Economic Neutron Bomb You Should Have All Seen Coming: Interest Rate Cuts Won't Help

Discussion in 'Wall St. News' started by ByLoSellHi, Feb 7, 2008.

  1. It's very real, not some remote possibility, and you will see the macroeconomic effects very, very soon.


    This fallout will be immense.

    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.
  2. Brandonf

    Brandonf ET Sponsor

    There is right now a liquidity crisis, but its going to turn into a solvency crisis as everyone just walks away from their house. A lot of people have been pointing this out for a good bit of time though, of course your usual cast of permabears, but also anyone who's just a bit of a thinker. Anyway, it will get uglier before it gets better.
  3. Ive been short for over a week plus. Positions are back to being deep in the profits....however, I don't like the signals from the last two days. The market is either trying to base for a move higher of it is consolidating for a move lower..

    To me its a 50/50 shot. I would not add more shorts nor will I cover.

    The Econ news is not built in. A surprise rate cut is doubtful but more cuts are for sure.

    We need to break through the 12200 and head down to 11500. I will cover all my Financial, Blue Chip shorts if we do not push through 11500 after testing.

    I may add if we sell off more but bounce a little.

    At this point, its all grey. Recession is already agreed upon. Now, lets sit back and see what layoffs are coming.

  4. Solvency is not an issue and will not be...

  5. These ARMS should be converted to 40 year fixed. this will save the banks lots of trouble.
  6. toc


    Only idiots will overspend and underpay their mortgage and eventually fall prey to the foreclosures and mortgage sharks. ONLY IDIOTS!
  7. you'd be surprised how much damage 1 million idiots can do.
  8. MattF


    "Never underestimate the power of human stupidity."

    Even if the bank project is only converting those *currently* behind....can't imagine others like the above that'll eventually fall behind in the next year, 2 years, then the reset point in 3...long after this project is in the works/done when everyone forgets about it.
  9. If rate cuts don't help and have ZERO EFFECT as you say, then how do you explain why 15y and 30y mortgage rates are down big time on average over the last 6 months:
  10. mak, please. Don't be naive enough to claim mortgage rates are indicative of anything other than fudged government policy and lack of economic clarity.

    Also, tell your story to those who have ARMs resetting HIGHER.

    Americans Selling Homes Find Prices Sink Below Mortgage Values

    By Kathleen M. Howley

    Feb. 13 (Bloomberg) --
    When Mary Kamanu paid $409,000 for a house in Folsom, California, she never imagined that three years later it would be worth about 20 percent less and she would have to pay the bank more than $80,000 just to sell the place.

    ``I'm completely upside-down on my mortgage, like a lot of people,'' said Kamanu, who wants to move 12 miles away to live with her fiancé in a suburb of Sacramento. ``I know I'm going to have to come up with a big chunk of change.''

    By the end of this year as many as 15 million U.S. households may owe more on their mortgages than their homes are worth, according to an estimate from Jan Hatzius, chief U.S. economist of New York-based Goldman Sachs Group Inc. That may fuel an increase in foreclosures, erode prices, and increase mortgage bond losses, he said in a Feb. 1 report.

    ``If borrowers who are underwater go into foreclosure, the properties are likely to be sold at discount prices and will further depress the price of housing,'' said Robert Engle, a Nobel laureate in economics who teaches at New York University's Stern School of Business in Manhattan. ``It becomes a spiral.''

    Thirty-nine percent of people who purchased a home two years ago already owe more than they can sell it for, according to a Feb. 12 report from, a real estate data service. Only 3.2 percent who bought five years ago are in that situation, the report said.

    Home prices probably will decline 4.5 percent this year and 2.6 percent next year after falling 2.2 percent in 2007, according to Fannie Mae, the world's largest mortgage buyer. New foreclosures averaged about 2,900 a day in the fourth quarter, double the pace of a year earlier, according to RealtyTrac Inc., an Irvine, California-based real estate data company.

    Walking Away

    ``If people owe more on their mortgage than their house is worth, a substantial number of them will give their keys back,'' said Kenneth Rosen, head of the University of California's Fisher Center for Real Estate and Urban Economics.

    Refinancing won't be an option for homeowners with negative equity who have mortgage rates that are spiking, he said. About a third of U.S. borrowers have adjustable-rate home loans, according to the Federal Housing Finance Board in Washington.

    ``They will lack refinancing ability, and will obviously be under financial strain as their rates adjust,'' Rosen said. ``We're going to see credit card delinquencies rise and car loan delinquencies rise as a result.''

    As many as 5 million U.S. homeowners may have mortgages that exceed the value of their homes by the end of this year, according to estimates from Rosen. He said he expects a 16 percent decline in home prices from 2006 to 2009, compared with Hatzius' estimate of a 22 percent drop.

    Economic Threat

    Falling prices and rising foreclosures are a threat to an already slowing economy since many homeowners used their equity to finance purchases such as cars or computers.

    U.S. property owners took out about $318 billion of equity from their homes in 2006 by refinancing home loans, according to Freddie Mac, the world's second-largest mortgage buying company. Add to that $146.2 billion lent in home equity lines of credit, according to the Federal Reserve.

    In all, $2.2 trillion of home equity has been liquidated since 2001, which was the first of five years of record-setting house prices and sales.

    Kamanu refinanced her house in May 2007 and owes $415,000 on her mortgage. Homes in her neighborhood now sell for about $330,000, she said. The median home price in California dropped 17 percent from a year earlier in December, according to the state's association of Realtors.

    Sunset Wedding

    Kamanu said she doesn't want to put her life on hold until the housing market improves. She's planning a sunset wedding later this year on the beach at Folsom Lake, about half a mile from her property, even as she waits for a buyer.

    She said she's willing to sell the three-bedroom, two-bath, 1,272-square foot house fully furnished and include two wide- screen televisions to entice a buyer. The home has a fireplace and a two-car garage.

    ``I'm hearing it might be a year or two before the housing market comes back, and I can't wait that long,'' said Kamanu, 38. ``I'm relying on luck, hoping that someone will come along and fall in love with the house, like I did.''

    Real estate assets represent about one-third of the net worth of U.S. households, said Michael Darda, chief economist of MKM Partners in Greenwich, Connecticut. In 2006, Americans owned $20.5 trillion in homes, compared with $6.3 trillion in corporate equities, according to Federal Reserve data.

    ``The decline in home prices will cause a ding in household balance sheets,'' said Darda.

    Riding Out the Slump

    Declining values may keep many people from trading up. Owners with fixed-rate mortgages probably will ride out the slump without moving, even if they have a growing family and need more room, said David Berson, chief economist at PMI Group Inc. in Walnut Creek, California. They won't be spending much for clothes or dishwashers or Disneyland vacations, he said.

    ``Economists call it a negative wealth effect,'' said Berson, the former chief economist of Fannie Mae. ``When housing values go down, people tend to stay put, save more and spend less.''

    The economy probably will shrink 0.5 percent in the current quarter and 1 percent more in the second quarter as the real estate decline takes its toll, said Hatzius. An economic recession began in late 2007 and will last until at least July, he forecasts.

    Values in `Freefall'

    ``All aspects of residential real estate remain in freefall,'' said Hatzius. ``At present, there is no sign of a bottom.''

    Ricardo Fornos is part of that plunge. He's trying to sell his two-bedroom, two-bath condominium in Davie, Florida, near the Miami Dolphin football team's practice field at Nova Southeastern University. Fornos paid $190,000 two years ago and now expects he may get $165,000 for it.

    With a mortgage of $171,000, Fornos said he may have to pay as much as $20,000 to sell the property after covering the broker's fee and the buyer's closing costs. The Florida market is so bad buyers must now reimburse sellers for the cost of closing a transaction, he said.

    Fornos, 50, is eager to get out now before prices worsen. In December, the median price for a condominium declined 8 percent from a year ago and sales dropped 31 percent, the Florida Association of Realtors said.

    ``It comes to the point where you have to decide: Do I want to take a big loss now or an even bigger loss later?'' he said.
    #10     Feb 13, 2008