Sonoma Housing Bubble

Pulling the cork out of Sonoma's bubbly housing foolishness

Tuesday, April 03, 2007

What a F%*#ing Disaster!

Title and most of today's content is courtesy of a sharp cookie economist who happens to be a Sonoma Housing Bubble reader. (thank you!)

We are going to discuss what happens when payment shock sets in from ARMs and Negative Amortization loans. Otherwise known as NAVLP according to Harm and Surfer-X (Negative Amortizing Voodoo Loan Product)

What exactly is a Negative Amortizing Voodoo Loan Product?

"These loans allow buyers to make minimum payments that don't cover all the interest due each month. The interest that isn't paid is added to the principal. The shocker comes when the principal grows to a pre-determined level (perhaps 110%, or 115% of the original loan) and the loan is "recast" immediately as a fully amortizing loan, in some cases resulting in a doubling of the monthly payment."

Did you know...?

* More than 70 percent of the mortgages originated in California during the past two years were variable rate loans, and most were interest only, according to David Lereah, the National Ass. of Realtors chief economist, who notes in the June 2006 Real Estate Insights that “a median-income household living in San Francisco had to stretch its credit with an interest-only mortgage to afford a home in a metro area where the median price was more than $740,000."

Well, now he would know wouldn't he?

* Something else true that Lereah actually said: '“If rates continue to increase, the higher monthly mortgage payment from the repricing of variable-rate mortgages could result in high delinquency and foreclosure rates that could aggravate already sluggish local markets.”'

* Nationally in 2005 about 28% of loans in the U.S. had some form of Adjustable Rate, where low initial interest rates expire and are replaced by current, presumably higher rates.

* In 2004 the % of Adjustable Rate loans was 33%

* In 2001, ARMs represented about 12 percent of all mortgages, according to national mortgage buyer Freddie Mac. But in 2004, the figure had risen to 33 percent. Last year, it dropped to 28 percent.

* Freddie Mac's survey in 2006 says that 40% of loans in their survey were 5/1 hybrids, with an average initial rate of 5.96 percent fixed for the first five years.

* Nationally, about 10% of the loans taken out in the past two years had negative amortization.

* New research by the Mortgage Bankers Association of America found that adjustables accounted for 59 percent of subprime loan originations as of mid-2006.

* In California, 60% of all loans made in 2005 were interest-only or payment-option adjustable rate mortgages. 24% were NAVLP. In the Bay Area 29% were NAVLP.< < * In Sonoma County 69% of loans in 2005 were interest-only or payment-option adjustable rate mortgages.

* About 13% of the owners who face a mortgage rate reset this year have less than 5% equity in their home, and therefore will not be able to refinance unless they have other assets.

* If prices fall 5%, the percentage with no equity would grow to 23%, according to Christopher Cagan, director of research for First American CoreLogic, a mortgage research firm in Sacramento. And if prices fall 10%, it would jump to 35%.

March 25th, 2007 the California State Senate Banking, Finance, and Insurance Committee held an informational hearing to inquire into the collapse in this state and the nation of the "subprime" mortgage market. There is concern over the ticking time bomb for ALL "teaser" rate adjustable rate mortgages, but of course they are only claiming to be worried about the "subprime" meltdown, though you don't need to be a rocket scientist to know from the stats that there is much more to worry about than Subprime.

When the teaser rates expire and the interest rate increases, it is predicted foreclosures will also increase. More white elephants will come out from under the carpet and onto the market, and will depress prices and make it difficult for owners to "dump" their albatross.

People like Paul Leonard, director of the California office of the Center for Responsible Lending made an appeal to help borrowers and strengthen mortgage laws.


I have an effing suggestion for you Paul! How about you let the market correct itself and rid itself of idjits who handed out money to people who couldn't repay it? Next time around try hiring people who can do math, and can calculate income vs. expenses and only lend to people who don't spend more than they make.

"It used to be that the mortgage industry refused to lend more money than borrowers could repay. There were strict standards requiring a hefty down payment and limiting the size of a loan. These standards helped create the largest secondary mortgage market in the world, which gave big investors the confidence that they'd get their money back with a nice return if they funneled trillions of dollars into the U.S. housing market."

"But that was before lenders realized they could make more loans and earn higher profits if they bent the standards, right under the noses of the investors who bought those mortgages."

"The result was an explosion of exotic mortgages, all designed to maximize the amount of the loan: adjustable-rate loans with little or no money down, loans with no documentation of income or assets, loans with a simultaneous second mortgage, mortgages with low initial "teaser" rates, and even mortgages with monthly payments so low they don't even pay all the interest due."

"It might be more accurate to call them "lemming loans," however, because that metaphor best describes the mass insanity and suicidal financial consequences of such loans."

"If it hadn't been for the extra leverage created by lemming loans, the housing bubble would have never gotten off the ground. It's how ordinary bungalows began to be priced like mansions -- suddenly families with ordinary incomes were getting approved for almost unlimited credit."

"For the first time in the nation's history, a significant number of Americans are being threatened with the loss of their home even though they still have a steady, good-paying job.
It's not just an issue for people with poor credit, those with subprime loans."

"It also affects people with good enough credit to qualify for a prime loan. Known as Alt-A mortgages, these loans were written for 1 in 5 U.S. mortgages and could have a big impact on the economy and on credit markets -- bigger, perhaps, than the effects of the recent shockwaves buffeting the subprime-lender market, economists say."

'"This is different," said Mark Zandi, chief economist for Moody's, who warns that the problems in the subprime mortgage market will spread. "It will mean the difference between an economy that will glide through the slowdown and an economy that sputters."
"The risks are all negative," Zandi said."

"In coming months and years, the credit crunch that's now squeezing mainly the poor is likely to hit millions of middle-class homeowners who took out risky loans during the great housing boom earlier in the decade. More than 1 million families will lose their homes in the next few years, by one estimate. Another study predicts 2.2 million foreclosures."

"According to a Credit Suisse report, tighter lending standards, increased foreclosures, more supply on the market, lower prices, and less construction of new homes will affect all parts of the market."

"It's not just a subprime issue," Ivy Zelman, a housing analyst for the bank, wrote in the report.

"This threat is new in American history. In the past, homeowners have generally lost their home to foreclosure only when they suffered a major life-changing event, such as loss of their job, a major illness or death of a family member. A big jump in foreclosures was unheard of outside a recession that brought high unemployment."

"Because this risk is so novel, experts don't have a clear grasp yet on how big of an impact the credit crunch might have on the economy."

"Researchers are studying three major channels through which a mortgage meltdown's shockwaves could rattle the economy. The most direct way would be through falling home prices."

"Demand will continue to fall. Tougher mortgage underwriting standards will eliminate about 20% of the potential buyers, including 50% of the subprime buyers and 25% of the Alt-A buyers, according to estimates by Credit Suisse. The supply of homes would also grow."

"Foreclosures and homes dumped on the market by desperate sellers would further depress prices, which in turn would further depress voluntary home sales and home building in a vicious downward spiral, some analyst say. Housing would remain a drag on the economy and on employment for far longer."

"In a weak market, some homeowners facing a large payment shock would find it difficult, if not impossible, to refinance their loan or sell their home for what they owe on it."

"And then there's the chilling effect of a slowdown on consumer spending. According to Federal Reserve data, consumers have taken about $3 trillion in equity out of their homes in the past five years, adding about 7% to disposable incomes every year. That boost kept the economy humming and has driven the personal savings rate below zero for the first time since the Great Depression."

"Homeowners experiencing rising equity felt richer and didn't feel the need to save as much. Economists say consumers spend about 5 cents of every extra dollar in (imagined) housing wealth."

"If home prices fall or even flatten out, consumer's ability to fatten their wallets based on home equity would be curtailed. In addition, households faced with much steeper mortgage payments would cut back on discretionary spending to avoid defaulting on their mortgage."

"Investors who eagerly bought these risky mortgages on the secondary market are having second thoughts, not just about subprime mortgages, but also all the other bits of paper in their portfolio that they didn't pay much attention to. They are finding out that there's not as much collateral in the collateralized debt obligations, known as CDOs, as they were led to believe."

"And once investors turn cautious, it's difficult to predict how it will play out. After all, in the Asian financial crisis of 1997-98, even countries with sound policies were punished by investors rushing to get their money out of Asian markets. There's not much reliable information about who owns the riskiest mortgages."

'"This has the potential to undermine global investor confidence," said Zandi of The result could be a general drying up of credit, even to the most qualified and untainted borrowers."

"In a paper issued last month, Joseph Mason, a finance professor at Drexel University and visiting scholar at the Federal Deposit Insurance Corp., and Joshua Rosner, managing partner of Graham Fisher & Co., concluded that the market hasn't accurately priced in the risk of default on non-traditional loans, or of the even-more complex mortgage-backed derivatives they are spun into."

'"Even investment-grade CDOs will experience significant losses if home prices depreciate," Mason and Rosner wrote. And decreased funding for mortgages from big investors "could set off a downward spiral in credit availability that can deprive individuals of home ownership and substantially hurt the U.S. economy."'

"In the worst-case scenario involving a credit crunch, "a vicious cycle of lower spending, weaker hiring and income gains, tighter credit and still lower spending could result, pushing the economy into recession," according to a recent report by Goldman Sachs."

"So far, defaults and foreclosures in the subprime market have received all the attention. The latest data show that more than 14% of subprime adjustable-rate loans were delinquent at the end of 2006, compared with 2.3% for prime fixed-rate loans."

"America's housing bubble wasn't fed by subprime borrowing alone. Especially on the coasts where home prices were soaring, many buyers with excellent credit, high incomes and good jobs took out more debt than they can repay. Nationally, these Alt-A loans accounted for about 20% of mortgages last year, and more than half of the loans in the states with the frothiest housing markets, according to Credit Suisse."

"Goldman Sachs economists have concluded that delinquency rates are rising nearly as fast for the riskiest prime ARMs, the loans some are calling "toxic loans," or "exploding mortgages."'

* "Last year, 55% of the Alt-A loans came with simultaneous second mortgages."

* "The average loan-to-value ratio was 88%. More than 80% of Alt-A borrowers chose to provide no documentation of their income, and 62% took an interest-only or option ARM that reduced payments at the beginning with the promise of higher payments later."

* "More than one quarter of the Alt-A loans were one-year adjustable loans, not the five-year adjustable that has been the standard for prime borrowers."

"During the big housing bubble, all these loans performed well. With rising prices giving homeowners additional equity, they could always roll one lemming loan over into another, and they could usually take thousands of dollars of equity out as cash. The credit rating agencies gave their seal of approval to these loans. Now, however, home prices are no longer rising, and that could make many of these loans go sour in a hurry."

'"Cumulative foreclosures on 'teaser-rate' mortgages -- which are classified as jumbo or Alt-A rather than subprime -- could significantly exceed those on subprime mortgages," Jan Hatzius, chief economist of Goldman Sachs, wrote in a research note."

"The danger of the lemming loans is that as more of them go bad, more homes will come on to the market. That will drive down prices even more, taking away what little equity the remaining homeowners have and eliminating any chance for them to refinance their loan or sell the house for what they owe. And even more homeowners will go off the cliff."

* "Cagan figures that every percentage point drop in home prices will mean another 70,000 foreclosures."

* "According to Cagan's research, about 8.4 million households have adjustable-rate mortgages that are expected reset to a higher rate in the next few years."

* "About 1.3 million have mortgages with initial teaser rates below 2% that will reset to a much higher payment when the introductory period elapses. On average, they'll face an increase of $1,512 in their monthly payment."

"Someone with a $500,000 mortgage (not uncommon in the Bay Area where such loans are popular) with a 2% teaser rate could find her $1,850 monthly payment rising to $3,500 or more. That would represent a mortgage payment of more than 50% of the median household income ($86,300) in San Francisco."

"For homeowners already stretched to the breaking point, the mortgage reset will be catastrophic. But there's something even worse: negative amortization."

"Large percentages of recent buyers ranging from California and Florida to Washington and Virginia will face an additional shock because they took out a negative-amortization loan."

"This comes on top of any scheduled reset of the mortgage rate."

"Negative-amortization loans were most popular in the areas with the fastest-growing prices during the real-estate bubble. Now most of those same areas have experienced falling prices, meaning the house may be worth less than what the owner owes the bank."

"According to the S&P/Case-Shiller index, U.S. home prices were falling in most metro areas at the end of the year. Even in the San Francisco Bay Area, prices fell at a 5.5% annual rate in the last half of 2006, and 9.2% in San Diego."

ps. Do you like rollercoasters? Hat's off to Speculative Bubble for this awesome production.


At 4/04/2007 07:08:00 AM , Anonymous tom stone said...

Avalanch is a beter analogy than rollercoaster.The rating companies are STILL rating CDO's with large subprime components as AAA!.how would you like to be the person at a large pension fund who had to explain that there was no money? and then claim that there was no violation of fiduciary duty...that "due diligence" was performed? I'm not seeing subprime problems,and the BK atty i am friendly with isn't either.we are seeing an Alt-a meltdown,and the borrowers incomes run $125k and up.I look at these,and usually BK makes a lot more sense than a refi, SW santa rosa there is a cobblestone home development with a recent sale at $ sold less than 2 years ago for $575k.this is a distress sale,and these homes are shoddily built,but that is a big drop for a 2 year old home,and an indicator of market conditions that should not be ignored.They will be cutting down forests just to make enough paper for the subpoenas.But no bailout unless some member of the "coalition of the willing" steps up,perhaps micronesia? cause the chinese won't be doing it,and the USA is Bankrupt.Interesting times.

At 4/04/2007 07:18:00 PM , Blogger Lisa said...

Nice to see someone clearly connecting the dots between subprime and the rest of the mortgage market. MSM is mostly clueless on this, of course, but perhaps as the year goes on, the story will become clearer.

It's mindboggling to think how many BA homeowners are going to be upside down, whether they had no equity to begin with or "liberated" whatever they did have and spent it.

At 4/05/2007 10:20:00 AM , Blogger sf jack said...

"we are seeing an Alt-a meltdown,and the borrowers incomes run $125k and up."


It's the "Alt-A Bay Area" that we live in!

At 4/08/2007 07:08:00 AM , Anonymous Anonymous said...

In theory it would seem quite possible to have a fixed rate neg-am. Could this explain the falling ARM Percentage between 2004 and 2006?

(And didn't Surfer-X coin the acronym as NAAVLP? ;))


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