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ARM Resets Hit Peak

Well, it seemed like a good idea at the time. During the summers of 2005 and 2006, wannabe homeowners opted for adjustable-rate mortgages with smaller initial payments scheduled to reset two to three years out. Now those ARMs are resetting, and many are watching to see if higher monthly payments will add more stress to an already troubled housing market in the United States. The Washington Post’s Renae Merle wrote in the Chicago Tribune yesterday:

The number of homeowners facing an increase in their subprime adjustable-rate mortgage payments will peak this summer, testing the efforts of lenders and others to keep those people out of foreclosure and stabilize the housing market.

The timing reflects the height of subprime lending in the summers of 2005 and 2006, when many borrowers secured loans scheduled to adjust in two or three years. For many, an adjustment means their interest rate will go up 2 to 3 percentage points.

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Mark Fleming, chief economist for research firm First American CoreLogic told Merle:

The next six months, the industry, all of the folks that are out there trying to solve this problem, they are going to be very busy. There are a lot of people facing their resets right now. A good share of them don’t have the refinance option.

Merle noted that more than 300,000 such loans will adjust this summer. She wrote:

Lenders, federal officials and housing counselors have worried that borrowers will not be able to afford the higher payments after the reset and will quickly fall into foreclosure. Declining home prices have made it impossible for many of these homeowners to refinance.

It will not be clear for months how many will lose their homes, Fleming said. “A lot of those are resetting now,” he said. “We may not see the impact in foreclosures until the middle of 2009.”

RealtyTrac, an online marketer of foreclosed properties, told CNN Money last week that during the first six months of 2008, 343,159 Americans lost their homes, up 136% from 145,696 recorded during the same period in 2007.

Sources:

“ARM resets to hit peak this summer”
Renae Merle
Chicago Tribune/Washington Post, July 13, 2008

“Six months, 343,000 lost homes”
Les Christie
CNN Money, July 10, 2008

The Housing Crisis, Part Two?

While it’s a beautiful afternoon here in the Windy City, the tone of the housing-related material I’m pouring over is just plain miserable. Take, for example, this excerpt from a piece that BusinessWeek’s Prashant Gopal wrote back on June 5:

The American homeowner must feel like one of those characters in an old cartoon who has just been hit by a falling piano. After dusting himself off and touching the large bump on his head, he probably doesn’t expect another piano to be dangling overhead. But he’d be wrong.

But what’s often funny in a cartoon is anything but in real life. With the subprime mortgage crisis already crippling the U.S. economy, some experts are warning that the next wave of foreclosures will begin accelerating in April, 2009. What that means is that hundreds of thousands of borrowers who took out so-called option adjustable-rate mortgages (ARMs) will begin to see their monthly payments skyrocket as they reset. About a million borrowers have option ARMs, but only a fraction have already fallen due….

According to Credit Suisse, monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010. Some of these loans have already started to recast. About 13% of option ARMs that were issued in 2006 were delinquent by 60 days by the time they were 18 months old, Credit Suisse said.

That’s it, where’s my stogie…

Source:

“The Next Real Estate Crisis”
Prashant Gopal
BusinessWeek, June 5, 2008

Bush Administration May Expand Homeowner Rescue Program

According to the Associated Press, U.S. Treasury Secretary Henry Paulson said this morning that the Bush administration was looking into expanding a program to help at-risk mortgage holders. In a CNBC interview, Secretary Paulson said the administration was involved in “discussions” with the mortgage industry to expand the current program, which freezes adjustable-rate mortgages for five years, to include borrowers of loans at prime rates. At this time, the rate freeze covers a much smaller segment of adjustable rate loans that were made to subprime borrowers with weak credit histories.

In the CNBC interview, the former Goldman Sachs chief executive said:

We have a wave of resets coming… One thing we will consider with the HOPE NOW alliance is… maybe expanding this beyond subprime borrowers to other borrowers.

According to the Associated Press, there are 1.8 million subprime mortgages that are scheduled to reset to higher rates this year and next. The HOPE NOW alliance is a coalition of mortgage industry companies which are seeking to reach at-risk borrowers to help them avoid foreclosures.

Bloomberg reported today that the New York-based American Securitization Forum, which represented investors in the talks that led to the creation of HOPE NOW, said it was open to including prime and other types of loans in the program. George Miller, the group’s executive director, said in a statement:

To the extent that servicers can develop and apply systematic approaches to assist them in their efforts to identify appropriate loss mitigation outcomes for adjustable rate mortgages other than subprime, we support those efforts.

The Treasury chief used a speech Monday to defend HOPE NOW, according to CNN Money. Paulson said yesterday, “Over the next two years, we… face an unprecedented wave of 1.8 million subprime mortgage resets, raising the potential of a market failure.” Supporters of the rate freeze note that the spread of the foreclosure crisis could derail the larger U.S. economy, hurting even responsible borrowers. The Bush official added that the rate freeze plan is not subsidized by taxpayer dollars and helps the administration “fulfill our primary responsibility of protecting the broader U.S. economy.” Critics claim that adjusting mortgage contracts amounts to a bailout, and “those who take on risk should suffer the loss when bets go bad.” Paulson countered:

It does not. Mortgage servicers have contractual obligations to their investors, who are spread all over the world. Servicers will fulfill these contractual obligations by pursuing all loss-mitigation options when it is in the best interest of investors, as they normally would.

Housing Scorecard

Yesterday I came across a Chicago Tribune article that tallied up the damage in the U.S. housing sector last year. Kenneth Harney, the author of the piece, talked about how Queen Elizabeth II once famously referred to 1992 as her “annus horribilis,” a year in which almost everything went wrong. The same could be said about the housing sector in 2007. According to the Tribune piece:

• American homeowners lost $160 billion in net equity in their homes from Q1 to Q3 2007.
• When looking at homeowners’ equity stakes (property value minus mortgage balances), it dropped to 50.4% from 56.1% as recently as 2002.
• Foreclosures on single-family homes reached 1.69% in Q3 2007, “the worst in decades,” according to the paper.
• 5.6% of all U.S. home mortgages were delinquent by 30 days or more in the same period.
• 1 out of 5 adjustable-rate subprime loans was delinquent by the end of Q3 2007. The Tribune noted that the proportion was higher in Michigan (26.2%) and Massachusetts (almost 23%).
• Home sales “tanked in almost every local market that had seen hyperinflation in prices in the boom years of 2001 to 2005. Local declines in excess of 50 percent are not unusual in parts of California, Florida, Nevada and Arizona.”
• One-quarter of new foreclosures in Arizona, California, and Nevada, involved “flippers” who gambled- and lost.
• The national inventory of unsold homes jumped to 10.8 months.
• Housing and mortgage-related job losses have been “staggering, into the hundreds of thousands by some estimates, and extend to the highest executive ranks of Wall Street’s and banking’s most prominent firms. When you lose billions on dumb bets on subprime mortgage securities, you can also lose your head.”

Vanguard Founder Says Recession Odds At 75 Percent

Earlier today, CNN Money posted the answers to questions Fortune readers asked of John Bogle, the 78-year-old founder of mutual fund giant Vanguard. With $1.3 trillion in assets, Vanguard is now the second-largest mutual fund company. Bogle talked about the odds of a U.S. recession, the U.S. housing market, the subprime crisis, and challenges to the U.S. economy, among other issues.

What are the odds of a recession right now?

I would put the odds of a recession at 75 percent. This economy is very much consumer-based, and I believe that 70 percent of the GDP is consumer spending. That’s a very high number. Two things are happening there: Consumers have fewer resources because from 2001 to 2005 they took $5 trillion out of real estate. That will not recur. This is a big drop. We also see weakness in auto sales and retail spending - we even see it at companies like Starbucks. There is another, equally important factor in consumer spending, and that is confidence. Consumers are not going to spend if they are worried about the future.

Will the real estate market improve anytime soon?

It doesn’t look so good. I really don’t see it improving soon. At some point homes will have to be built. But right now there is not much incentive to build new places when there are so many old places on the market. When those lines cross I don’t know. It’s complicated by the fact that many people have gotten into ARMs [adjustable-rate mortgages] who didn’t know what they were doing. I don’t know what is going to happen to those people when lenders foreclose. When banks were community banks, they were more careful. But when banks sell loans in a bundle, they are clearly not going to be concerned about mortgage quality. So we have to have a better system in the future to make sure we have a much better element of credit quality in mortgages.

How does the U.S. subprime mess compare with other crises you have seen in your career?

I’d say the most similar example was the S&L crisis of the late ‘80s and early ‘90s. The issues were somewhat the same: Institutions borrowed short and lent long.

The immediate concern for most investors is the subprime market, but over the long term what do you see as the biggest challenges facing the U.S. economy?

Externally, we are faced with $1.5 trillion already poured into Iraq and Afghanistan. So you have enormous expenditures in a corner of the world that is important to us, but it is very unwise to think we can bring democracy to a place that doesn’t share our values. There are also the challenges from low cost production in China and India. At home, we have a tremendous future financial problem with the federal deficit. We’ll have to take action on Social Security someday. Government spending has gotten to the point where we will have to either cut spending or raise taxes. Another problem is this deadlocked Congress. And I see the quality and caliber of our presidential nominees, and I am not impressed.

It raises the question of whether this country is even able to run itself anymore.