“There has been a failure in some of the key assumptions which supported our analysis and modelling,” Mr [Ray] McDaniel admits. “The information quality deteriorated in a way that was not appreciated by Moody’s or others.” Mortgage borrowers, in other words, did not behave as expected.
The issue at stake revolves around so-called delinquency rates, the proportion of people who fall behind on their debt repayments. When American households have faced hard times in previous decades, they tended to default on unsecured loans such as credit cards and car loans first ”“ and stopped paying their mortgage only as a last resort. However, in the last couple of years households have become delinquent on their mortgages much faster than trends in the wider economy might suggest. That is particularly true of the less creditworthy subprime borrowers. MoreÂover, consumers have stopped paying mortgages before they halt payments on their credit cards or automotive loans ”“ turning the traditional delinquency pattern on its head. As a result, mortgage lenders have started to face losses at a much earlier stage than in the past.
“In the past, if a household in America experienced financial problems it tended to go delinquent on its credit cards, but kept on paying its mortgage,” says Malcolm Knight, head of the Bank for International Settlements, the central banks’ bank. “Now what seems to be happening is that people who have outstanding mortgages that are greater than the value of their home, or have negative amortisation mortgages, keep paying off their credit card balances but hand in the keys to their house”‰.”‰.”‰.”‰these reactions to financial stress are not taken into account in the credit scoring models that are used to value residential mortgage-backed securities.”