It's very real, not some remote possibility, and you will see the macroeconomic effects very, very soon. ALL THE RATES CUTS IN THE WORLD BY THE FED WILL NOT EASE THIS LOOMING CRISIS WHATSOEVER. This fallout will be immense. http://www.bloomberg.com/apps/news?pid=20601109&sid=aX74xQnVfBfI&refer=home Exploding ARMs Roil Bernanke's Drive to Calm Markets (Update3) By Bob Ivry and Jody Shenn Feb. 7 (Bloomberg) -- Joe Ripplinger took out a $184,000 mortgage in 2006 and makes his payments every month. Now he owes $192,000. The 66-year-old Minneapolis house painter has a payment- option adjustable-rate mortgage. It allows him to write a check for $565 a month even though he owes $1,300. The difference is added to the mortgage, and when his total debt reaches $212,000, or after five years have passed, he said his monthly minimum could jump to about $2,800, which he can't afford. ``We're barely making it right now,'' Ripplinger said. The estimated 1 million homeowners with $500 billion of option ARMs are beyond the help of interest-rate cuts by Federal Reserve Chairman Ben S. Bernanke. While subprime borrowers face an average increase of 8 percent or less when their adjustable-rate mortgages reset, option ARM homeowners may see their monthly payments double after their adjustments kick in. ``We call them neutron loans because they're like a neutron bomb,'' said Brock Davis, a broker with U.S. Express Mortgage Corp. in Las Vegas. ``Three years later the house is still there and the people are gone.'' Once option ARM borrowers' loan balances reach a predetermined limit, called a negative amortization cap, usually 110 percent to 120 percent of the mortgage amount, their payment rates immediately increase. They also automatically shoot up after five years. Otherwise, increases typically are capped at 7.5 percent of a borrower's initial payment per year. One in Five ``These could be called long-fuse, exploding ARMs,'' said Kathleen Keest, former assistant Iowa attorney general and now senior policy counsel at the Center for Responsible Lending in Durham, North Carolina. ``I've heard people say they are the most complicated product ever offered to consumers. They are the real liar loans.'' The loans accounted for 8.9 percent of the almost $3 trillion in U.S. home loans made in 2006, up from 8.3 percent in 2005, according to an estimate by industry newsletter Inside Mortgage Finance. Originations of option ARMs fell 50 percent during the first nine months of last year, the newsletter says. One in five option ARMs packaged into bonds last year required less than 10 percent down payment and no proof of a borrower's income, according to a Jan. 22 report by New York-based analysts at UBS AG, Europe's largest bank by assets. Two percent required no down payment at all from the borrower, the analysts said. Better Scrutiny Delinquency rates on option ARMs tend to be low in the early years, misleading some investors to think they will remain safe, said Sean Kirk, a debt trader at Seaport Group LLC, a New York- based securities firm focused on bonds of distressed or restructured companies. Four types of borrowers typically get option ARMs. Speculators, who plan to sell the property quickly, made up 12 percent of all option ARMs packaged into bonds last year, according to UBS. That included only borrowers who identified themselves as investors and not residents, who get lower mortgage rates. Wealthy people have used the loan for its flexibility, according to Thornburg Mortgage Inc. in Santa Fe, New Mexico. The rest either took out the loans as an ``affordability'' product to buy more expensive homes, according to Standard & Poor's, or borrowers may have been misled about the terms, according to federal bank regulators. Minnesota Legislation ``I never heard of a payment-option ARM before,'' said Ripplinger, the Minnesota borrower. ``We thought they were putting us on a 30-year fixed. They didn't put us on a 30-year fixed. I believe that's why a lot of people are losing their homes now.'' Minnesota passed legislation in August requiring mortgage brokers to act in borrowers' best interest, a law that may have made Ripplinger's mortgage illegal, said Brandon Nessen, executive director of Minnesota ACORN, a housing activist group in St. Paul. ``You can't make a loan that puts someone in a worse position than they were in before,'' Nessen said. Sophisticated borrowers can take out option ARMs and avoid problems, said Ira Rheingold, executive director of the National Association of Consumer Advocates in Washington. It's just that mortgage sellers marketed them to people who didn't understand the terms and couldn't afford them, he said. `Cheat People' ``It was used to cheat people,'' Rheingold said. ``It helped artificially keep housing prices higher than they should have been.'' Delinquencies of more than 90 days on option ARMs increased to 5.7 percent in the fourth quarter from 0.6 percent in the same period of 2006 on loans held by Countrywide Financial Corp., the Calabasas, California-based company said in a regulatory filing last week. Lenders hold loans in their portfolios when they don't bundle them into securities for sale to investors. Countrywide had $28.3 billion in option ARMs in portfolio at the end of October, according to Inside Mortgage Finance. The only banks with more were Charlotte, North Carolina-based Wachovia Corp., with $117.8 billion, and Seattle-based Washington Mutual Inc., with $57.9 billion, according to the Bethesda, Maryland- based newsletter. Option ARMs, which can adjust monthly, are more attractive for banks to keep in portfolio than fixed-rate loans because they adjust at the same time as savings accounts and other deposits used to fund the loans. Staying Current Countrywide wrote down the value of $35 million of the loans in the fourth quarter, up from $1 million a year earlier, according to a regulatory filing. The company agreed to be acquired by Charlotte-based Bank of America Corp., after losing as much as 89 percent of its market value. Wachovia-originated option ARMs were higher quality than other companies' option ARMs, Chief Executive Officer G. Kennedy Thompson said in a Jan. 30 conference call. That's because the bank made sure borrowers could stay current on monthly payments at the reset amount, not just the teaser interest rate, which can be as low as 1 percent, he said. That was a standard that regulators, including the Fed, recommended in 2006 after the total U.S. foreclosure rate climbed to a five-year high. It has since surged to the loftiest level since at least World War II, according to data compiled by the Washington-based Mortgage Bankers Association. Tougher lending guidelines have made it more difficult to refinance into new option ARMs. Regret Making Loans ``The option ARM volume that was done was part of the excess,'' IndyMac Bancorp Inc. CEO Michael Perry said in a telephone interview from his office in Pasadena, California. IndyMac, the second-largest independent U.S. home lender, made $43 billion of the loans from 2005 through the third quarter of 2007. ``Obviously we've been through what we've all been through, there's many things we regret,'' Perry said. IndyMac no longer makes the loans because mortgage-bond buyers aren't interested, he said. Washington Mutual also is no longer issuing option ARMs, CEO Kerry Killinger said on a conference call last week. The company's unpaid principal balance of option ARMs exceeded their original principal amount by $1.73 billion at the end of 2007, almost double the $888 million of a year earlier, Washington Mutual reported on Jan. 17. Regional Banks Regional banks are feeling the effects of option ARM delinquencies, said Andrew Laperriere, managing director of New York-based research firm International Strategy & Investment Group. FirstFed Financial Corp., the Santa Monica, California-based savings and loan whose net income slumped 75 percent last quarter, blamed option ARMs hitting their negative-amortization caps for higher delinquencies. More than 1,800 of its borrowers hit the limits, and 2,400 more may this year, the company said Jan. 25. Laperriere estimates that 85 percent of option ARM borrowers owe more than their original loan balance. ``The problem is, you can refinance an option ARM to a 30- year conventional loan at a 5.5 percent interest rate, and you're still looking at your payment going up 150 percent,'' Laperriere said. ``That's pretty ugly.'' About $460 billion of adjustable-rate mortgages are scheduled to reset this year, with the next spike in resets coming in 2011, when $420 billion in mortgages will adjust to new interest rates for the first time, according to New York-based analysts at Citigroup Inc. That's the year that Joe Ripplinger's payment will jump, provided he doesn't reach his negative amortization cap before then. ``It's the worst thing we could have done,'' he said.