A Day of Reckoning- Coming Soon to a Bubble Near You!

"A Bubble With a Fuse

By Fred Dattolo
Monday, February 20, 2006

Starting this year and picking up speed in 2007, as much as $2.5 trillion of non-conventional mortgage debt is scheduled to be repriced. Millions of Americans will soon face significantly higher mortgage payments. Unfortunately, many can barely afford their current payment.

Why is this happening?

What will be the consequences?

In a bid to keep business booming, banks and mortgage lenders in recent years have found “creative” ways to make home loans more affordable—even to people with spotty credit histories or weak credit.

By issuing “hybrid” mortgages that typically have low interest rates in the first two years, lenders have been able to entice otherwise unqualified buyers into buying a home. However, the initial low “teaser” rates must eventually be adjusted to the fully indexed level of whatever index is specified in the loan agreement.

These adjustments are coming due in a big way, this year and next. That means mortgage payments are set to climb hundreds of dollars a month for a substantial number of Americans!In the past, when these mortgages were “reset,” it didn’t cause a lot of disruption to the economy. One reason was that the sub-prime market—borrowers with weak credit who could least afford the payment hikes—was proportionately a much smaller share of the overall market. Not so anymore.

According to Barron’s (February 13), the amount of sub-prime loans issued in 2004 and 2005 was $540 billion and $628 billion, respectively. Barron’s estimates that a whopping $600 billion is scheduled to be adjusted higher in the next two years! Fannie Mae figures almost two thirds of all sub-prime loans will be reset in 2006 and 2007. Remember, that’s just the sub-prime market—those who could barely afford a home loan to begin with.

Senior economist Michael Fratantoni at Mortgage Bankers Association estimates that in 2007 alone, more than one trillion dollars of all hybrid mortgages in the U.S. are going to be reset higher.

That is going to impact the pocketbooks of millions of Americans to a degree that many are not expecting. A typical hybrid mortgage contract is indexed to some type of money-market benchmark like the six-month London interbank offered rate (libor). In the last two years, the libor rate has risen more than 3 percent and is heading for a 4 percent increase!

Even if a mortgage contract has an annual cap limiting interest rate hikes to 2 or 3 percent, many Americans have no idea how much their mortgage interest rate is shortly going to escalate—perhaps 2 or 3 percent this year or next, and more in subsequent years, according to how the index rises.

What may currently be a 5 percent teaser rate (or 7 percent for sub-prime borrowers) will shortly be reset to 7 or 8 percent (9 or 10 percent for sub-prime loans) and most likely higher after that. That means these mortgage payments will go up by hundreds of dollars a month.

All this is coming due at a time when Americans’ discretionary income (after more or less fixed costs of taxes, housing, healthcare, auto, energy, etc.) is declining while debt levels are mounting, interest rates are climbing, sales of existing homes are sinking, inventories of unsold homes are building (especially in areas of the country that led the recent housing boom), federal regulators are pushing for stricter lending standards, and houses are greatly overvalued.

National City is a top originator of prime mortgages. This company incorporates a very sophisticated methodology in its valuation studies. Its latest survey as of the third quarter of 2005 shows “38 percent of the U.S. housing market is at an ‘extreme’ overvaluation level of 30 percent or higher. … [S]uch levels of overvaluation are typically followed by price declines of about 15 percent that take an average of three years to unfold” (Barron’s, February 13; ).

As many homeowners face rapidly rising mortgage payments in the next couple of years, all indications are that a lot of them will not be able to refinance to get out of their predicament this time around.

Look for foreclosures and bankruptcies to soar. The end of the housing boom will be very detrimental to the U.S. economy.

In the last few years, the housing boom has accounted for about 40 percent of all new American jobs created in the private sector.

According to the Economist, “[T]he global housing boom [led by the U.S.] is the biggest financial bubble in history. The bigger the boom, the bigger the eventual bust” (June 16, 2005).

We are moving ever closer to that day of reckoning. As we do, it becomes evident that the housing bubble appears to have a burning fuse sticking out of it that makes it look more like a bomb than a bubble. Are you prepared for the explosion?"

From Yet Another News Source- same thought is beginning to make headlines all over the nation...

"America's most dangerous 'housing bubble'

For people trapped in an escalating schedule of mortgage payments, this mortgage bubble is real.

For the past five years, everyone connected with housing -- owners, would-be-owners, Realtors, builders, and analysts -- has fixated on ''the bubble.'' How high will prices soar? When will prices moderate? Will the bubble burst?

A Google news search tabulated over 650 ''housing-bubble'' citations last month.Yet the term ''bubble'' was always a misnomer. So long as demand, fueled by new households (undergirded by immigration), remains high, and supply, curtailed by restrictive zoning regulations, remains low, prices in growing regions will not collapse.

Indeed, in some regions of the country (such as parts of the Midwest), prices never soared. And today, in the ''hot'' cities of the Northeast and West Coast, prices have started to stabilize and homes are remaining longer on the market. Yet while everyone has watched this bubble-that-was-never-a-bubble, a more menacing bubble sits on the horizon.

This is the bubble of future mortgage payments.Frantic to buy a home before prices soared even higher, too many households have latched on to ''exotic'' mortgages, fixating only on the here-and-now. Looking at a dream house, the would-be owner asks, ''How much will the monthly payment be next year?'' Not ''What is the price?'' Or '''How much will the overall indebtedness be?''

With an optimism born of myopia, the would-be owner signs up for a deal he can afford in the present but that may bankrupt him in the future. Consider the recent emergence of negative amortization. In the not-so-old days, with a 30-year fixed-rate mortgage, each year a homeowner paid back an increasing amount of the principal, along with the interest. That is classic amortization.

Negative amortization turns that on its head. In the first few years, the homeowner pays none of the principal, and only part of the interest. So in the early years he has amassed debt, not accumulated equity.He escapes catastrophe only by selling for much more than he paid, or earning substantially more money to pay for the rising debt. Option adjustable-rate mortgages (ARMs) and interest-only mortgages can lead to negative amortization, and these ''products'' are the mortgages du jour. How alluring!

The minimum payment may be based on an interest rate of only 1.25 percent, even though the actual interest rate may be closer to 6 percent. Notwithstanding a flat yield curve, today a third of all loans offer negative-amortization options.

In 2005 in California, half of the new mortgages were interest-only. In the next 12 to 18 months, 7 million households (representing $1 trillion in mortgage balances) will see their payments ''adjust'' -- i.e., increase. In addition, the other household expenses will rise. Property taxes rarely remain stagnant and even more rarely fall. Ditto for heating and fuel prices:They will rise. So will maintenance costs, as roofs, windows, and plumbing systems deteriorate. As for rises in income to compensate, the owner naturally hopes for hefty annual raises. But this is not the era of automatic wage increases.

One of three jobs in the United States pays less than $12 an hour, with little prospect of regular increases. Nor is it the era when a spouse can get a job to help out. Today, both partners in a household are already working to qualify for a mortgage. Unhappy events will gobble up income: a layoff, an illness, the need for a new car. So will happy events, such as the birth of a child. Ironically, the homeowners who have been watching prices soar in their neighborhoods have felt house-rich: Thanks to the dizzying escalation in sale prices, their net worth has been doubling, maybe tripling. But this is a paper gain, to be realized only if the homeowner sells and moves to a less expensive region (from California to Oklahoma, for instance), or scales down to a smaller house. For most people, the increase in net worth has been almost fictive.

For people trapped in an escalating schedule of mortgage payments, this mortgage bubble is real. Before the bubble traps more homeowners, lenders should screen buyers and explain the not-so-fine-print implications of option ARMs and interest-only mortgages, especially the prospect of negative amortization. And buyers should scrutinize the contracts, perhaps deferring the purchase, purchasing a more modest home, or finding a more affordable neighborhood. In a context of rising interest rates, this mortgage bubble will not deflate.For many, the bubble could burst into foreclosure."

But only 7% of people in Sonoma can afford to purchase a home- and yet we have close to 200 for sale right at this moment... how are these houses going to be sold if unqualified people can't get risky exotic loans to mask their inability to afford these houses? Oh NO!!! What will happen to the flippers? What will happen to all the people in the RE industry? What about all the jobs created in the real estate and construction industry? What will become of them? Here's a hint....

"Washington Mutual to cut 2,500 jobs
Bank cuts costs as mortgage market cools

(MarketWatch) -- Washington Mutual announced 2,500 job cuts at its home-loan business late Wednesday, another sign of a cooling real-estate market.
The bank, one of the largest mortgage lenders in the U.S., said its network of processing offices that provide administrative support to its home-loan businesses will be reduced to 16 from 26.
The job cuts represent more than 4% of Washington Mutual's total workforce of about 60,000.
After an acquisition spree, Washington Mutual is trying to boost efficiency by reducing the real estate it uses and moving back-office functions to lower-cost domestic and offshore locations.

But the bank also said in a statement on Wednesday that it's cutting costs at its home-loan business to "better match current and anticipated mortgage-market conditions."
Signs that the once-hot housing market is beginning to cool have accumulated this year.
U.S. banks reported weaker demand for mortgages in the past three months, a Federal Reserve survey of senior loan officers found in January. See full story.

Homebuilder KB Home said on Feb. 13 that it's seen a surge in cancellations and a decline in orders during the first two months of fiscal 2006.
Last week, luxury homebuilder Toll Brothers cut its outlook for fiscal 2006 home deliveries for a second time, citing slowing demand." See full story.