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Thread: weekend commentary - subprime defaults will seem minor ...

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    Default weekend commentary - subprime defaults will seem minor ...

    compared to the time bomb of coming defaults by PRIME mortgage holders ...



    (snip)"There really has not been much mentioned in the MSM about one of the Crazy Aunts, pay option ARMS, made almost exclusively to “prime” borrowers. The LA Times finally got around to writing a good article about them. One of the data points I was wondering about was mentioned, and that’s the number of Crazies who are making minimum payments. The answer is a rather stunning 75%. This means that negative amortization is piling on to pay option ARMs loan balances at the rate of 4-5% a year.

    In fact, more than 75% of option ARM borrowers have been making only the minimum payments, analysts at Standard & Poor’s Corp. said last week.

    As payment requirements are scant, delinquencies have been relatively contained to date. Since nobody has ever made any real attempt to discount the future beyond the three month old data released by financial firms, this Crazy Aunt has stayed in the attic. But behind closed doors she is ripping all the bathroom fixtures off the walls.

    The initial low payments on option ARMs have kept a lid on serious delinquencies — 3.7% of all option ARMs, Standard & Poor’s analysts said in a report last week. That’s higher than before, but still low compared with the 6.3% delinquency rate on loans to good-credit borrowers with so-called hybrid ARMs, which have a low fixed rate for two to 10 years before becoming adjustable-rate loans.

    Of course it doesn’t take rocket science to see that these are time bombs. Pay option ARMs almost always have two trigger points when they “suddenly” revert to regular amortization loans. At that point monthly payments will at least double. Those triggers are when the loan balance reaches 110% and 115% of the initial loan balance. I have never been able to locate the data on how many are 110s versus 115, so let’s just assume 50/50. If it’s 110%, you can look at the next chart, and see when 75% of the amounts will reset. 4-5% a year of neg am means 2-2.5 years for 110ers, and 3-4 years for 115ers. 75% making minimum payments from the 2005 group is $180 billion. Late 2008-2009 becomes the trigger for the 115ers, and starting late 2007 for the 110ers. But then comes the 110ers in the 2006 cohort, followed by the 115ers going into 2009. Some of the 2006 110ers will start triggering in late 2008. The amounts involved are not as much as for subprime, but more lethal to the lender, as the loan balance has increased significantly. And actually the later resets with 115% triggers will be even worse for the lenders, promising lousy recoveries."

    Of course this is just the effect of the additional balances. Even the lagging housing price reporters like Shiller have finally been using 6.1% national price drops on their Big Chief writing tablets. In locales where neg ams are used aggressively it’s even more. So even using that ludicrous Shiller estimate, we begin to see just how underwater these loans are. And connecting the dots on affordability comes this from Christopher Thornberg on California prices.

    By 2006, the cost of that same house doubled, to $540,000 — pushed by unbridled speculation fueled by unparalleled access to mortgage capital. But median income rose a paltry 15%. So today that same set of costs come to 60% of gross income.

    Incredibly the minds like steel traps at Countrywide et al, or more accurately their financiers, have come to the realization that this just doesn’t add up, and have closed the barn door on the whole tawdry affair.

    Had those guidelines been in effect previously, Countrywide recently said, it would have rejected 89% of the option ARM loans it made in 2006, amounting to $64 billion, and $74 billion, or 83%, of those it made in 2005.(snip)




    As usual, Russ Winter has managed to provide an early warning for the next great 'stealth' risk factor to the US economy. Take a minute to digest his point ... that aside from the subprime borrowers who will be bankrupted by their ARM resets, there are also untold numbers of PRIME borrowers who are currently cruising along via not only paying a 'teaser' interest rate on their Pay Option ARM's, but who are also allowing the principal balance of their mortgage loan to increase via negative amortization due to making minimum payments on their Pay Option ARM's. This is happening at the same time that the market value of their collateral i.e. their house is also falling.

    As Russ further points out, the Pay Option ARM's have provisions which force a reset in monthly payments when the outstanding principal balance hits 110% or 115% of the original mortgage - and that these forced resets will begin to occur in 2008 but will really start hitting in force in 2009. If you figure that 2009 real estate market values will have dropped by 10%-15% since the Pay Option ARM's were written in 2005-2006, and also figure that the amount of outstanding mortgage principal will have risen by 10%-15% due to 75% of Pay Option ARM borrowers making only minimum payments, this will absolutely lead to a situation where PRIME borrowers will face a situation where their mortgage payments will more than double at a time when they have a deep underwater situation in terms of negative equity (with many loans likely to be underwater by 20-30% ( = $100k-$150k-$200k on a median priced home).

    The obvious conclusion is that by 2009 these PRIME borrowers will choose bankruptcy as the only means available to escape from their underwater mortgages with their IRA's / 401k's intact. The just as obvious implication is that banks and foreign lenders who thought that they were 'safe' by loaning / investing only in PRIME credit markets will also get smoked by mounting losses. And as Russ points out, while the dollar volume of total loans is less than subprime, the dollar volume of probable losses to banks and foreign lenders will be much higher due to the additional 10%-15% that negative am has added to mortgage loan principal thus gap between outstanding loan balances and recoverable value of collateral. This development will dwarf the fallout from subprime defaults / bankruptcies, and will ultimately be the end for under 20% down payments and 'affordable' loan interest rates on loans of all types for ALL would-be borrowers - subprime, Alt-A and prime.

    ~
    Last edited by Melonie; 12-30-2007 at 07:12 AM.

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    Default Re: weekend commentary - subprime defaults will seem minor ...

    and here's why we're not just talking about mortgage loans but auto loans and credit cards as well ...

    (snip)"Similar to the home buying market, lax lending standards in the automobile marketplace have led to gross distortions that must be painfully corrected. For years standard practice allowed millions of car buyers to trade in old cars (that were worth less then outstanding loans), and roll the balances into new low interest rate loans for new cars. Although these "E-Z" financing terms allowed many over-stretched buyers to stay current on their debts, and vendors to move bloated inventories, they immediately saddled lenders with loans that far exceeded the value of the collateral. Such a situation encourages defaults and is toxic to lenders. Vendor financing (especially with publicly traded companies focused on short-term results) compounded the problem as conflicts of interest encouraged lenders to sweep these problems under the rug.

    The same phenomena also occurred with credit cards. For years, low short-term interest rates and low defaults encouraged banks to aggressively seek new customers. The competition became so intense that balance transfer wars enabled debtors to constantly stay one step ahead of default by transferring their balances to new issuers who often permitted low, or zero, interest for up to six months. When the teaser periods expired there was always another card company willing to accept a balance transfer on similarly friendly terms.

    For a while at least, this high wire lending act in the auto and credit card sectors was kept aloft by repeated waves of mortgage refis in which extracted home equity was used to consolidate other consumer debts. By turning higher interest rate, non-tax-deductible consumer debt into lower rate, tax deductible mortgage debt, consumers were able to temporarily manage their debts. In addition, since home equity extractions often exceeded the amounts of other debts, the extra cash in homeowner's pockets temporarily made higher mortgage payments more affordable. Plus with their credit cards paid off, card holders were not only free to run their balances back up again, but their improved credit scores resulted in even more credit card offers.

    Because defaults were low, bonds backed by auto loans and credit card debt were rated AAA, allowing Wall Street to easily package the debt for investors. However this is all coming to an end. Lenders, burned by subprime losses are cutting back. The home equity ATM has been shutdown and credit card and auto loan delinquencies are already at record highs. In fact, to make up for losses, credit card companies have been raising their rates, thus compounding the problems for those struggling to pay. Auto lenders will no longer allow potential buyers to roll their negative auto equity into new loans.

    It was inevitable that all of this debt would eventually catch up to us. Americans are now so upside down on their auto loans that new car sales will collapse; and when many loans go sour lien holders will be stuck with substantial losses on repossessed vehicles. As the music finally stops for serial credit card balance transferors, the inability to renew low teaser rates means that fewer borrowers will be able to afford their payments.

    As delinquencies continue to rise rating agencies will downgrade bonds backed by auto loans and credit card debt, inflicting subprime type losses on a much wider scale. As defaults increase and losses mount, credit will tighten like a noose around the neck of America's consumer based economy. Just as subprime homebuyers are being shut out of the housing market, soon Americans will find that their credit is no longer good at car dealerships or department stores. American consumers that want to buy will need to be prepared to pay cash.


    The bottom line is that a host of factors that temporarily allowed default risks to be underestimated and credit to be miss-priced have disappeared. As a result, Americans have simply borrowed more money then they can possibly repay. Ratings agencies once again missed the boat by feeding garbage data into computer models and blindly accepting what came out."(snip)

    from

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