Dr. Housing Bubble 12/16/08

[Crewleader]

Option ARM: No one saw it Coming According to the Mainstream Media. The Alt-A and Pay Option ARM Tsunami Quickly Approaches. Charting the Option ARM and Alt-A Wave.

Option ARMs are arguably the most toxic mortgage product on the market. I remember having this discussion with people many years ago. Without fail, you would get someone throwing out the hypothetical unicorns in the sky case, “well what if you are a doctor with a side business and don’t want to document your income? This product makes sense.” Yet that is the exception and not the rule as we are now painfully learning. I’m sure some of these people were sincere but the vast majority were simply delusional and licking their gluttonous chops for a fat commission. Never were they looking out for the client. To ease their conscience they tell themselves, “well at least I warned the client about the risks of the mortgage.”

These loans were setup for that unicorn pie in the sky scenario of the wealthy business owner who simply does not want to document income but instead, became the primary product for many brokers in states like California and Florida for those who needed that extra pinch of leverage to buy that over priced home. Back in June of 2008 I wrote a detailed articled called:

Stage Two of the Mortgage Collapse: $500 Billion in Pay Option ARMs Meet the Piper in 2008 with 60 Percent Being in California.

In it I talk about the dangers of the option ARM mortgages. I don’t think the article could have been clearer. Many of you saw the CBS 60 Minutes piece this weekend. I know because I have gotten a lot of e-mails regarding the piece:

because I have gotten a lot of e-mails regarding the piece:

60 minutes

http://www.doctorhousingbubble.com/option-arm-no-one-saw-it-coming-according-to-the-mainstream-media-the-alt-a-and-pay-option-arm-tsunami-quickly-approaches-charting-the-option-arm-and-alt-a-wave/

[girl gone mad]

1. ..

My gut tells me upwards of 80% of all underwater pay option ARMs in California will default. Bookmark it like the other articles linked above. And why wouldn’t they default? Prices are not going to jump up. If IndyMac is any sign of loan modification success, we already know over 50% re-defaulted within 6 months. And IndyMac was an option ARM specialist! The market is only getting worse here in California and Florida, the 2 primary option ARM states.

I think that could end up being a conservative estimate.

[ipfilter]

2. Those toxic mortgages might have been ok

for someone who is financially savvy with an appetite for high leverage. They should have never been marketed to your average home buyer who probably had only the faintest idea of amortization and APR's.

Our entire economy has been taken to the edge of a depression over the subprime collapse. The pay option ARMs and other toxic Alt-A chickens are just now coming home to roost. This is far from over.

[Citizen Number 9]

3. Just out of curiosity

How much do you think it would take to adequately educate the "average home buyer" as to what they were actually buying?

Could we include this sort of thing as part of the required High School curriculum, for example, "Freshman Consumerism"? Wuld this sort of instruction be suitable or beyond the scope of a one-semester long HS class?

If students couldn't pass the class would we then bar them from obtaining a mortgage of this type?

We often hear about how the average person can't even balance their checkbook, so I am wondering if we should just not make these kinds of things available at all.

Maybe home mortgages should only be of the fixed 30 year type and only available to the much smaller number of people who might qualify for them. Presumably they could understand this basic sort of thing.

[ipfilter]

4. It's really not so much the mortgage product

but the leverage ratio. Lenders used to keep people from committing financial suicide by enforcing 20% down payments. Buyers might not have understood every nuance of the real estate transaction, but they certainly understood the $20,000 of their own cash put into a hypothetical $100,000 home. When people are required to put a lot more of their own skin in the game they might have more incentive to perform some due diligence. One shouldn't need an MBA to buy a house, but those with the MBA's shouldn't create an environment where home buyers can take on dangerous leverage ratios using complex financial instruments.

I would never suggest someone should take a test to obtain a mortgage. That's way too authoritarian for my lefty liberal ass. The type of mortgage, whether it be a 30 year fixed, or a pay option neg am exploding ARM is really irrelevant if the person obtaining the loan does not understand how their equity, or lack thereof, could impact them in the future. This is where I think our education fails. We don't put enough, if any, emphasis on leverage and how it effects our buying power and future staying power in a down market. If someone simply buys a home with a 30 year mortgage and makes the payments this stuff about leverage really doesn't matter much. However, once people started taking out 105% loans, negative amortization loans, and maxing out HELOC's the leverage ratios absolutely come into play and should have been well understood.

[Citizen Number 9]

5. Well, where's the dividing line?

Before the most recent housing bubble, I can remember that a lot of effort was put into increasing the home ownership rate amongst Americans. Not offering mortgages that would allow certain classes of people to qualify for a loan would probably draw fire from a number of sources claiming that opportunities were being denied. Part of that complaint would probably include people who weren't able (or hadn't bothered to) come up with a down payment. I think a lot of Americans did well during this big run-up and I know for a fact that some of the more prudent ones were significantly helped. If there hadn't been this huge downturn in housing values, a lot more probably would have done well and no one would be complaining about that.

Do we have to appoint a czar to decide who can and who can't get into a home? I don't want to make the decisions that would require and it sounds like you don't want to, either.

Ultimately you're left with giving families the right to decide for themselves if they will or won't risk it. If you weed out the pushy mortgage brokers and the fraudulent "bending" of the rules, you're still going to have people making bad decisions for themselves. Even then, you have to have consumers who have some sort of sense to protect themselves - buyer beware, remember?. I just don't know how to address that problem.

Maybe we do need to require that home buyers take a class if they are going to fall into a financial danger zone. At least they will have been "informed".

[ipfilter]

6. Anyone who qualifies for a mortgage

according to the underwriting standards of a given lender should be allowed to take one. If they can borrow 100% LTV then so be it. The bank is a counter party to the risk and the homeowner is pledging their home as collateral. Lenders never act as fiduciaries but they protect themselves and the borrowers, somewhat, by requiring down payments, or at least some form of loan guarantee from the Government through FHA, VA, or whatever. I'm the beneficiary of an FHA loan on my first home and I used my VA entitlement on my current home. I think home ownership is a great thing and anyone should be able to do it. I just think as a society we should train ourselves to think of home financing as the leveraged financial instrument that it is instead of some sappy "realization of the American Dream".