The coming crisis that 'no bailout will solve'

We're at a point in the housing crisis where some stories have been written again and again and again (The Coming Option ARM Reset Crisis!). Sometimes, though, a new and compelling version of an old story comes along that is worth reading -- and this particular version of the "coming Option ARM crisis" story, from Slate.com, is worth the effort.

We all know of the massive pile of ARMs due to reset, with bad consequences. The Slate story stresses a new angle: The biggest, baddest, stinkiest pile of ARMs due to reset is in California, and home prices in California are dropping rapidly. Do the math: resetting mortgage payments plus recession plus falling home values equals... a potentially huge wave of homeowners walking away from their mortgages: "Unfortunately, the crisis in California is going to get much worse, and there is no bailout that will solve it. Why? Because if the first stage of the foreclosure crisis was about people who could not afford their mortgages, the next stage will be about people who have every reason not even to try to pay their mortgages."

More from Slate.com's Mark Gimein: "Over the next several months, we're going to be subjected to a chorus of hand-wringing about the moral turpitude of people who walk away from their mortgage..."

We've discussed this issue at length here, and many of you have argued that this is an economic issue, not a moral or ethical one. The lenders knew the risk when they made these loans that one day they might end up owning the house. That day is coming: "Lenders had no reservations about selling borrowers loans with rising payments that would be poisonous in a rising market. Now it seems borrowers have no reservations about leaving those lenders with the risks they begged to take."

This is the wave of jingle mail that scares Washington and Wall Street and is motivating federal policy discussion right now.

Worth reading. Your thoughts? Comments? Email story tips to peter.viles@latimes.com.
Hat tip: PS via email, others via comments.
Photo Credit: LATimes

Comments

[Corntrollio]

Not every ARM reset will be disastrous. Because of the recent Fed rate changes, some ARM customers will have lower payments, whereas others will have higher payments. See this link for a detailed analysis:
http://globaleconomicanalysis.blogspot.com/2008/
04/closer-look-at-arms-reset-problem.html

I do wonder about Option ARMs, since most of those mortgagors are making minimum payments. If people are only paying only interest or, worse, are having their loans negatively amortize, this could be the next disaster. There should be a lot of concern about when people actually have to start paying principal.

Some of these factors will take a few more years before we really know what's going on, and some of them might require the Fed to increase rates before they affect people.

[Fred]

I'm starting to agree that walking away is not a moral issue anymore. It's a business decision. Those who do will face penalties (and those penalties should DEFINITELY be increased - a foreclosure should never leave your credit report, and banks should be able to go after your other assets), but they shouldn't be jailed.

[firesale]

The key to reducing chaos are new laws that
will increase the penalty for walking away
from a debt. The 500 point/15-year hit on a
credit score. No credit of any kind during
the same term. Changing non-recourse to
recourse and allowing banks to seize or freeze
assets like the IRS. Alter bankrupcy laws to
permit this get tough approach. We need quickly
forged, sharp new financial tools to keep the
scum chained to their oars for a generation.
If they want their hands out of the shackles,
let them chop them off!

[LA in my rear view mirror]

It's absolutely an economic decision.

In 6 months, our LA monthly payment went from an affordable $2875 to $5110. Value dropped from $800K to $540K (based on the lender's appraisal). Lender's servicer refused to talk to us -- said they couldn't negotiate any changes. And they refused three short sale offers that would have left them whole.

They're gettin' the f'in keys. We filed BK. And we've started over in another part of the country. Losing our shirts in CA real estate actually works to our advantage here -- everyone understands and landlords don't hold it against us. Our FICO went up 80 points after we filed.

Buh-bye California. Hello freedom and excellent public schools.

[Chris]

The amount of return on investment is related to the risk of that investment. Banks were addicted to high fee and high interest loans. Now they will have to deal with the downside of the risk they took. Unless of course Karl W. Marx in the White House decides to bail them out.

[HulaGirl]

I used to be part of the morality chorus singing, "Low-lifes mailing back their keys, losers, losers".

But now, after seeing the big-business bailouts, I say stick it to the Man. Bad Gov. and big biz are going to stick it to us and we will be stuck for a very long time.

Wish I could walk away. Unfortunately, I put 30% down to keep my payments low. That's too much cash to walk away from..Today....

[peteviles]

To "LA in my rear view mirror" -- I'm interested in hearing more of your story. Email me if you have a chance, at peter.viles@latimes.com.

Thanks.

[D]

"Lenders had no reservations about selling borrowers loans with rising payments that would be poisonous in a rising market.

That should read "poisonous in a falling market"

right?

[D]

As of today the 1 year LIBOR rate is 2.64%
most ARMs are based on this index with a 2.5% margin
You do the math

[Trooper]

Anyone who bought with zero down in 2005 or 2006, should walk. Period. Mail in those keys people....get the monkey off your back.

[Lisa w]

How can you say the bottomfeeders should be forced to suffer when the banks and wall street are strapping on serious cash loans from fed shareholders or are getting bought up for pennies on the dollar by the same folks? Those massive profits didn't just dissapear, they are being shifted to the top feeders--National bank leaders/shareholders (Aka world bank leaders). This all began last May 2007 when the really wealthy suddenly put all their luxury homes on the market. Who tipped 'em off? Then in the Summer of 2007 (August) suddenly the top feeders called in their loans, forcing subprime lenders who had no liquidity, to pay them or give up their loan holdings (ie. mortgages). The Fed shareholders thought they were just creating a ripple in the pool and when they were through grabbing up the last 5 yrs of profits, all would smooth out again. Not to mention the panic that is created will allow the Fed to seize more power (the power to loan govt money to private raiders like Chase Manhattan to seize Bear Stearns) which they did. Some in the Govt are resisting this power play, and now Bernanke is touting raising interesrt rates in the name of inflation. It's a standoff between the invisible Uber-rich and the US Govt. Wake up. Go stock your pantries for 5 years of serious food shortages and stock up on medical supplies.

[are they crazy]

Rear View: If the payments would have started off at $5110/mo, would you have bought the house? I'm just wondering what made you buy an $800K house to begin with. If it were still worth $800K, but you couldn't sell, would you still walk away? If the payments stayed at $2875, but the house still declined in value as much, would you continue to pay and live there? I make no judgments about others finances, I just want to understand how you make the decision. At what point does it cross from a moral decision to a business decision?

[Geek Seek]

Lisa, whoa dude... hasn't been called Chase Manhattan for like 8 years.

The Manhattan Company, was founded in 1799 by Aaron Burr:

"Chase traces its history bank to the founding of The Manhattan Company in 1799:[1]

After an epidemic of yellow fever in 1798, in which coffins had been sold by itinerant vendors on street corners, Aaron Burr established the Manhattan Company, with the ostensible aim of bringing clean water to the city from the Bronx River but in fact designed as a front for the creation of New York's second bank, rivaling Alexander Hamilton's Bank of New York.

—The Economist[4]"

Supposedly, the pistols from the Burr/Hamilton duel are on display at the JPM Bank building

[Ace]

Rear view 'In 6 months, our LA monthly payment went from an affordable $2875 to $5110. Value dropped from $800K to $540K (based on the lender's appraisal).'

You gotta be kidding... you bought a $800k house and paid less than someone with a $500k mortgage. You didn't think that bill was coming due at some point?

[LA in my rear view mirror]

Ace: Of course we knew that. We had a couple of refis crash and burn. What we should have done was sell in Spring 2007 and pocket the profit.

[Laker]

In 2005 i was offered an Option ARM loan to buy one house that i claimed was not affordable to me. Even though i wanted the house, i knew that anything with ARM in it, smells bad. Also, i'm a kind of person that cares about purchase price not monthly payment when i buy a house or when buying a car. Since most people paid minimum on those Option ARMs, they would adjust/recast sooner than was planned by design. The idea is that if you pay interest only, it usually starts to adjust after 4-5 years. But paying minimum cuts this time a lot, as the balance gets closer to the 115% mark. However, as the Slate article stated, this will start showing on at the end of 2008 and more likely middle 2009...Option ARMs were used to by the $1M houses in the valley (for example), rest assured priced will be sliced by half as a result. You can simply find it by check that a $3000 a month as minimum Option ARM payment will buy TWO TIMES the same house as a 30 year fixed mortgage will.
That is $3000 of minimum Option ARM can buy $1,000,000 house.
A $3000 of fixed rate 30 year mortgage can buy $500,000 house.

[dilbert dogbert]

ace,
rear view learned a lesion, the lender learned a lesion. rear view got away not too badly injured and most likely the lender will not suffer too much. The us gov will bail the lender or who ever buys the lender. the rest of us who did not participate will pay. hope the bill is not too big.

[LA in my rear view mirror]

arethey and Ace: we didn't buy an $800K house. We bought a $450K house several years ago -- full-doc with a down payment -- and did a refi at $550k almost three years ago. Don't jump to conclusions you can't support.

[LA in my rear view mirror]

arethey and Ace: I didn't buy an $800K house. I bought a $450K house several years ago, full-doc with a down payment, and did a refi at $550k almost three years ago. Don't jump to conclusions you can't support.

[I Am Not Dead, So This Must Be LA]

Rearview

I would LOVE to know how I can also get a $2875 payment on an 800k house. Would that mean I can get a 400k house for a payment of $1437.50?

[JED]

the article is, actually, quite poor. see here for a reasoned critique -

http://calculatedrisk.blogspot.com/2008/
04/we-are-not-all-subprime-now-thank-you.html

[AB]

D:

I think the author meant to write:

"In a rising market, lenders had no reservations about selling borrowers loans with rising payments that would be poisonous (if the market fell)."

[MyLessThanPrimeBeef]

People used to complain (probably still do) that we eat too much, don't exercise and are too sedentary and now when we have a group of motivated homeowners prepared and eager to 'walk' or 'run,' and people still complain.

[Andrew Z]

No one seems to write an article about all the people who took cash out refi's and now have recourse loans. Unless I misunderstand the whole thing, won't these people (who many here rail against as getting SUVs and boob jobs) have to pay the lender back somehow?

[MBWatcher]

Forget the interest rate resets, it's the recasts that matter.

Simply switching from an I/O payment to an amortizing payment at the end of the rate lock can add $1k or much, much more to the monthly nut. This is a real hit; not as dramatic as the end of an "option" period but still a big increase.

Very smart and financially savvy people all over the place took out I/O loans with the belief that they'd never have to pay the amortizing payment because they could just re-fi out when the time came. Now: uh-oh.

The Slate story misses this aspect, which will be a more common toxic mix, IMHO, with lower property values, that will lead to defaults and jingle mail even among the middle and upper-middle class. (Can we talk about class?)