Now even mainstream media and mainstream analysts regularly speak of the sub-prime “meltdown” or “carnage” and refer to these sub-prime mortgages as “garbage” or “trash”. Since most of these sub-prime mortgages were junk that should have never been originated in the first place, now the new spin in financial markets is to minimize the nature of the problem by making two arguments: first, sub-prime loans are only a very small fraction of the housing market, specifically only 6% of it; second, sub-prime problems are a niche problem that is not affecting other parts of the mortgage market. Both arguments are utter spin without any basis. Let us see why.

Where did the Mortgage Bankers Association (MBA) get the “sub-prime is only 6%” figure that it is spinning around in every possible media? Their trick is to consider all homeowners, even the 35% of homeowners who do not have any mortgage and then argue that only 6% of homeowners are sub-prime borrowers. Why is this spin and why is the actual figure for “garbage” mortgages actually closer to 50% of the flow of new mortgages in 2005-2006 rather than the “6%” being spinned around? Several reasons.

Let me elaborate:

1. Sub-prime are now 13% of the stock of mortgages, not 6%.
2. Sub-prime mortgages were at least 20% of mortgage originations in 2005 and 2006.
3. The same “monster” lending practices used for subprime mortgages were also used for most “near-prime” and “prime” mortgages.
4. Many pseudo “near-prime” mortgages (such as Alt-A) are undistinguishable from sub-prime ones and have now sharply rising default rates
5. What is defined as sub-prime is subject to highly cosmetic accounting by banks: the rule that FICO scores of 660 or below are sub-prime is often diluted down to 630 or even 620 to exclude many mortgages from a sub-prime classification.
6. Counting all of the categories above, subprime-like mortgages accounted for almost 50% of all originations in 2005 and 2006 not the 6% figure spinned by the industry lobbies.

So whenever you hear the spin about the sub-prime meltdown not being such a big deal as “sub-prime mortgages” are only 6% of the housing market beware of such misleading spins. Properly measured sub-prime and near sub-prime and effectively sub-prime (because of creative accounting) mortgages accounted for almost 50% of all originations last year. So the mountain of “garbage” and “trash” that has been piling up in this sub-prime carnage includes a good half of new mortgages created in recent times. And the meltdown of these mortgages – both those that are formally sub-prime and those that are effectively sub-prime – will create a massive credit crunch in short order. At the end of the day “garbage” is garbage, whatever you name it. What is labeled as “Prime Garbage” stinks as much as the “Subprime Garbage”. And if it walks, ducks and quacks like garbage it passes the smell test of being garbage. Some of that garbage may rot more or faster than the rest but the overall state of the mortgage and housing market is the worst in decades.

Also, note that with new home sales down 16.4% in January ( the biggest drop since 1994 as reported today) and housing starts down another 14% in January alone, both the demand and the supply side of the housing market are in literal free fall and collapse. The only things that are mushrooming in the housing market are cancellations (in the 30 to 40% range for major home builders) and the stock of unsold new and old homes that is at historically unprecedented highs. All this means home prices headed sharply south in the months ahead. As I argued last summer (see here and here and here) this is the worst housing recession in the last five decades. In a long paper with Christian Menegatti that I will publish next week I will flesh out in much detail the arguments on why the housing recession is nowhere close to bottoming out and why the housing recession will get much worse before it reaches any bottom.

Instead, let me now go into some more detail about each of the above monstrosities on how "sub-prime" mortgages are measured and why the "garbage" in mortgages is closer to 50% of recent mortgages rather than 6%.