Default

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Loans fall into default, also called delinquency, when borrowers stop making their scheduled payments, and the risk that they will default is usually priced into the borrowing cost. A spike in default on U.S. subprime mortgages in 2007 helped tip the mortgage market into decline and exacerbated the credit crisis.

The Roots

Early signs of the current credit crisis emerged in April 2007 when U.S. mortgage default rates hit an all-time quarterly high of 2.87 percent and rose in 44 of the 50 states.[1] Subprime mortgage defaults peaked one year later to 12 percent, while mortgage defaults on prime loans doubled to 2.7 percent in the same period.[2] That initial wave of mortgage defaults began cresting in mid-2008 but a second wave is expected over the next year or two as interest rates on prime loans rise and credit tightens further.

Default rates during the expected second wave of mortgage delinquencies are expected to be higher than in the first deliquency wave that began in early 2007. This after the IMF released a report in October 2008 showing U.S. mortgage writedown estimates up to $1.4 trillion from $945 billion six months earlier.[3]

Blue Chip Defaults?

In mid-late 2008 the costs of derivatives known as credit-default swaps, which essentially insure creditors against a borrower defaulting on its bonds began rising even on the bonds of large corporations with triple-A credit ratings. Latest victim was financial-services giant GE Capital, where the annual cost per year to insure $10,000 worth of their bonds for five years recently jumped to $680.[4] Exposure to credit default swaps have been partially blamed for the collapse of several investment banks during 2008.

References

  1. US mortgage default rates hit an all-time high in the first quarter of 2007. FinFacts.
  2. Housing Lenders Fear Bigger Wave of Loan Defaults. New York Times.
  3. US mortgage losses hit $US1.4 trillion. The Age.
  4. GE Capital Default Risk Soars. Seeking Alpha.