One Economist Sees Potentially Big Risks From 'Exotics'

Register now

At least one credit union economist is suggesting there are even greater risks in the 2006 mortgage market than some might believe. And the problems could start in his home state.

"The risks are very big right now," said Dwight Johnston of WesCorp. "The biggest plus in our economy has been the mortgage market, so it will be a big deal if that falls. Even if it just flattens, there will be economic fall-out."

Johnson cited a recent study that suggests the mortgage market has fueled the creation of about 800,000 jobs over the last three years, so a problematic mortgage market could be felt in unemployment numbers for example.

"The exotic loan is mostly a coastal experience, and particularly in California," Johnston noted. "These loans were made possible because there were investors out there willing to take on the added credit risk as they were reaching for yield because they felt like the underlying credit would improve. No lender will do these loans without those investors out there, and the investors have had enough."

The problem is, a lot of that paper is already out there, Johnston offered. "We're seeing an alarming rise in defaults on paper issued in 2003, and that tells us that, sure enough, they can't make that first interest-adjusted payment," he explained. "This is a far greater issue on the coasts than in the heartland, and I don't believe a lot of credit unions have jumped on board with these types of loans. But if they did, and then offered a home equity loan to those same members, the credit union could be on the hook."

The real issues for those consumers who got into these loans is what won't be available to them when they realize they are in too deep: lenders willing to settle up with them.

"In the past, lenders would work with the borrowers when they got into trouble to try to keep them from defaulting," he commented. "But most of these loans have been sold off, so there is no lender, in the traditional sense, for the borrower to try to work with."

And while many economists are optimistic about the strength of the economy, Johnston suggested that strength is based on a "shaky foundation" that could be a problem if the U.S. were to take any sort of hit.

"We're still somewhat optimistic about the strength of the economy, at least in the first six months of 2006," Johnston offered, "but the odds have increased that something drastic could transpire. It's still less than 50/50, but I would say that over the last 18 months, the odds have increased."

And oddly enough, something that was designed to help credit unions and other lenders when a loan goes south could actually end up hurting them: the bankruptcy reform law.

"The new bankruptcy laws, which financial institutions cheered so hard for, are not going to help," Johnston suggested. "It used to be that if you were going to file bankruptcy, you'd still work hard to keep your mortgage current and then write-off your credit card debt, for example. That's going to be a whole lot harder to do now."

Though Johnston's predictions were bleaker than his counterparts at CUNA, CUNA Mutual and NAFCU (see related story, page 1), he agreed that it would still take a lot of different things to all go wrong before anything truly dire would happen to the economy, and even though he doesn't see anything drastic on the horizon, he cautioned that sometimes these things come from out of nowhere.

"Look at what happened to the NASDAQ in March of 2000," he related. "There was no event that caused that sell-off, but suddenly, the market was for sale, and it had a snowball effect."

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER