Mortgage rates have held last week’s 6 percent low (also the low for 2006), but there is no follow-through and the market is vulnerable without news of deepening economic slowdown.

The Federal Reserve’s meeting next week will be a non-event (the Fed will stay put at 5.25 percent and say nothing except “wait-to-see”). Housing data due before Christmas might move rates, but the next substantial news will be consumer performance in holiday shopping, which is weeks away. November payroll data came and went this morning without altering anybody’s outlook — pessimists and optimists found whatever they wanted in a modest gain of 132,000 new jobs and unemployment still dead low at 4.5 percent.

As a species, our sense of urgency is calibrated for getting the bear out of the cave, not for the advance and retreat of glaciers.

Observers inside the mortgage industry and out have known for years (five, roughly) that mortgage credit was too easy and defaults deceptively low — easier and lower than ever — and would someday begin to reverse to tight and high. Elders of the tribe remember the last time: after the too-easy Savings & Loan fiasco in the 1980s, it took 10 years before the red lines came off whole states, and low down-payment lending and reasonable underwriting of incomes returned.

When we look back at the fall of 2006, it will mark the moment of another cyclical turn in credit. Housing markets went flat one year ago, and it takes a long time for the absence of magical gains in price to expose the unlucky and the foolish. Today’s higher loan defaults are still far short of normal, and it may take another two or three or four years for the inevitable rise above long-term baseline to crest.

The financial press reports mortgage-credit risk as one huge fur ball, or sub-prime only, and it is not: the risk is in loans with small or no down payments, and in explosive structures. In normal times these segments are small; in the last five years they have grown to something like one-third of new purchase loans (the industry is so fragmented that not even the Fed is confident of the numbers).

Low- or no-down includes: 100 percent piggyback second mortgages, misbegotten versions of the old and reliable FHA, me-too Fannie and Freddie inventions, and most of the sub-prime class. If your home does not gain in value and you get in trouble, you can’t pay the costs to sell. You’re a foreclosure statistic.

The press includes all adjustable-rate mortgages in the explosive-device class, and that’s an error. Most ARM borrowers facing upward rate reset are going to be able to refinance to an affordable fixed — those with equity and good credit. The terminal risk lies in the standard sub-prime loan: little or no equity, poor credit, often weak income, and you get a reasonable interest rate for two or three years, which then adjusts to LIBOR plus 5 or 6 percent. It is not a loan; it’s a suicide pact.

These sub-primes have been around for five years, but closed in hugely increasing numbers, over a half-billion dollars’ worth last year and this. Until this last year, adjusting 5 percent over LIBOR was no big deal: from 2002-2004, Fed-following LIBOR was in the 1 percent range. Now LIBOR is 5 percent, and 5 percent plus 5 percent equals foreclosure.

A rise in default is bad, but the next stage is worse: Wall Street’s rocket scientists, the buyers of all this junk, are just beginning to stumble out of the mortgage laboratory with their eyebrows blown off. One of the big sub-prime providers, Ownit (but not for long), yesterday had its plug pulled by the Street and the surprise instantly re-priced the sub-prime market to higher rates.

That’s the second-stage effect that could deepen or prolong the housing market slowdown: a progressive tightening and re-pricing of credit would reduce the pool of eligible buyers and remove options for defensive refis, which would lead to more defaults, tougher credit, more defaults, and…

Lou Barnes is a mortgage broker and nationally syndicated columnist based in Boulder, Colo. He can be reached at

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