In 2008 interest rates will be reset upward on $362 billion worth of adjustable-rate subprime mortgages [ARMs] -- a scenario that could significantly worsen the already serious subprime crisis, according to a report in Saturday's Wall Street Journal. While many believe rate resets have been the main culprit in the crisis to date, more than half of existing subprime delinquencies occurred in their mortgages' first year, before the rates changed. The "real crest of the reset wave" has yet to take place, which "promises more pain for borrowers, lenders and Wall Street." "The initial wave was largely driven by a higher frequency of fraudulent loans... and loose underwriting," said Larry Litton, CEO of Litton Loan Servicing. The reset surge will likely intensify political pressure to take the heat off borrowers caught by rate adjustments and unable to refinance or sell their homes in the current environment. FDIC Chairman Sheila Bair is urging lenders to find ways to help borrowers keep their homes, and the issue is becoming a talking point among presidential and congressional candidates. "Keep it at the starter rate," Bair said in October. "Convert it into a fixed rate. Make it permanent. And get on with it." In addition to the $362 billion of subprime ARMs, $152 billion of other adjustable-rate loans are scheduled to reset in 2008, including jumbo mortgages and Alt-A loans. The Mortgage Bankers Association estimates that 1.35 million homes will enter foreclosure in 2007 and another 1.44 million in 2008, up from 705,000 in 2005. The anticipated supply of foreclosed homes constitutes approximately 45% of existing home sales and could add four months to the existing homes inventory -- a "fundamental shift" in the housing supply, according to Bear Stearns senior MD Dale Westhoff.
Commentary: Ultra Short Financials Proshares ETF: Profit From the Housing Bubble • 2008 Housing: Increased Defaults, Decreased Prices • Paulson Offers Gloomier Outlook for Home-Loan Defaults • Follow-up on Expensive ARMs
Stocks to watch: SKF, SPY, DIA, QQQQ, XHB, ITB, ICF, IYR
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