From the U.S. Government Accountability Office, www.gao.gov Transcript for: Watchdog Report: Defaults and Data Issues in the Nonprime Mortgage Market Audio interview by GAO staff with William Shear, Director, Financial Markets and Community Investment Associated Report Number: GAO-10-805, Nonprime Mortgages: Analysis of Loan Performance, Factors Associated with Defaults, and Data Sources Released on: September 23, 2010 [ Background Music ] [ Narrator: ] Welcome to GAO's Watchdog Report, your source for news and information from the Government Accountability Office. It's September 23, 2010. Nonprime mortgages—the risky home loans that became increasingly common between 2000 and 2006—played a central role in the nation's current financial crisis. A group led by Bill Shear, director in GAO's Financial Markets and Community Investment Team, evaluated the current status of the nonprime mortgage market. GAO's Jeremy Cluchey [assumed spelling] sat down with Bill to learn more. [ Jeremy Cluchey: ] What sorts of mortgages are we talking about when we talk about nonprime mortgages? [ Bill Shear: ] Jeremy, nonprime mortgages fall into two basic segments. One is called subprime mortgages, which are really mortgages that serve borrowers with blemished credit histories. And some of these mortgage products have some risky features to them. The second type are called Alt-A mortgages. And these are mortgages that also have some risky features to them, such as limited documentation of borrower income. [ Jeremy Cluchey: ] And why did GAO choose to focus on nonprime mortgages in this report? [ Bill Shear: ] The surge in foreclosures that began in late 2006, and continues today, was initially driven by nonprime loans. [ Jeremy Cluchey: ] What are some of the factors that your team identified as being influential in a nonprime loan's likelihood of default? [ Bill Shear: ] One thing we're all aware of from our press accounts are states where you've had large declines in home prices, states such as Nevada and Florida. So those locations where you had large downward changes in house prices, there was much greater likelihood of default. Also related to that, loans that when they were written, when the loan to value ratio was high, those loans, for the same reason, they're more likely to end up with what we call negative equity, would end up in default. Some of the mortgages where we see higher rates of default are those where the borrowers have lower credit scores. [ Jeremy Cluchey: ] The role these types of mortgages played in the surge in foreclosures that began in 2006 was well publicized. What did your team find with respect to how these loans have performed since then? [ Bill Shear: ] We continue to see persistent weak performance in these loans. For example, the number of active, nonprime loans originated from 2000 through 2007 that were seriously delinquent increased from 1.1 million loans at the end of 2008 to 1.4 million loans at the end of 2009. In addition, 475,000 nonprime mortgages completed the foreclosure process during 2009. [ Jeremy Cluchey: ] The report mentions some challenges the GAO encountered when trying to find useful data on nonprime mortgages. Can you talk about some of these challenges? [ Bill Shear: ] Yes, Jeremy. That's a very good question. And first, we had to obtain industry data from a private source. Second, not all the nonprime mortgages are covered by this data source. And third, borrower characteristics, such as whether the borrower is a first-time home buyer, is not known from this data source. So, we had tremendous detailed information on the mortgages, but not on the borrowers. These efforts we made to try to merge data sources had challenges of their own that are difficult to overcome. What I'll mention here, is that currently the Federal Reserve Board and others are trying to create data that would be more useful to analyze policy choices and to analyze the performance of these loans. [ Jeremy Cluchey: ] What steps are being taken to address and possibly prevent a recurrence of these ongoing problems in the mortgage market? [ Bill Shear: ] As many know, Congress passed the Wall Street Reform and Consumer Protection Act. And to protect borrowers, it created minimum standards for all mortgages, such as the borrower's ability to repay. And then, this act also created some liability for those whose securitized loans that are considered risky to borrowers. We have a mandate that we have begun work on from the Wall Street Reform and Consumer Protection Act to analyze the impacts of the act on borrowers and the risk faced by borrowers, as well as on the availability of mortgages to different groups of borrowers. [ Background Music ] [ Narrator: ] To learn more, visit GAO's Web site at gao.gov, and be sure to tune in to the next edition of GAO's Watchdog Report for more from the congressional watchdog, the Government Accountability Office.