Alt-A Mortgages: The New Subprime Meltdown?

The infamous subprime meltdown has come and passed, but does that mean that we are in the clear? Maybe, but a look at a Mortgage Rate Reset Timeline graph suggests otherwise:

This chart originated from an IMF report pertaining to the risks affecting global economic stability. See report here.

Assuming that Alt-A borrowers have a better chance of handling these resets, it shouldn't be as big of a shock as the subprime meltdown. But the economic crisis has worsened since that event, and borrowers may have an even tougher time repaying their mortgage, no matter what their credit rating is.

Fact is, we are definitely not in the clear yet, and any bump in the road could cause the economy to lose any traction it's gained. This combined with a recent report from the CoStar Group (Commercial Real Estate Industry Says Recovery is Not Around the Corner) could spell trouble for not only the real estate sector, but for the economy as a whole.

Comments

[user396040:]

Reviewing the landscape, this is the chart that is most effective at preventing me from sleeping at night. I think it is a very strong argument against those who are worried about imminent inflation; the Fed should keep rates low, should be agressive buying Fannie and Freddie securities and take whatever measures are necessary to offset this ominous development.

Jun 19 10:48 AM

[HardwoodFlo...:]

What's worrysome here is that these people didn't qualify or weren't interested in an FHA backed fixed loan.

Jun 19 01:42 PM

[TB1000:]

Resetting ARMs shouldn't be much of a problem right now as LIBOR has dropped to near historical lows. The problem in 2006/2007 was that LIBOR spiked several % points so when the ARMs reset, the payments were drastically higher and unaffordable for many.

While immediate interest rate risk is somewhat taken off the table, it doesn't mean that the overall effects of the economy (layoffs, wage decreases, etc) won't negatively affect the ability of a homeowner to continue to pay their mortgage or have the means to refinance into a solid fixed rate.

Jun 19 01:47 PM

[BostonObserver:]

Weren't many of these Alt-A and Option ARM loans set with "teaser rates" as low as 1-2%? If that's the case, then the "owners" (mortgage holders) will see their monthly payments rise by 50% or more upon reset, even with today's very low rates.

Am I misunderstanding this?

Jun 19 02:20 PM

[TB1000:]

The Option ARM wasn't an Alt-A product but many did include an option for a low teaser rate with triggers on them to start amortizing once the PIK interest got to a certain level or with very short lives on the low teaser rate, which was only one of the payment options (of course one that was probably very popular with most of the people taking those out).

Jun 19 03:48 PM

[Donald Ingram:]

You got it. We still have 24 months of residential mortgage pain to come. On top of the commercial real estate defaults that are just about to start in earnest. If this isn't bad enough, the commercial loans that have hold-to-maturity agreements and that allow a line of credit for interest payments, are beginning to fail. When they default its made all the worse because the line of credit is drawn down also. I could go on but won't. This in my mind is a depression, because the stats are clearly depressing!
Do you ever notice that the truth you hear is bad news and all the good news is lies, or badly bent truth from the government or spin doctors?


On Jun 19 02:20 PM BostonObserver wrote:

> Weren't many of these Alt-A and Option ARM loans set with "teaser
> rates" as low as 1-2%? If that's the case, then the "owners" (mortgage
> holders) will see their monthly payments rise by 50% or more upon
> reset, even with today's very low rates.
>
> Am I misunderstanding this?

Jun 20 01:57 AM

[Mad Hedge F...:]

This isn't going to help. Iam more convinced than ever that real estate has another 25% to fall, and best case, it is dead money for another five to ten years. The New York Times produced some insightful data on inflation adjusted home prices for the last120 years, which baselines at a $100,000 for a single family home in 1890. Few people realize how superheated the recent real estate bubble really got. Past bubbles very consistently peaked at $125,000 in 1896, 1979, and 1989. This last one peaked at $205,000 in 2005, almost double the previous record highs. And while we have dropped 34% since then, to $135,000, we haven't even fallen tothe past all time highs yet. If you look at historical lows, my call for a further 25% slump looks positively bullish. We saw lows consistently around$66,000 in 1920, 1932, and 1942. Postwar lows came in at $105,000 in 1976,1983, and 1996. These figures suggest the best case low is down a further 28%,and the worst case is down another 51%. I think I'll go find something else to trade.

Jun 20 05:45 AM

[BostonObserver:]

As a data point for consideration --

In our town, 43 single family homes have sold this year. The collective sale price across this set was just 0.5% above assessed value -- but almost every home that sold was initially listed at 5-20% above assessment, so reductions were basically built into the pricing from the start. Hope spring eternal.

Then factor in the longer term outlook, with resets looming on Alt-A and Option ARM mortgages, which I know became increasingly popular in our town during the 2004-2007 period. What does this mean for the next few years?

There are a dozen homes on the market now that I have an eye on (more for tracking purposes than any genuine in purchasing, given the prices). These dozen houses are collectively listed 9% above assessed value, so again they appear to be overpriced from the start -- and most have been sitting for 100 days or more already. Looking at comp sales for single family homes since January, these houses need to fall in price by at least 10% before they will sell.

Then I try to consider "fair value" on these houses (knowing of course that value is determined by whatever someone is willing pay). If I roll back to the assessed value of these dozen houses ten years ago, and then inflate the value forward at 5% per annum (generous by historical measures), the outcome implies a potential price decline not of 10%, but 20%.

I readily admit that this may be wishful thinking (I am a renter looking to buy), but it seems logical. Allowing for 5% annual price growth since 1999 on the set of homes I'm tracking today sets target prices that are 20% below current asking. It will be very interesting to see how this plays out.

Jun 20 10:48 AM

[MGA_1:]

Yep... this isn't looking pretty. So, is the $2 trillion the govt is pushing on the open market going to push up interest rates?

Jun 20 11:40 AM

[ksmithdc:]

Interesting read, thanks.

Jun 20 12:34 PM

[Alphameister:]

There remains an ugly mess facing banks for the next two years or more, but the sense of panic is gone, the economy seems headed for at least a weak recovery in the short run, banks have been able to raise capital and to make money by borrowing free money to lend out at highly profitable rates, and it's not as if this chart is unknown to those with the responsibility for ameliorating consequences.

Jun 20 12:56 PM

[Fighting Yoda:]

It is just not At-A, next also is prime. There was last month's MBA (Mortgage Bankers Assn) report suggesting prime mortgages are likely to default- job losses, lack of financing, investment properties.

Jun 20 05:05 PM

[Northstar10000:]

Could spell trouble !!@#@#

Jun 20 06:44 PM

[Steve Soden:]

Get a grip!
I have my Condo sold in the Bay Area for $165,000, the appraisal came in at $135,000 the last Short Sale.
There were higher offers on the $135,000 property but The Realtor would not present them to the bank @ $145,000, a rigged sale.
Now investors are driving appraisals even lower while The Banks
are now accepting cash offers over financed ones.
We will not hit bottom until The Investors are done, 2011?
You can rent my unit 2 Bdm 1 1/2 Bath remodeled for $1250, nice place about 35 Min. from Downtown SF, swimming pool.
What a bunch of crap!

Jun 20 07:40 PM

[2houndz:]

TB1000 - The nominal interest rate is only half the story. A large number of ALT-A mortgage holders are underwater - their balance is greater than the value of the house at the amount of leverage needed to refinance, so unless they can write a big equity check, they can't refinance at any rate.


On Jun 19 01:47 PM TB1000 wrote:

> Resetting ARMs shouldn't be much of a problem right now as LIBOR
> has dropped to near historical lows. The problem in 2006/2007 was
> that LIBOR spiked several % points so when the ARMs reset, the payments
> were drastically higher and unaffordable for many.
>
> While immediate interest rate risk is somewhat taken off the table,
> it doesn't mean that the overall effects of the economy (layoffs,
> wage decreases, etc) won't negatively affect the ability of a homeowner
> to continue to pay their mortgage or have the means to refinance
> into a solid fixed rate.

Jun 21 02:47 PM

[punk_ash:]

Good point, but is it not that these home owners will have to refinance and they will not be able to do that since some of them could have the negative equity and they need some good amount of money to get the fixed loan.

On Jun 19 01:47 PM TB1000 wrote:

> Resetting ARMs shouldn't be much of a problem right now as LIBOR
> has dropped to near historical lows. The problem in 2006/2007 was
> that LIBOR spiked several % points so when the ARMs reset, the payments
> were drastically higher and unaffordable for many.
>
> While immediate interest rate risk is somewhat taken off the table,
> it doesn't mean that the overall effects of the economy (layoffs,
> wage decreases, etc) won't negatively affect the ability of a homeowner
> to continue to pay their mortgage or have the means to refinance
> into a solid fixed rate.

Jun 22 12:41 AM

[driftwood2:]

People should also keep in mind that Option Arms are mostly located in california and a few adjacent states. It's going to get very ugly over there. The rest of the nation will have a much easier time with residential real estate since they only have alt-a resets to deal with going forward. Unfortunately, commercial real estate will be a big problem soon.

Jun 22 01:28 AM

[markfl:]

If you compare forecasts from three sources over the past week or so, it's easy to see that economic growth, if it occurs in 2010, is not likely to be much better than 1%. We might get lucky, but there are substantial headwinds. Any positive growth this year seems more optimistic than probable. Alt-A is simply superimposed thereon. Current government policies operate on the unproved assumption of a reasonable recovery of about 2% next year. The familar "prosperity is around the corner" mantra. If it doesn't happen, you'd be lucky if you only had 2011 unemployment at 10% in California. Nevertheless, the state can't plan their responsibilities much beyond one week, to say nothing of 2 years. The downside risks are being understated by the media's desire to feed a public hunger for optimism. This does them a disservice.

Here are a few quotes for perspective:
"In its annual report on the world's biggest economy, the IMF projected US gross domestic product (GDP) would shrink at an annualized rate of 2.5 percent in 2009 and post modest 0.75 percent growth in 2010." .75 percent is so weak you couldn't find it with a microscope.

"The IMF estimates were less rosy [no kidding] than the latest US official figures. The Federal Reserve on May 20 estimated the economy would contract between 1.3-2.0 percent in 2009, in the worst downturn in decades, and grow at a modest pace between 2.0-3.0 percent in 2010."

However, "[t]he World Bank, which has recently cut its forecast for the global economy to a contraction of 2.9 percent from a
projection for a 1.7 percent decline set in March, released
details on individual economies for the first time on Monday." Those details revised the US downward to a 3% 2009 contraction, and downward to 1.8% growth in 2010.

I try to constrain my opinion and look at evidence. WHATEVER happens with employment and housing, and it doesn't look great in the near-term, I think you can make an excellent case that popluar assumptions are unrealistically positive. By unrealistic I mean "how about the US press undertakes a reality check of 1.5 growth for 2010?" I think they're afraid to do so. FWIW, World Bank has the Euro Zone at a real break-neck .5% positive growth in 2010. Almost statistically insignificant. No job growth--nothing of perceptible gain.
Time after time, decade after decade, governments and markets choose to see only what is convenient, and ignore balanced analysis from multiple sources.

Any bets on the chances the US federal budget will balance in 5 years? How 'bout all that health care savings? No chance, none. And yet they will repeat their rosy assumptions over and over.

Jun 22 03:35 AM

[PainfullyAware:]

Ryan Vonzo - It is good to see this chart keep circulating.

Things Are Not Well And The Children In DC Are Still Pretending.

Jun 22 09:19 PM