the same period, subprime mortgages in those three categories increased by fewer than 14,000, reaching 1.65 million. The number of similarly troubled Alt-A loans — those given to people with slightly tainted credit — rose 159,000, to 836,000.

Overall, more than four million loans worth $717 billion were in the three distressed categories in February, a jump of more than 60 percent in dollar terms compared with a year earlier."

Why Credit Cards Will Fall, too

As the unemployment rate mounts, so will credit card defaults.

Experts are predicting millions of Americans will not be able to pay credit card debts, leaving a big hole for troubled banks trying to recover.

Worse, the bogus stress tests released suggested the banks could "expect nearly $82.4 billion in credit card losses by the end of 2010 under what federal regulators called a ‘worst case’ economic scenario," according to the New York Post.

However, if unemployment rates hit 10%, defaults could explode. At American Express and Capital One, for example, about 20% of the credit card balances are expected "to go bad this year and next," according to the stress tests. As for Bank of America, Citigroup, and JP Morgan Chase, we’re talking about 23%.

And the last thing the financial sector needs to feel is a further squeeze, as Americans have accumulated some $970 billion in revolving consumer debt since the end of September 2008, up 3.4% from the close of 2007.

Sure, the credit card industry is typically resilient during our economic slowdown, thanks to pricing flexibility. And the assumption is, as the economy sours and consumers become late on payments, credit companies can boost earnings through late fees and higher interest rates. But that may not be the case, as the Obama Administration looks to overhaul the industry.

Defaults are growing. Charge-offs have been pushed well beyond expectations. And losses are far out-pacing what companies were hoping to account for with extra card fees and higher interest rates.

And despite the recent rally in financials, nearly all credit card lenders are facing mounting losses as more of their customers fall behind on payments or default on loans. According to

As unemployment has risen sharply, credit card defaults have also climbed. During recessions, credit card losses tend to closely mirror unemployment rates, though some analysts now believe default rates will move even higher than where unemployment rates might peak in the coming quarters.

It’s already happening at Citigroup. The company’s 10.2% credit card charge-off rate for Q1 has already broken the correlation to unemployment and shows no signs of improvement.

The outlook is so bad that Advanta Corporation is shutting down accounts for one million customers next month as the recession pushes default rates even higher. Lending will draw to a close on June 10, 2009, as part of a plan to preserve capital now that uncollectable debt has reached 20%.

As a result, major credit card issuers have been approving fewer applicants, lowering credit lines, and closing out unused accounts. Even Meredith Whitney expects for lenders "to cut the lines of credit they extend to borrowers by a total of $2.7 trillion through 2010. That is equivalent to a 57 percent reduction in the credit they made available two years ago at the height of the boom," says the New York Post.

Things are bad. And they’ll only get worse for credit issuers like American Express and Capital One. But we’ve been saying that since late last year.

Housing still has a ways to drop before bottoming. And credit cards are teetering.

Good Investing,

Ian L. Cooper

P.S. My readers have already banked hundreds of percentage points playing this extended crisis and the intermittent rallies. We banked over 57% shorting treasuries this month. Credit cards and prime loans are next. Click here to make sure you get in on my next wining play. . . and the 49 I’m guaranteeing after that.