Option ARMs Still a Gaping Hole

Hmmmm....

Despite that fact, delinquencies have moved steadily higher with the 30 day + delinquency now reaching close to 50% of all outstanding Option Arms.

"I told you so!"

These loans were never designed to lead to actual home ownership.

They were sold as a means to "buy" a home, but the lenders knew full well that this could never, ever happen given the structure of the note.

These notes were more akin to a levered bet placed on commercial real estate, in that they were worse than the typical commercial "interest-only" loan in their inclusion of a requirement that values continually increase to stay ahead of the negative amortization.

These loans cannot be cured.

The typical OptionARM customer was qualified on the initial rate on the minimum payment, which was usually 2%, interest-only.

For a typical $500,000 California or Florida home, this resulted in a monthly payment requirement of roughly $850 (2% of $500,000 is $833 a month.)

The "real rate", however, on the loan was typically around 6 or 7%, and the rest of the principal and interest was "capitalized". If the amortizing rate was 6% on the note then the P&I for a "full payment" would be $2,982.83, resulting in about $2,100 a month in negative amortization.

If you try to "work these out" and manage to go "to the wall" on the note with a 40 year, 4% amortizing refinance, the note still comes up to $2,082.75 - more than a clean double of the original payment!

The "homeowner", however, can't afford the doubling of the payment. Further, the house isn't worth $500,000 any more - at best it is worth $300,000, which is a big part of why he stopped paying.

These notes were the worst sort of abuse and they're littering the landscape. I know people who have them here in Florida and have defaulted, and there are a scad load of them in California. My prediction originally was that half or more of them would wind up being worth recovery value at best, and this appears to be the case. Since these were nearly all written in the bubble areas, recovery will be fortunate to be 50% of face value.

How many of these are out there? Good question. I have seen numbers from $200 - $500 billion, all from reputable sources. Why don't we have an accurate number from the banks and Fed on these things?

In the "best case" this is another $50 billion in losses and about 25% of the homes purchased in bubble areas from 2003-2006. In the "worst case" this is well over another $100 billion in losses and perhaps as much as half of the homes purchased in those areas during the bubble years.

Either way you slice these losses have not been recognized or accounted for nor has their impact on home inventory and price.

Comments

[Leftfield:]

We don't have accurate numbers because this is so bad they can't come up with a "headline number" in this category they can spin positively into a green shoot. Goes into the memory hole until something blows up, and taxpayers get put on the hook to keep bonuses flowing to bankers who created and originated the mess.
Actually, this is one of many situations that cries out for clawback.

Oct 30 09:33 AM

[Donald Ingram:]

Foreclosures for 2009 expected at 2.4 million, estimate over the next four years at 8.1 million. This is a conservative number.
Existing home sales fell 5.4% last month, despite the nonsense you have read elsewhere. Home sales did not rebound, that was purely the result of seasonal adjustments.
After you dig beneath the "official" numbers issued by the department of propaganda and their collaborators, you come up with some assemblance of the truth which in no ways matches what the "official" release was.

Oct 30 11:22 AM

[Russ Wetherill:]

These loans are the main reason I still haven't bought a home in California. The Option ARM is operates as a five-year leasehold agreement with the remainder to revert to the lender upon nonpayment. It will take many more years for these loans to work their way through the system. Fortunately, there are a lot of really nice low-priced rental houses out there.

Many of these Option ARMs were a very good deal for the 'owner' since no money was required up front and 'rental payments' were far below market value. There was also the potential for great profits if the wager paid off. No real down side except for impact to their credit score. But, when you have bad credit to start with there really isn't a downside, is there?

And in California, thanks to California Code of Civil Procedure Section 580b, defaulting purchasers are not liable for a deficiency judgment, provided they don't refinance:

"No deficiency judgment shall lie in any event after a sale of
real property or an estate for years therein for failure of the
purchaser to complete his or her contract of sale, or under a deed of trust or mortgage given to the vendor to secure payment of the
balance of the purchase price of that real property or estate for
years therein, or under a deed of trust or mortgage on a dwelling for not more than four families given to a lender to secure repayment of a loan which was in fact used to pay all or part of the purchase price of that dwelling occupied, entirely or in part, by the purchaser.
Where both a chattel mortgage and a deed of trust or mortgage have been given to secure payment of the balance of the combined purchase price of both real and personal property, no deficiency judgment shall lie at any time under any one thereof if no deficiency judgment would lie under the deed of trust or mortgage on the real property or estate for years therein."

Oct 30 03:09 PM

[Jasper M:]

Lefty, you are substantially correct about 'clawbacks', but that is a slippery slope - such methodology is easily abused, and will necessarily be decided by law and the courts. And while those august institutions may decide for the benefit of the wronged, they will always decide for the benefit of themSelves. Remember the horror stories of RICO, under Bush the Elder?

Mr. Wetherill makes good point. California is what's called a "no recourse" state, where the property is all the creditor can recover. This seemed reasonable, when real estate could only go up, but it is going to end up really discouraging bank operations in Cali for some considerable time.

Oct 30 11:27 PM

[Seth Chalnick:]

While negam loans did comprise less than 25% of the purchases during the boom time (let alone 50%) I not only agree with the author's take on them, but actually stopped executing them back when they were still in vogue because they were simply insane. And it's also why I shorted the hell out of wamu and wachovia when they started to sink because they were the biggest players in this space. It will also be interesting to see how WF and Chase and BOA handle their 2 dollar deal of the century acquisitions as the derivatives come home to roost.

These loans are like guns. For the right party, i.e. a sophisticated investor in a steady 2-3% rising market, who has enough cash down to stay ahead of the cashflow curve... negams can be a useful tool. For most dumbass, short-sighted, misinformed greedy people this loan is disastrous.

Meantime, while these loans were thankfully the minority behind subprime, alt-A, and prime... just like people are coming out of the woodworks now proclaiming how crazy negam loans were... give it a few more months... and then we'll start to see the negam and yes, "prime" loans follow suit, with the public shock and outrage to follow. But they won't blame it on the fundamentals... nope, instead, they'll blame it on the subprime fallout bleeding into the prime markets.

And while derivatives continue to confuse the heck out of me... I still can't help but shake the notion that Wall St. didn't bake the downside into the subprime exposure... and now that everyone's talking about a real estate L shaped bottom... nobody wants to see the writing on the wall... that the true real estate capitulation has not even started yet. So what does this mean for derivatives... and the big Wall St. banks like Chase who hold a preposterous amount of them... and, in turn, the world financial markets?

This is why my VIX calls are still way out of the money after today’s huge increase... because I'm expecting it to push 70 before cashing out.

Many objective SA observers have been calling for this implosion for about 18 months now. It looks like the fundamentals are finally starting to catch up with the "trend is your friend" camp.

Oct 31 02:09 AM

[Jasper M:]

Mr. Chainelk, I am with you on those VIX calls! Sounds our strikes are neighbors . . .

Oct 31 02:55 AM

[ThePhoenix:]

Its better than that, taken together, sections 726, 580a, 580b, and 580d of the California Code of Civil Procedure constitute a comprehensive statutory scheme that specifically protects defaulting borrowers from being taken advantage of by overly aggressive lenders who may care more about making loans than protecting borrowers. If they do a non-judicial foreclosure in California, on non-purchase money, the one form of action rule kicks in and they cannot pursue a deficiency judgment as well. Where the problem lies is a sold out junior that is non-purchase money, they can pursue a deficiency. But so what, that is what Chapter 7 bankruptcy is for.


On Oct 30 03:09 PM Russ Wetherill wrote:

> These loans are the main reason I still haven't bought a home in
> California. The Option ARM is operates as a five-year leasehold agreement
> with the remainder to revert to the lender upon nonpayment. It will
> take many more years for these loans to work their way through the
> system. Fortunately, there are a lot of really nice low-priced rental
> houses out there.
>
> Many of these Option ARMs were a very good deal for the 'owner' since
> no money was required up front and 'rental payments' were far below
> market value. There was also the potential for great profits if the
> wager paid off. No real down side except for impact to their credit
> score. But, when you have bad credit to start with there really isn't
> a downside, is there?
>
> And in California, thanks to California Code of Civil Procedure Section
> 580b, defaulting purchasers are not liable for a deficiency judgment,
> provided they don't refinance:
>
> "No deficiency judgment shall lie in any event after a sale of<br/>real
> property or an estate for years therein for failure of the
> purchaser to complete his or her contract of sale, or under a deed
> of trust or mortgage given to the vendor to secure payment of the
>
> balance of the purchase price of that real property or estate for
>
> years therein, or under a deed of trust or mortgage on a dwelling
> for not more than four families given to a lender to secure repayment
> of a loan which was in fact used to pay all or part of the purchase
> price of that dwelling occupied, entirely or in part, by the purchaser.
>
> Where both a chattel mortgage and a deed of trust or mortgage have
> been given to secure payment of the balance of the combined purchase
> price of both real and personal property, no deficiency judgment
> shall lie at any time under any one thereof if no deficiency judgment
> would lie under the deed of trust or mortgage on the real property
> or estate for years therein."

Oct 31 10:39 AM

[TeresaE:]

I have heard of homes bought in the past 3 years with Option Arms. They didn't even stop them last year after the crash.

Most ARMs were Insanity at best. It sometimes looks like my husband and I were the only couple in America in 2004 that made sure our house payment was doable even in the worst of times (or so we thought - that "worst" is becoming more variable daily).

You just have to wonder, between increasing foreclosures, bankruptcies, commercial loans being restricted, regulation, forced taxation for "health" (and cap n' tax and unionism and etc. etc.), what are we going to look like in 3 years? How can we be strong and prosperous is 25% (or more) of our population can't afford food, housing or utilities?

Oct 31 10:56 AM

[artkarl:]

An interesting play would be SRS : AMEX.
This ETF shorts REITs.
-Karl Krachenberg

Nov 01 07:06 PM