In A Credit Crisis, Large Mortgages Grow Costly

When an investment banker set out to buy a $1.5 million home on Long Island last month, his mortgage broker quoted an interest rate of 8 percent. Three days later, when the buyer said he would take the loan, the mortgage banker had bad news: the new rate was 13 percent.

I have been in the business 20 years and I have never seen such a big swing in interest rates, said the broker, Bob Moulton, president of the Americana Mortgage Group in Manhasset, N.Y.

There is a lot of fear in the markets, he added. When there is fear, people have a tendency to overreact.

The investment bankers problem was that he was taking out a so-called jumbo mortgage — a loan greater than the $417,000 mortgage that can be sold to the federally chartered enterprises, Freddie Mac and Fannie Mae. The market for large mortgages has suddenly dried up.

For months after problems appeared in the subprime mortgage market — loans to customers with less-than-sterling credit — government officials and others voiced confidence that the problem could be contained to such loans. But now it has spread to other kinds of mortgages, and credit markets and stock markets around the world are showing the effects.

Those with poor credit, whether companies or individuals, are finding it much harder to borrow, if they can at all. It appears that many homeowners who want to refinance their mortgages — often because their old mortgages are about to require sharply higher monthly payments — will be unable to do so.

Some economists are trimming their growth outlook for the this year, fearing that businesses and consumers will curtail spending.

In the last 60 days, weve seen a substantial reduction in mortgage availability, said Robert Barbera, the chief economist of ITG, a brokerage firm. That in turn suggests that home purchases will fall further. Rising home prices were the oil that greased the wheel of this engine of growth, and falling home prices are the sand in the gears that are causing it to grind to a halt.

At the heart of the contagion problem is the combination of complexity and leverage. The securities that financed the rapid expansion of mortgage lending were hard to understand, and some of those who owned them had borrowed so much that even a small drop in value put pressure on them to raise cash.

You find surprising linkages that you never would have expected, said Richard Bookstaber, a former hedge fund manager and author of a new book, A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation.

What matters is who owns what, who is under pressure to sell, and what else do they own, he said. People with mortgage securities found they could not sell them, and so they sold other things. If you cant sell what you want to sell, he said, you sell what you can sell.

He recalled that the crisis that brought down the Long-Term Capital Management hedge fund in 1998 started with Russias default on some of its debt. Long-Term Capital had not invested in Russias bonds, but some of those who owned such bonds, and needed to raise cash, sold instruments that Long-Term Capital also owned, and on which it had borrowed a lot of money.

It appears that in this case, securities backed by subprime mortgages were owned by people who also owned securities backed by leveraged corporate loans. With the market for mortgage paper drying up, and a need to raise cash, they sold the corporate securities and that market began to suffer.

The Wall Street investment banker who wanted a jumbo mortgage had a good credit score, and is not a subprime borrower. But private mortgage securities are now hard to sell, leading to his problem. In the end, he was able to get a mortgage with a lower interest rate, but it will adjust in five years, possibly to a much higher level.

The size of the rate increase he faced is unusual. But all jumbo lenders have raised rates. Bankrate.com reports that conventional 30-year mortgages cost about 6.23 percent now, less than they did a few weeks ago, due to a decline in Treasury bond rates. But the average jumbo rate is now 6.94 percent. The spread between the two rates rose from less than a quarter of a percentage point to more than two-thirds of a point.

Jumbo mortgages are most important in areas with high home prices, most notably on the East and West coasts. In California, it has shut down the purchase market, said Jeff Jaye, a mortgage broker in the Bay area. It has shut down the refi market.

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