Friday, March 23, 2007

Sub Prime and the WSJ

Yesterday the Wall Street Journal ran an article titled "Finding A Mortgage in Tougher Times" and started out with this arresting paragraph:

'Just two days before Shari Scott and her family were supposed to move into their new home, her loan officer at New Century Financial Corp. called her with some bad news: The company wasn't going to be able to lend her the money for her mortgage after all.

"I literally stopped the car and threw up," says the 30-year-old accountant from Burleson, Texas, who got the news on her cellphone while driving home from work this month. By that point, she already had the mortgage title papers in hand and was supposed to close on the loan the next day. "Homeless was the first thing that went through my mind," she says.

Later in the article they provided a "happy" ending to the story:

Ms. Scott was able to arrange a new subprime mortgage, but the monthly payment was several hundred dollars more than the New Century loan.

Traditional Journalism - Missing The Point:

From the perspective of "classic" journalism - this is a perfect story. A business event looms that is abstract - the fall of the subprime loan market and New Century Financial is on the edge of bankruptcy. The intrepid reporter went out and found the "human" touch - someone who embodied the issue at hand - and then a gold mine! The person said they opened their car and vomited when their mortgage was rejected (due to New Century's crisis). Finally, the protagonist, Ms. Scott, had a happy ending when she received another loan. A gold star for this reporter, right???

The real story is something else entirely:

1) New Century Financial's problems stopped Ms. Scott from signing up for a dubious product, inappropriate for her, that she probably barely met the qualifications to receive
2) Her loan being rejected SHOULD HAVE been a blessing in disguise... a chance to re-evaluate her reasons for purchasing the house and how it will impact her financial picture. The fact that she contemplated homelessness because she couldn't pick up a sub-prime mortgage doesn't paint a pretty picture of financial health
3) Look at the sad ending. The only thing lousier than the sub-prime loan that she failed to get was the WORSE sub-prime loan the she picked up, instead, costing her several hundred dollars more each month
4) and even though the housing market is cratering, Ms. Scott just barely crept in under the wire, managing to purchase a house at the peak of the bubble market, virtually guaranteeing little or no price appreciation for the next five years or so

The sub-prime mortgage market is complex. There are products that are interest only, meaning that every payment doesn't dent the principal for a period of time. Some of these interest only mortgages DON'T EVEN COVER THE INTEREST, meaning that the balance is actually growing while people are making payments. Virtually all of these products have almost nothing down, so there is very little equity in the home, meaning that as soon as prices dip even a little the borrower is underwater.

It is hard to think of who these loans are appropriate for. If you don't have money for a down payment, then you probably shouldn't be buying a house. If you can't afford a payment that is part interest and at least reducing the principle a bit, then you shouldn't be buying that house (maybe a smaller one is better for you). About the only situation I can think of is when someone is an investor and wants to buy a house, pay minimum payments, fix it up, and "flip" the house in a short period of time. This is a "gambler" mindset, and it can certainly work well, in some circumstances, but it doesn't sound like Ms. Scott's situation.

The sub prime market is a new creation, and one that is unlikely to be as robust after the current shake out. Many of these fringe borrowers will go bust as soon as price appreciation ceases and about a year passes, and the market will be overloaded with cut-rate homes. These homes will put pressure on other marginal borrowers, and lead to tough times. Meanwhile, the originators of the mortgages, companies like New Century Financial, will go belly up when they are forced to take back the terrible loans they originated. These problems which stemmed from poor regulation will likely be fixed and credit standards will be tightened, as well as standards for loan originations (i.e. get rid of the fly-by-night companies).

That is the real story... poor Ms. Scott had her chance, but doubled down on the wrong plan. Too bad the WSJ didn't catch it.


Dan from Madison said...

I will add one more - with the tightening of credit the overall demand for houses will go down over the next year or two, making prices go down even further. Truly a buyers market.

Jonathan said...

Your post describes, in a nutshell, the flaws of conventional journalism: everything gets forced into a simplistic story template; important details that don't fit the template are ignored; reporters are often inexperienced generalists who lack the interest or ability to make sense of complex or specialized issues.

Carl from Chicago said...

Your comment sums up the situation very well. This is where bloggers can excel if they write about topics where they have comprehensive knowledge.

Probably the reason that journalists are able to get away with it is that they write for a general audience that knows even LESS about the topic at hand, and if they go into more subtle points or points that aren't "on topic" they will lose their "base" audience.

Probably this is why we get 100-200 hits / day :)

Frank Borger said...

Actually the reporter has a real problem. They have to reduce a story to maybe 10 inches of column. Maybe more in a Sunday Suppliment, but that's all.

This post would never make it in a paper, it's too long. It's beyond the attention span of the typical paper reader.

Come to think of it, a course in the economics of papers / magazines might be in order.