The ARM Problem has not gone away. Today we examine an updated ARM reset schedule and consider its impact on our local housing market.
Irvine Home Address … 89 WINDING Way Irvine, CA 92620
Resale Home Price …… $615,000
it's time for me to get away from here
just thought you oughta know the end is near
did you honestly think it would've worked at all
cuz evrything i've seen has only made me fall
there ain't much i can do now that i've seen the truth
there ain't much i can do now they've made me into
one of you
for the kingdom of oblivion is at hand
not a thing for all's as it was planned
false gods false hopes and false ideals
push the button game over no more time to steal
Left Spine Down — Reset
Wouldn't life be much easier if we could hit a reset button and wipe away the excesses of the housing bubble? In the housing bubble era, reset is associated with a bad thing that happens to adjustable rate mortgages. I remember last year a few astute observers much wiser than me chastised me for worrying about adjustable rate mortgages because they were all resetting to lower rates — problem solved. Foolish me. I must be a Chicken Little sounding a false alarm, right?
I wrote most recently about The ARM Problem in the summary post Option ARM story. The problem with adjustable rate mortgages resetting and recasting to higher payments has diminished in importance because many of the loans have defaulted early, so now the major problem is shadow inventory. The ARM problem is still with us, and much of our shadow inventory — and ultimately foreclosure and resale inventory — is spawned from this lending monster.
By Zach Fox
Credit Suisse made waves in 2007 among housing bears with a chart that estimates the volume of adjustable-rate mortgages to face a reset each month. An updated version of the chart, which was provided to SNL, shows resets remain a worrying force over the next few years.
Most of the resets are expected to occur through 2012. Between 2010 and 2012, the chart indicates that $253.25 billion of option ARMs will adjust, while Alt-A loans totaling $163.71 billion will reset over that time. Altogether, $1.010 trillion worth of ARMs will reset or recast during the three-year period.
"Option ARM resets are still pending. … Nothing much has happened yet because rates were so low that resets were pushed back," Chandrajit Bhattacharya, head of non-agency RMBS and ABS strategy at Credit Suisse, told SNL.
That is not entirely true. Many of these loans are still pending, but the borrowers are not paying. The reset chart is not adjusted for shadow inventory. Many of the loans facing reset are already in default. Numerous of the light blue (Option ARMs) have already defaulted as have many of the light green (Alt-A loans).
Borrowers who already have seen their ARMs reset might be sitting on their hands and not refinancing into fixed-rate products, McBride said. Because mortgage rates have been so low recently, resets can actually lower, not raise, monthly payments. When that happens, borrowers might feel little urge to refinance into a fixed-rate product that would cost more per month.
This is the real problem; people will do anything, no matter how foolish, to lower their monthly payment because they believe the government will bail them out if interest rates move against them. Why wouldn't they? Moral hazard caused by lending bailouts emboldens both lenders and borrowers and ultimately increases the cost of the bailouts demanded.
"The avoidable scenario is interest rates start to go up over the next couple of years, and all of a sudden, millions of homeowners who are stuck in adjustable rate mortgages and haven't been able to refinance out of them become sitting ducks for big payment increases," McBride said. "And then here we go again. It's like 2007 all over again. And again, the HARP program is key to avoiding that iceberg, and we're headed right for that iceberg, and no one's turning the wheel because everyone's focused on mortgage modifications."
"If you look at it, there's almost probably 5 million borrowers sitting there in some sort of delinquency right now who have yet to be foreclosed upon. So if you say [the Home Affordable Modification Program] is going to save only a small fraction of that, the rest of them have to go through in some form of foreclosure or distressed sale," Bhattacharya said. "So it's definitely not over by any means."
Credit Suisse projects 10 million foreclosures over a five-year period starting in 2008.
To put the ARM resets schedule in context, these timelines represent the totality of the carnage the markets face from ARMs, but the actual foreclosures related to these loans may occur early due to unemployment, negative equity or a number of other reasons. Shadow inventory emerges from this schedule and pulls destruction forward. Loan modifications, which are supposed to be the market savior, increase the problem with terms that have escalating interest rates and increasing payments. So why is this a big deal here in California?
… option ARMs are concentrated in just a few states. A Fitch Ratings study from Sept. 8, 2009, reported that three-quarters of all option ARMs were in California, Florida, Nevada and Arizona.
Don't worry; Irvine has none of those problems, right?
More Foreclosures are Coming
From the OC Register: Foreclosures now are just 'tip of the iceberg':
[Bruce] Norris told hundreds of investors attending a seminar he held in Costa Mesa this past weekend that numbers indicating the appearance of firming home prices and fewer foreclosure auctions are “illusions.”
Government repayment and loan modification programs make foreclosure numbers appear lower for now, but are delaying the inevitable inability or disinclination of homeowners in trouble to hang on to property that has dropped in value by hundreds of thousands of dollars, he says.
Meanwhile, he says, redefaults on loan modifications are “sabotaging” government efforts.
Mortgage delinquencies will continue “skyrocketing,” he says, because:
- “The resets of the Option-Arm loans will cause a larger number of foreclosures than the subprime loans.
- “Resets are part of the problem, but a bigger concern is the owners who owe more on their home than it’s worth.
- “Commercial loans and credit card losses will soon add to the problem.”
- Unemployment is a signifcant factor. He says: “I think we will fall back into recession by the end of 2010, and the unemployment rate and underemployment rate will be about 20% in 2011.”
- Owners are finding it more and more acceptable not to make their house payments. The mindset, according to Norris: ” ‘I see my next door neighbor has stopped making his payment, and he just bought a camper.’ You can see that coming. We haven’t really been through the biggest part of the problem.”
Updated ARM Reset Schedules
For historical reference, I superimposed the new reset chart onto the old one to see how the original projections have changed.
In the cleaned up graphic below shows the next four years of adjustable rate mortgage resets.
More reason to believe the Bernanke Put, the implied protection of mortgage interest rates, is going to be kept in place.
The results of amend-pretend-extend are apparent, and in case the obvious is overlooked, restructured loans only postpone bank losses.
The amend-pretend-extend policy is like shoveling snow; the more you push the snow, the larger the build-up on the front of the shovel. Eventually, you will need to stop and remove the snow or you get stuck. Similarly, pushing ARMs out further simply adds to the problem and makes correcting the problem costlier.
Lenders believe that a rolling loan gathers no loss, so they would push the problem back endlessly if they could. Eventually, appreciation may bail them out, but the existence of these loans and the inevitability of higher interest rates will weaken appreciation or kill it entirely. Also, despite the foolishness of it, many of these loans are being underwritten today as affordability products. Rather than eliminating ARMs at the bottom of the interest rate cycle, we are expanding their use.
If the ARM problem becomes large enough, politicians will deem it too-big-to-fail and engineer another bailout. At this point it is difficult to advise people to take on conservative financing and do the right thing. So much moral hazard exists that I can not persuasively argue with someone considering an ARM loan. The system is there to be gamed, and everyone seems OK with that. Personally, I find it appalling.
Irvine Home Address … 89 WINDING Way Irvine, CA 92620
Resale Home Price … $615,000
Home Purchase Price … $736,000
Home Purchase Date …. 5/25/2006
Net Gain (Loss) ………. $(157,900)
Percent Change ………. -16.4%
Annual Appreciation … -4.5%
Cost of Ownership
$615,000 ………. Asking Price
$123,000 ………. 20% Down Conventional
5.01% …………… Mortgage Interest Rate
$492,000 ………. 30-Year Mortgage
$127,487 ………. Income Requirement
$2,644 ………. Monthly Mortgage Payment
$533 ………. Property Tax
$300 ………. Special Taxes and Levies (Mello Roos)
$51 ………. Homeowners Insurance
$274 ………. Homeowners Association Fees
$3,802 ………. Monthly Cash Outlays
-$453 ………. Tax Savings (% of Interest and Property Tax)
-$590 ………. Equity Hidden in Payment
$240 ………. Lost Income to Down Payment (net of taxes)
$77 ………. Maintenance and Replacement Reserves
$3,076 ………. Monthly Cost of Ownership
Cash Acquisition Demands
$6,150 ………. Furnishing and Move In @1%
$6,150 ………. Closing Costs @1%
$4,920 ………… Interest Points @1% of Loan
$123,000 ………. Down Payment
$140,220 ………. Total Cash Costs
$47,100 ………… Emergency Cash Reserves
$187,320 ………. Total Savings Needed
2 full 1 part baths Baths
2,000 sq ft Home size
($308 / sq ft)
n/a Lot Size
Year Built 2006
2 Days on Market
MLS Number S607533
Condominium, Residential Property Type
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Does the geometry of this picture look correct to you?
Do you like the carpet cleaning patterns? They look like rake patterns in Japanese rock gardens.