Subprime Risks

Subprime woes: How far, how wide

Problems in lending to home buyers and owners with less than top credit becoming big threat to the markets - and the economy.

By Chris Isidore, CNNMoney.com senior writer; March 5 2007: 1:03 PM EST

NEW YORK (CNNMoney.com) -- Lending to home owners and buyers without good credit has suddenly become a very bad business, and possibly a very big problem for the U.S. economy as a whole.

The sector is known as subprime mortgages, which pumped $640 billion into the economy through financing home purchases and refinancings in 2006, according to trade publication Inside B&C Lending. That's nearly twice the level of this kind of lending seen as recently as 2003.

But experts in the field see bankruptcies and a sharp decline in this type of lending in 2007, due to rising delinquencies and defaults by borrowers, and proposals to toughen lending standards and regulation. That's sending shares of some major financial firms sharply lower Monday.

"Everyone in the subprime sector this year is going to lose money," said Bose George, analyst with Keefe, Bruyette & Woods, a Wall Street firm specializing in banking and finance. "They're getting squeezed on all sides. Going into the year, we were looking for a decline of 15 percent, but clearly now that is far too low. It's now looking like a 25 to 30 decline."

The biggest drop came at New Century Financial (Charts), the No. 2 subprime lender according to Inside B&C Lending. Its shares lost more than half their value Monday after the company said in a filing late Friday that its outside auditor KPMG had informed it that it now believed there was substantial doubt about New Century's ability to continue as a going concern.

But other lenders in the sector also got hit, including Fremont General Corp. (Charts), which tumbled some 25 percent after it announced it would exit the subprime sector.

It's not just smaller banks and financial services firms that play in the subprime sector, thought.

Among the leaders in subprime mortgage lending in the United States are of the nation's biggest financial services firms, including units of HSBC (Charts), General Electric (Charts) and Citi (Charts).

Some economists say that choking off more than $100 billion in home financing will cause problems for real estate and home prices overall by keeping some buyers out of the market, and forcing some current homeowners to sell or face foreclosure.

"People who a year ago could have purchased a house with a subprime mortgage aren't going to be able to purchase," said Paul Kasriel, chief economist with Northern Trust in Chicago. "Increased foreclosures will mean more inventory on a market that already has a glut of homes for sale."

And Kasriel said the additional hit to real estate from the subprime meltdown is likely to mean serious problems for the economy overall.

"Housing has played a very large role in this expansion and one of the reasons it's played that role is there has been a change in the mortgage market," he said. "This has been a credit-induced housing boom that lifted other sectors of the economy and it's all in reverse now."