The economy should be able to handle the subprime mortgage meltdown, but the pain will continue into the next decade, CNBC’s Senior Economic Reporter Steve Liesman said Monday.
Citing data compiled by First American, Liesman said there will be about 1.1 million foreclosures over the next six to seven years as adjustable rate mortgages reset to higher interest rates.
"This will involve 13% of all adjustable rate mortgages issued between 2004 and 2006," Liesman said.
That amounts to $326 billion in defaulted debt and $112 billion in lost equity. However, the bad debt represents only about 1% of total mortgage lending in 2004-2006 so it will be manageable for the mortgage industry and the economy as a whole.
But Liesman warned that falling home prices could result in an additional foreclosures. This is because many of the new mortgage loans were written with little or no equity.
"If housing prices fall sharply, a lot of new loans could wind up underwater and in foreclosure," Liesman said.
According to the data, about 2% of all new loans written were based on no equity and 3.2% were based on less than 10% equity in 1990. But underwriting standards became more liberal over time, and by 2006, 17.6% of new loans were written based on zero equity and 38.6% were based on equity of less than 10%.
Those standards could change again and will result in fewer people being able to get mortgage loans.
According to Cassaday & Co.'s Barry Glassman, the wave of trouble could begin next month, when the mortgage market sees the largest adjustment for homeowners with three-year adjustable-rate mortgages.
"Those who locked in an ARM in April of '04, will actually see their interest rate increase over 100% if interest rates stay where they are today," Glassman told CNBC.
Michael Youngblood, a portfolio manager at FBR, expects default rates on subprime mortgages to rise to 11% by the end of this year. If it does, that rate would be "significantly higher" than the rate of default during the 2000 recession, he said.
"This reflects the liberal underwriting practices of the past year," Youngblood said. He explained that subprime mortgage lenders provided loans to borrowers with "radically weaker" credit histories and lower credit scores last year in an attempt to boost profitability.