The next shoe to drop will cost us an arm and a leg

Okay, mangled puns at 7:00 a.m. aren’t funny, but neither is this guy’s prediction that there’s a wave of option ARM mortgages set to implode in the next couple of years that will make the recent mortgage fun look like, well, fun.

Essentially, by giving money to the banks, the Fed has postponed the resetting of these loans to catastrophic levels (one such loan I’m aware of dropped nicely this year, with the result that the borrower is paying $2,000 less per month. Of course, it resets every year so ….).

Read the whole article for an explanation in clear language of what these things are. Here’s the conclusion:

When the lender implosion began in Aug 07, those of us in California, Florida, Arizona and Nevada already knew what the rest of the nation would soon find out. Foreclosure activity was increasing, property values were falling, and the economy was stalling out. The Fed knew this and so did those who were buying the One Year Treasury Bonds and Notes, and as a result, the Bonds and Notes were increasing in value and dropping in rates.

By Jan 08, the Federal Reserve knew the market was in freefall. They Fed knew that the Foreclosure Crisis would only worsen. They also knew that the Sub-Prime Crisis would worsen, and then later would come the Option ARM and Alt-A Crisis. The first objective would be to attempt to deal with the Sub-Prime Crisis. Their actions drove the LIBOR Index down to .31% by the beginning of 2009. Unfortunately, that was too late for most Sub-Prime borrowers. They had originated loans from 2003 to 2006, usually fixed for two years, and by the time LIBOR rates fell to a “reasonable” level that would prevent foreclosures, it was too late. The majority of the loans had recast and people had given in to being foreclosed upon.

While the Fed was dealing with the Sub-Prime Crisis, they were also hoping that their actions would prevent the Option ARM Crisis. By lowering the MTA Index, it would postpone the recasting of the Option ARM loan to the full 5 year term. Within that time, the hope was that the “lending crisis” would end. Of course, once again, the Fed was out of touch with reality.

What the Fed failed to realize, or did not care about, was that homes were completely overvalued. As foreclosures continued to occur with the Sub-Prime Crisis, home values continued to fall. Even more short sighted, the reaction of the Servicers was not considered. The Servicers had no concern for the homeowner. Instead, they mostly wanted to foreclose (as I have detailed in previous articles).

The one action that the Fed has accomplished is to postpone the Option ARM implosion. By decreasing the MTA and other indexes, they managed to extend the period of time for when the Option ARM would recast. Now, most Option ARM loans will recast in 4-5 years. Since 2005 and 2006 saw the bulk of the Option ARM loans originated, the implosion will really occur during the next two years.

6 Comments

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6 responses to “The next shoe to drop will cost us an arm and a leg

  1. shoeless

    OT, sort of:

    This is a relatively new NAR data series, started several months ago. There’s no readily available history I was able to locate (anyone?). They don’t provide a data series I could see, so I had to cull the numbers from the Economists’ Commentary on their website. (No specific methodology details are given).

    Regardless, what I was able to pull together (with the help of a friend) was shocking. In September 2009, single family home sale prices look like this:

    21% less than $100k
    49% $100K to $250k
    22% $250 to $500K
    5.6% $500k to $750K
    1.3% $750k to $1m
    1.3% $1M and up

    Less than 10% of the homes sold in the US were > $500k. We know the high end has collapsed, but we are not disucssing multi-million dollar homes, mind you, but over $500k as a mere 8.2% of sales. I was surprised. (I wish we had data going back decades, which we could then normalize for inflation).

    In September, 70% of transacted homes were priced under $250,000.

    Check out the year-over-year growth rates — also astonishing:

    Homes under $100k are up 22.5%
    $100-$250 +6%
    $250-$500 -5.2%
    $500k-$750 +4.0%
    $750-$1m -2.6%
    $1M up -1.2%

    In the West, home sales under $100k are up 116% in the past year. And total US SF is up 6.4% y-o-y.

    Amazing stuff . . .

  2. anon

    I have a 5yr ARM mortgage on my house which I arranged 6yrs ago. When it came time for the rate to reset, last winter, my rate actually went down! I pay 250bps over the 1yr US t-bill rate, so the fact that the gov’t is keeping rates so low is saving me money. I only pay 3.125% sucka!

    • christopherfountain

      anon, that’s the same deal my friend has. And it is great, until the rates reset. I figure you guys probably have another two years or even three before things start pinching so by all means enjoy that extra cash, but I’d begin to keep an eye out for an attractive fixed rate and if you can get one next year,you might consider grabbing it.

  3. Anonymous

    shoeless, thx for interesting data

    Very difficult to find useful older comparables data for RE, esp as houses have varying degrees of desirable suburb or public schools/land/size/newness or maintenance capex invested, etc etc….to separate mix issues from price changes

    Indeed, no one “needs” to buy a >$500K house with so much rental supply for basic, liquid shelter

    And many creditworthy folks already live in a decent >$500K house, so aren’t eager to try to sell their current shelter to roll more cash into a more costly, illiquid house

  4. Riverside Dog Walker

    Anyone not locking in a fixed rate mortgage at today’s rates needs a risk management lesson.

  5. shoeless

    RDW,

    The bought too much house in the bubble and used the home like an ATM can’t refinance b/c they are under water. It’s too late to save them; they are going down with the ship.