A "classic double bubble"

Good morning. Repeat after me: It's not just a sub-prime mortgage crisis, it's a mortgage crisis. Or, as PIMCO's Paul McCulley writes, it's a "classic double bubble" -- one bubble is the asset, the other bubble is the lending against that asset.

One bubble is housing, the other is mortgage lending. Not just sub-prime lending. All of it.

If you don't believe me, read E. Scott Reckard's piece in today's L.A. Times about growing troubles with Option ARMs.

Option ARMs, Reckard writes, "were the easiest and most profitable home loans for lenders and brokers to make for much of this decade."

Why did borrowers like them? Simple: Option ARMs allow you to buy maximum house for minimum initial monthly payment. They are not particularly complicated or confusing. You buy now and pay later.

"... more than 75% of option ARM borrowers have been making only the minimum payments, analysts at Standard & Poor's Corp. said last week. As a result, the delinquency rate on option ARMs already is jumping and is likely to keep rising sharply, S&P said."

Why was there a bubble in mortgage lending? Because mortgage lending, particularly products like option ARMs, was wildly, shockingly profitable. According to John Diamond, a Chino broker, while a broker might earn $4,500 for selling a $300,000 fixed-rate loan, the commission could total $12,000 on an option ARM of the same size. "These loans drove the whole industry from late 1999 through late 2006," Diamond said. "It was just about the only thing any broker wanted to sell."

Don't blame just the brokers. Borrowers wanted these things.

Your thoughts? Comments? Insights? E-mail story tips to peter.viles@latimes.com.

Comments

[RealityHitsHard]

Frankly, I feel stupid and embarassed. We refinanced about one year ago to get out from under one of these ARMs with a reset after 2 years. I was happy that we finally got a 30 year fixed loan. After reading the recent article in the L.A. Times on Option ARMs I did some research and found out I was given an Option ARM by the broker that helped us. I feel stupid yes, however I'm not a stupid person. The broker that gave us this option new what he was doing; he was trying to push what would give him the most commission. I was conned into believing everything he told us. I take responsibility for not doing my homework, however the dishonesty and greed just amazes me. My heart sinks at the thought of losing this house. It is what it is, you live and learn.

[Uncle Billy]

For all those who don't believe that a lot of folks were scammed heavily with option arms, feed on this:

Borrowers with good credit, and full doc loans in general were given loans based on libor, mta, cofi etc. with a spread of 2 percent over these indices. There is tell of subprime and alt-a borrowers given spreads of 6 points over these indices. As the indices are centered about 4.75% currently, the prime borrowers are at about 6.75-7.5% depending on how much they were gouged. The more naive borrowers with their much larger hidden spreads are going to be at a whopping 10-11%.

Ay Dios Mio

[toby]

Why is it that where there's a Bush, there's a Banking crisis? Is Neil apart of this one too?

[shockg]

Vile Peter, repeat after me " I am a biased housing crash cheerleader who can't get my facts straight"

[sunsetbeachguy]

I see the trolls/permabulls from the OC Register blog are filtering over to the LA Times blog.

They sure are angry. Which menas they are only at step 2 of 5 on the Kubler-Ross grieving model. Bargaining is next, followed by depression and lastly to acceptance. The housing bubble is bursting.

Next stop reversion to the mean.

Peter:

Keep the moderation up, OCR's RE blogs really jumped the shark after moderation stopped.

[David Raether]

As recently as 2002 (just five years ago!) the average cost of a mortgage was 35% of median household income in Los Angeles. We had a normal marketplace with normalized transactions based on solid lending standards.

Last summer, the average cost of a mortgage as a percent of median household income was 65%.

We've had five years of an abnormal market.

Prices have to come down to a point in which a normal family income can afford a normal family home.

So... do the math: how far down does that mean this market have to go?

Pretty simple calculation, isn't it?

[Ann]

LAT is a litle behind the news curve on this one.

The Credit Suisse chart has been floating around for over a year.

Marketwatch covered the implications of Option-ARMS and Hybrid-ARMs (Option for 3-5 years with a reset into an ARM with principal repayments) nearly a month ago.

http://blogs.marketwatch.com/greenberg/2007/12/
straight-talk-on-the-mortgage-mess-from-an-insider/

Scary data in that article.

"75% of Option ARM borrowers make the minimum monthly payment. Eighty percent-plus are stated income/asset. Average combined loan-to-value are at or above 90%. The majority done in the past few years have second mortgages behind them. "

NINJA-Liar's loans...... 80/20s with the the primary loan an Option ARM......high LTV to start with.....

"The 3/1, 5/1, 7/1 and 10/1 hybrid interest-only ARMS will reset in droves beginning now. These are loans that are fixed at a low introductory interest only rate for three, five, seven or 10 years — then turn into a fully indexed payment rate that adjusts annually thereafter. They first got really popular in 2003. Wells Fargo led the pack in these but many people have them. The resets first began with the 3/1 last year.

The 5/1 was the most popular by far, so those start to reset heavily in 2008. These were considered ‘prime’ but Wells and many others would do 95%-100% to $1 million at a 620 score with nearly as low of a rate as if you had a 750 score. No income or asset versions of this loan were available at a negligible bump in fee. This does not sound too ‘prime’ to me. These loans were mostly Jumbo in higher priced states such as California."

The prime ARMS are over double in number the subprime ARMs.

http://online.wsj.com/article/SB11969621600071
5924.html?mod=hpp_us_whats_news

------

On another note, please relay something to the LAT guest columnist Sarah Miller who wrote: "If you can't say something nice ..." at http://www.latimes.com/news/opinion/commentary
/la-oe-housingtalk28dec28,0,1667536.story?coll=la-news-comment-opinions

She moans and whines that she doesn't want to hear people talking about housing prices are falling and those that who bought at the top of th emarket with risky financing are fools who will soon be parted from their money because of falling prices and values.

Please relay to her:

Do NOT whine.

Do NOT complain.

You and your ilk did NOT do unto others as you now wish they would do unto you. In fact you boasted long and loudly about how much your house and 'appreciated' and preened about 'how clever you were'; shrieked the 'buy now or be priced out forever mantra'; and said those who opted to rent when buying the same house cost more than renting it were 'fools'.

Pretty obvious that Miller was expecting never-ending appreciation at unheard of rates to in order to:

(1) Use a HELOC to pay for the kids' private schools
(2) Fund retirement by 'flipping' at the right time
(3) Generally maintain her lifestyle through real estate speculation and HELOCs

In the end she she compares hearing the economic realities about the housing market to getting a cancer diagnosis with this comment:

"If I am indeed screwed, I would prefer that whoever brings this to my attention does so with less obvious relish. I would rather hear someone assess my risk of cancer and, truly, it would be about as appropriate."

Sorry but (1) having cancer is an involutary situation. Making stupid financial decisons is completely voluntary. (2) She undoubtedly did not refrain from 'relishing' the paper value of he house in 2003, 2004, or 2005 and doing so long and loudly - kind costs her any sympathy.

"

[Raul X. Garcia]

Cognitive dissonance, figured the would come into play here.

Bush is the one who went to the Fed to lower the rates, selling home ownership as the American dream to boost a faltering economy and help finance his buddies at Haliburton.

What a sad state of affairs and such denial. The purchase of rope and plastic bags, duct tape and pistols must be at a all time prime.

Hope people use the suicide hot line before they go for the 'big sleep'.

Good time to invest in 3M and Smith and Wesson.

[AJ]

Amir,
You are right on.
Everybody was jumping on the band wagon/train when it was financially lucrative. Now everybody is jumping off the train and blaming anyone they can find. This is a train wreck and needs a forensic eye to figure it out.

[AJ]

Ben Brown,
I appreciate your comments. But is unbelievable to even imagine that any financial institution would even consider it.
Number 1: If it is an emergency where is the money for the taxes and insurance. remember there used to be "escrow" for this same reason.
In the old world the lender would require usually six months in reserve.
Number 2: Why? for three years? Crazy. They are not going to do it.
If the borrower is in default there is probably a very good reason. They never could afford the house from the beginning. Whose to blame? That should be judged on a case by case system. Don't generalize. Although there is a tendency to judge the borrower alongside the lender these days. For truth or lending... what a concept!
AJ

[producer08]

What do you think of the fractional ownership component, it is starting to pop up on a lot of highend home properties, example for 2MM you can live in a 12MM estate all taxes fees maintence paid for, you can live there for 2 months out of evey year.

Do you think this new idea will keep the prices up ?

[Robert S. Hoover]

Someone wrote:
>The biggest pump and dump in the history of the world created by the most corrupt regime in US History.<

Actually, the key elements were in place before the present Administration took office. But the rest of it is true enough. It is neither honest, honorable nor ethical but easy virtue -- at every level -- has simply become a cost of doing business in America. In effect, laws, rules and regulations have been reduced to a commodity. Anyone bright enough not to pee on their shoes understands that such a system is bound to implode.

[Kathryn]

One thing is that a lot of people in LA have the rental mentality, they don't want to own, they just want a house. Option ARMs gave buyers the option of not paying principal and being able to make the lowest payment possible.

I'm a practical midwesterner, when I bought my house, I put more than 20% down and wanted to pay off my mortgage as quickly as possible, so when rates went down, I refinanced, I got a 15 year loan and pay extra to the principal each month. I can't tell you how many people warned against this, saying that I was going to be house rich and cash poor. So many investment types don't think people should tie up money in a house and instead should invest in the stock market, etc. And in truth, it's much easier to walk away from a property you have no money invested in it.

I don't think brokers are entirely to blame. I think the borrowers got way too use to looking at the cost of a house based on the payment, not the total cost. It's just like with car sales, too many buyers just go for the deal where they can get into the car they want for a cheap monthly payment, regardless of how ridicules the terms of the loan are. As long as they get what they want and can make the payment, it's all good.

What loan brokers didn't tell borrowers was the other costs of owning a house. Most borrowers are getting hit with PMI, points, huge property tax bills, often large HOA fees, insurance, etc. Owning a home is not cheap, especially in LA. Lenders should require to do impound accounts for taxes and insurance. That would be a real reality check for many buyers.

[fly]

Today, I had a lady discuss with me her sad story about her LA realty adventures. She refinanced her LA house to the max, took the funds and moved to AZ. Now she cannot make the LA house payments and they are going to foreclose on it -she lives in AZ. There are a number of poor people, similar to this lady who have fallen victim to the fast talking bank agents and too good to be true schemes. I think it a good idea that Congress is trying to protect them. Maybe even taking all the houses away from the people who never refinanced, who did not cash out, who were not involved in fraud, and giving these poor people our houses. Or maybe forgiving all their RE debts, then let the Feds rescue the banks, then raise our taxes. That works!

[joeinlosangeles]

Personally, I wouldn't even think of buying a house in Los Angeles in the next nine months.

--Things actually look pretty good for the next six-eight months or so, which could prompt a false sense that, "Hey, we're through the worst of this" and actually ignite a "sucker's rally" in housing. Do NOT believe it.--

[Dominic Smith]

Figuring out who you can blame isn't going to get your money back. If anybody gets bailed out its going to be the lenders/investors who own congressmen and women.
Time to take a bath if you've come up holding the loosing hand in the money game. Seems to me only the mortgage brokers made out well on most of these transactions. I remember taking one hell of a bath when the tech bubble burst, I had discovered margin trading. Well, leveraged buying of a home sort of the same deal, isn't it? As one who owns a few properties and reads this blog and all the comments every day I have to say it's been the best education into the ins and outs of the real estate finance world. Sort of like learning what car dealers do to the marks that walk in the door, most of whom never figuring out they've been done.
Thanks Peter for this great forum.

[Patrick]

I often wondered how so many people could afford all these NEW homes at such young ages. I am in my mid-40's, college educated, and have never made the type of income that in my opinion would allow me to purchase a home. I was under the opinion one had to have a good income to purchase a home, didn't understand about those ARM's. Glad I didn't or I would be one of those people in crises today.

A lot of this can be blamed on the way housing is purchased and financed using "commissioned" sales people. The mortgage, and real estate industries need a change in business model.

[producer08]

check out this link

http://www.greenmarkinvestments.com/
wholesale_homes.htm?page=6&pagegroup=1

50 cents mansions asking price is 12MM ? I thought he was asking 20MM for it.

Now that site is a wholesale homes site, do you get a 50% discount when you buy homes at wholesale ?

If you buy a mansion for half off can you live in it ?

[jman]

My friend the LA based mortgage broker called all the lending in the mid-decade a huge "House of Cards". No foolin'!

[Duken4evr]

I agree with the previous postings about plenty of blame to go around. Lenders mislead people, buyers were foolish and it was lunacy for the financial markets to buy the collateralized debt objects (CDOs) created from these ill advised loans.

I read that there is about collectively about $1 in actual cash for every $30 loaned out . No wonder there is a credit crunch. We are in the early innings of this mess and there will be massive write downs at the financial institutions. We have seen this already, and it is just the beginning.

My attitude is to take what the market gives me and play it to my advantage. I sold my SoCal house, which I bought in 1996, in 2004 for a tidy multi six figure tax free profit and moved to a beautiful home in Colorado with a 135K mortgage and a six figure investment portfolio to manage. Given the storm coming, it is heavily in cash and bear market funds. This required changing jobs and it was a lot of work, but I think it was worth it.

The real estate bubble was foolish. I am doing my best to preserve the resulting windfall and profit from it. From where I sit, it amazes me any long term homeowner would stay in CA and watch their sudden increase in equity evaporate...

[poorpoorsarah]

Sarah. Sorry, you're going to lose equity. Now shut up and pay your upsidedown mortgage.

Not buy in 9 months? There is currently a year and a half's inventory out there. By summer it will be 3 years. Until that inventory is liquidated, you are overpaying for your So Cal shack.

[Michael Snyder]

Cal gets the "Hammer Award" for striking the nail square on the head. Commission myopia seems to have blinded many a broker who should have known better and as I've said, cash in your pocket plus a lower payment is a powerful pitch.
There's plenty of blame to go around but I tend to hold the professionals responsible for this mess. There's no way you can convince me a licensed loan broker wouldn't know these instruments were ticking time bombs. You will be even harder pressed to prove the people who bundled these loans weren't aware of their toxic nature or they'd be able to track individual loans to individual investors.
My "love" of the current administration is well documented but make no mistake; even a corrupt bunch of incompetents like the "Bush Brain Trust" couldn't cook this one up on their own. This mess had its' genesis in the Regan administration and didn't really gain legs before Clinton. King George just stood by and did nothing as his Wall St. supporters recouped their investments in his campaign. Now he's scrambling to avoid a depression on his watch.
Just as the mathematics of quantum physics expresses the essence of Zen thinking, there is no effective way to separate economics and politics.
Thomas Payne said, "The government controls our vices." And it seems the number one vice is unbridled greed. To regulate underwriting standards is a fools errand and the government prints the money anyway. Again Cal has the right idea in educating his clients. I'm betting he's the exception to the rule.
Most martial combinations contain at least three blows. Double bubble sticks to your mustache. What we're looking at here is the second blow in the combination. The knockout punch will likely come in the second quarter as credit card defaults fueled by crumbling equity rears its' ugly head.

Peter,
As I don't agree with many of my fellow bloggers, I'm sure the feeling is mutual. I enjoy the "edge" that brings to the conversation in this venue. There is real wisdom to be winnowed from the chaff in these threads and with the exception of threats and obscenities I believe everybody has the right to express themselves. It's important to remember in Nazi Germany everybody was "politically correct."

[Leavin' LA]

Congrats, Micheal! You invoked the word "Nazi", so this thread is officially over, thanks to Godwin's Law.

[Bianca Lohrey]

Perhaps too many people believed that the line "greed is good" from the film Wall Street. It never was it never will be...and oh, the price that all are about to pay. The domino effect is in the process.

[William Allen]

Bubbles have a long and colorful history. There was the South Sea bubble, tulip mania, 1929, the tech bubble. They all have the same characteristics which I will not repeat here. But by studying these bubbles, you can reliably make money on the way up and the way down if you have dispassionate personality.

There is plenty of opportunity to make up the money you may have lost during the burst on the way down with this bubble.