John Berry Notes that the ARM Reset Bomb Has Been Somewhat Diffused...

He writes, for Bloomberg:

Bloomberg: Many analysts and public officials have said that foreclosures of subprime adjustable-rate mortgages would soar this year as owners' monthly payments jumped when interest rates reset to a higher level. Not only is that unlikely to happen, this year's resets of earlier vintages of subprime mortgages may even reduce some payments that increased in 2007. The reason? The index to which many ARMs are tied is the six-month London inter-bank offered rate, or Libor, and that rate has fallen from more than 5.3 percent last fall to about half that level. The Federal Reserve's cuts in its target for the overnight lending rate -- the last to 2.25 percent on March 18 -- from 5.25 percent in mid-September, plus actions to increase liquidity in the inter-bank lending market, have caused the Libor to fall.

Unfortunately, most of the defaults and foreclosures that have wreaked havoc in financial markets haven't been due to resets so far. Many borrowers simply bought a house or condo they couldn't afford unless bailed out by rising prices, and lower rates alone won't help them much. Still, the big drop in Libor means there likely will be many fewer foreclosures than there would have been.

Much of the discussion about the danger of resets has focused on the initial interest rate, or ``teaser rate,'' that ARMs carried. That left the impression it was a very low rate that would adjust up a lot. Most of the initial rates were 8.5 percent or above, and now many are set to adjust hardly at all...

Comments

[spellingnut]

Shouldn't it be 'defuse', not 'diffuse'?

[save_the_rustbelt]

"Still, the big drop in Libor means there likely will be many fewer foreclosures than there would have been."

At the pace we are eviscerating the blue collar work force this may not be true.

[Alan]

What is left out of the analysis is the fact that more "development" means more need for infrastructure. Long after the developers have gone, someone needs to pay for sewage treatment, roads, schools, and civil servants. Anybody's property taxes going down? Even though the cumulative value of residential real estate may go 30% lower peak to trough, do the municipalities dare reassess at the lower values, and thus entitle themselves to less tax revenue at a time when they are already squeezed?

[Matt]

Alan got it. That is the real problem we have here in central california. The county development costs still hang on the taxpayer, a problem we were quite aware of here for many years. We have adjusted to the housing cycle by using the housing boom as an excuse for a government hiring boom, political make work.

Now, watta we gonna do with all those people the county trained to be unwanted clerks?

[Neal]

First, the intial mortgage resets will continue at an unusual level until 2012--that's still 4 years out.

Second, subsequent mortgage rate ajustments can occur at regularily scheduled intervals after that. Is it necessary to have the economy struggle along with a effective ZIRP for the duration of the mortgage in order for people to stay in their homes? That does not seem like a recipe for economic success to me.

Third, the next big wave of resets is in Option ARMS where many of these people are choosing to pay interest only, or less-than-interest only on their homes. These people will be hit big-time with any reset that requires them to actually pay-down on the value of the house. In fact, drops in house values can actually force these people to begin full payments after the value of the house drops by 10% from sale price. Look for this to begin happening now.

Fourth, many people, regardless of mortgage type, bought houses more expensive than they could afford on the anticipation of always rising prices and easy re-financing. Those conditions are no longer in place. As a consequence of over-buying, for many it's a struggle even if payments don't increase. It gets immediately impossible with any economic downturn, layoff, or illness. The struggle also becomes futile when the house value is far below mortgage amount. And at some point, people realize that a large mortgage payments when they are 60 or 70 years old is a far different prospect than cashing in on big value increases in their "house" IRA.

Fifth, an unually high number of properties will bought as "second", or "vacation", or "investment" homes. The falling prices mean that these will be abandoned by their owners at a much quicker rate than primary residences. This will create a faster, worse economic impact than people who actually want a place to stay.

But this all really misses the point that while housing and mortgages may have been at the beginning of this crisis, the real damage to the economy is occurring from the reckless leveraging of the mortgage money into $500T of credit derivatives over the past few years. The economic fallout from this will make the ultimate damage to the housing and consumer far, far worse than the dollar value of the resets occuring each month.

[Matt]

"Indeed, we have entered an era of unpleasant choices, with a fiat currency run by a monopoly issuer undergirding an extremely leveraged fractional reserve banking system."

We were in that period for 60 years, or as long as we knew about the problems of a monopoly monetary bank. The difference now is that we have externals demanding monetary power, and they have earned it. Now is an opportunity to open our system up, a grand opportunity not the doldrums.

First, the Fed must define the monetary bond as:

Large funds issue monetary bonds with redeemable face value. The also hold, in reserve, a faction of the collection of marketable bonds as reserves against their variation in value. Reserve accounting is based on the market value of the monetary bonds they hold. In return they get access to interest at the lowest rate, the discount window become the standard borrowing mechanism.

This, essentially completely removes the fed from having political obligations, the main problem. The fed becomes the arbitrage manager of the monetary bond market, and Ben would do well here. The fed is still a cyclic monopoly, but the perturbations that causes have a natural absorbtion factor in the monetary bond market.

[Ginger Yellow]

I thought the big problem with option ARMs wasn't the teaser rate per se, but the "option" part that increased the loan balance even as borrowers paid interest.

[Slocum]

"Anybody's property taxes going down?"

Yes. Here in Michigan, we long-time owners had a built-in property tax 'discount' due to the fact that taxable assessments were limited to annual inflation -- so, although valuations have dropped (and those declines have been registered by the assessor), our taxes haven't.

But for any homeowners who bought more recently and were being taxed on full value of their properties -- yes, they have actually seen their taxes go down.

"do the municipalities dare reassess at the lower values?"

Well, they probably wouldn't do that if they could avoid it, but it's not optional -- they're legally obligated to reduce assessments when market values decline. And they have done so here.

[Emma Anne]

There isn't any doubt that a lower LIBOR will mean fewer foreclosures than otherwise would have happened. But I think the estimates of future foreclosures were lowballed before, so the number of foreclosures will still be at least as bad as the estimates.

[ottnott]

Neal wrote my comment for me, but did a more thorough job.

I'll just emphasize and add to some of what Neal said.

"Diffuse" is in fact the word to use, not "defuse", because the ARM reset problem has been kicked into the future, not eliminated, by the negative real interest rates.

Unless the economy really tanks, those rates will have to rise, perhaps just in time for the peak in recasts and resets of Option ARMs (as Neal noted). Below is a graph of the various resets. The data is more than a year old, so mortgages created during 2007 do not appear in the graph:
http://www.bubbleinfo.com/storage/ivy%20arm%20reset%20schedule.png

If the economy does tank, we will still have the low rates, but it wouldn't be an argument for bullishness on housing.

The Bloomberg article noted: "most of the initial rates were 8.5 percent or above". That brings me to second Neal's point that people bought more home than they could afford. About the only fundamental factor housing bulls could point to when denying the existence of the housing bubble was the very low interest rates. 8.5% isn't low. Payments at that rate on homes purchased at peak prices aren't sustainable for many buyers.

Here in Southern Cal, the buyers of multiple homes for investment quite often were in the realty or mortgage business themselves. They were true believers in investing in homes, and they weren't intimidated by the buying process or the large $ sums involved. Many of them were raking in massive commissions at the time. They are now defaulting on multiple properties at a time. There is no interest rate that would allow them to hang on to those properties.

[mistah charley, ph.d]

Speaking of ARMs, Mike "Mish" Shedlock reports that Citigroup is contacting clients, warning them of mortgage resets and offering them a chance to switch to a fixed-rate mortgage - and in the process lying to them - i.e. warning them that their ARM payments are "probably" going to go up, when actually they are going to go down.

Details - http://tinyurl.com/2dxj7m

[anne]

The problem is very serious, and fine a reporter as John Berry has been he may not understand.

Goldman Sachs is telling clients to expect about $1.2 trillion is debt write-downs, and Goldman has been notably right so far. Suppose only $900 billion; we have a long way to go and going will not be because of mortgage rates resets but because the costs of mortgages as such are not affordable. The mortgage market is in trouble, not the subprime market but the market as a whole. Home prices are falling and falling fast and will fall further, there has revently been no job creation. Wealth stores are failing midle income homeowners. Darn, darn, darn.

[anne]

Emma Anne is correct both ways, but we have a serious and growing problem on balance and I see no simple solution short of fiscal policy which will not be forthcoming to the needed extent.

[christofay]

Good try in attempting to see silver linings in the approaching clouds of Hurricane Katrina

You should be putting Jim Grant's interview up for discussion to turn the discussion to someone who has been calling this correctly

http://bigpicture.typepad.com/comments/2008/03/james-grant-fed.html#comments

We still have trouble saying that this is a bubble in highly leveraged and opaque financial instruments, it's still the poor people who are troubling the United States.

In the meantime,

"Bear Stearns Cos. Chairman James Cayne on Thursday sold his holdings in the embattled investment bank ahead of its expected acquisition by JPMorgan Chase & Co.

"Cayne sold 5.66 million shares for exactly $10.84 a share for $61.3 million. However, it was not known if those shares were dumped into the open market or if Cayne sold them to another party."

http://www.huffingtonpost.com/2008/03/27/bear-stearns-ceo-sells-hi_n_93790.html

Fed intervention in the markets does help. He was able to escape with tens of millions of dollars from his black box rather than hundreds of millions of dollars.

As to fiscal help from Congress, lord mama, I want to crawl under the bed and hide. Fiscally Congress is special ed. We have an off the books Iraquian adventure because, geez, it'll make the books look bad if they have to count all the money they spend

"One witness saw Iraqi Shia policemen rip off their uniform shirts and run for shelter with local Sunni neighbourhood patrols, most of them made up of former insurgents wooed by the US military into fighting al-Qaeda."

http://www.timesonline.co.uk/tol/news/world/iraq/article3631718.ece?token=null&offset=12

Aren't we fiscally spending tens of billions of dollars out of the SS lock box so the Iraqis can stand up while we stand down?

[christofay]

Would it make you feel better to hear that Cheney is going to the Washington Fed to help direct rescue efforts "from the front lines" alongside Bernanke?