The subprime mortgage crisis just the beginning?

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Here Comes the Next Mortgage Crisis
Subprime was just the beginning. Wait until California's prime borrowers start handing their keys to the bank.
By Mark Gimein


California is to mortgage lending what Chicago is to pork bellies. For years, that meant it was a place with soaring house values; today, the foreclosure rate across the state is twice the national average and going up fast. Riverside County, outside Los Angeles, may be the foreclosure capital of the country, with a rate close to six times the national average. And housing prices are in freefall.

California should be the poster child for a mortgage-loan bailout. In few other places have so many taken on such onerous debts with so little equity. 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.

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 mortgages and pronouncements like last month's warning from Treasury Secretary Henry Paulson that people should honor their mortgage obligations. The problem with finger-wagging on what you "should" or "ought" to do is that, when it comes to money, you're usually given the lecture only when it's in your interest to do the opposite. Certainly, that's the case for all the California homeowners who in the next year or two are going to find themselves with the choice of whether, faced with a huge new wave of interest resets and a historic decline in the value of their homes, they will simply walk away.

First, those home prices: For a weird few months of the mortgage crisis, statisticians came up with peculiar numbers about home values, rolling out comforting stats showing single-digit declines. Well, that's over.

Last month, the California Realtors' association (folks who in October managed to "project" that prices would fall 4 percent in 2008) reported that, actually, California house prices in February fell 26 percent from a year ago. In the places where the foreclosure boom has hit hardest, it's worse.

A quick, almost random survey of some foreclosure prices in Southern and Central California:

* In San Bernardino, a house bought for $310,000 in 2005 is now being offered by the bank for $199,900.
* A 2,000-square-foot ranch house in Rancho Santa Margarita is down from $775,000 to $565,000.
* A starter home in Sacramento, sold for $215,000 in 2004, is now down to $129,900.

These are not sale prices. They are asking prices. Don't doubt that they are negotiable.

Unfortunately, when it comes to the California crash, these striking numbers are not the end. They are the beginning. (To give Paulson his due, he said that, too.) Which brings us to the other scary part of the California story: a coming wave of interest-rate resets in prime loans given to people with good credit that are just as bad, or worse, than we've seen in subprime.

The most common subprime loans were known as "2/28" in the industry: 30 years, including a two-year teaser rate before the interest rate rose. Now these loans have reset, and we're seeing the fallout.

But prime borrowers, too, got loans that started out with low payments; if you bought or refinanced your house in the last few years, it's not unlikely that you have one. With an "option ARM" loan you have the "option" (which most borrowers happily take) of paying less than the interest; the magic of "negative amortization." The loan grows until you hit a specified point—the exact point varies with the lender; with Countrywide, it'll come after about four and a half years—when the payment resets to close to twice where it was on Day 1.

Just two banks, Washington Mutual and Countrywide, wrote more than $300 billion worth of option ARMs in the three years from 2005 to 2007, concentrated in California. Others—IndyMac, Golden West (the creator of the option ARM, and now a part of Wachovia)—wrote many billions more. The really amazing thing is that the meltdown in California is already happening and virtually none of these loans have yet reset.

Option ARM loans were heavily marketed to upper-tier home buyers in California. It's hard to know how bad the option ARM crisis will be before it actually happens, but Moe Bedard, an advocate in Southern California who advises homeowners on foreclosure and blogs about the crisis at Loansafe.org says that the difference in the time until the rate rises is the main reason that upper-middle-class Orange County (now facing foreclosures at a rate merely twice the national average) hasn't yet been hit as badly as places like Riverside.

When those dominoes start falling next year, we may or may not have a subprime bailout plan, and the discussion will start about how to bail out this next tranche of borrowers. The bailout plans on the table now, such as the one put forward by Barney Frank (one of Congress' genuinely cogent financial minds), are reasonably based on the principle of bringing payments down to a point that homeowners can afford.

But where prices fall 40 percent to 60 percent, all that goes out the window. Why? Because in expensive locales like San Diego, tens of thousands of people with 100 percent loan-to-value mortgages and option ARMs are living in homes in which they have no equity and on which they owe a lot more than the house is worth.

In these places, accepting a government "bailout" that pays them, say, 90 percent of the value of the house to keep from foreclosing will be very tough for lenders, who (if the appraisers don't fudge the numbers) could be forced to take 36 cents or 45 cents on the dollar for their loans. On the other hand, any plan that makes them pay more if they can afford it is hugely disadvantageous for the borrowers, who have option ARMs about to reset and are much better off handing the keys to bank—and maybe even scooping up the foreclosed house down the street.

If you're one of the "homedebtors" (a fantastic neologism coined by the anonymous blogger IrvineRenter on the Irvine Housing Blog) in this position, you might start thinking very seriously about just how attached you are to the wisteria vine snaking over the basketball hoop on your garage. That's what a lot of other California borrowers will be doing.

The luckiest of those are the ones who used option ARMs to buy a house. For them, walking away is easy: Their loans are "nonrecourse," and the lenders can't go after them for more than the value of the house. The choice is harder for those who used the loans to refinance. The quirks of real-estate law regarding refi loans make it possible (though not necessarily easy) for lenders to try to get back more money even after taking the house.

If you think, however, that should make lenders a lot happier, forget it. LoanSafe's Bedard says that even in this group, most of the option ARM borrowers he talks to—some of them living in $800,000 houses—are already considering walking away from their deeply depreciated homes as soon as the rates reset.

Bet on this: Whatever moral qualms are being urged on borrowers to keep them from walking away from their mortgages, they'll count for a lot less than the economic reality facing borrowers whose homes have fallen in value by half. 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.

Consider, too, that, yes, going through a foreclosure kills your credit rating and makes it a lot harder to buy a new house—but as more and more prime borrowers go into foreclosure, it's perfectly possible that buying a new home a year later will in the near future be as routine and unsurprising as the once inconceivable idea that you can get a whole batch of new credit cards two years after a bankruptcy.

Of course, all those people stuck between rising mortgages and falling prices are free to follow Paulson's advice: Keep making payments on an outsized mortgage, and take a bullet for the greater economic good. Fortunately for them, and perhaps unfortunately for the economy, a lot of them will come to the realization that they just don't have to.
Mark Gimein is a New York-based writer.

Article URL: Why the next mortgage crisis may be worse. - By Mark Gimein - Slate Magazine

Copyright 2008 Washingtonpost.Newsweek Interactive Co. LLC

If you believe what this article says, then you have an entire industry based upon retarded as hell interest rates. As a guy who is looking to get his first house soon, this shit actually bothers the fuck out of me. So the question is: Just what in the hell can or should be done?

First of all, the entire industry IS in trouble. That is true.

However, you're in a GREAT position. The next few years will be the best buyers' market for housing that we've seen in decades. I'm posed to get into it shortly after graduation as well. In the end this'll work out in your favor.

True, it's going to ultimately yield a housing boom, but that will have to wait for many other economic factors swing around into a favorable position once more. That could take years considering the uphill battle against petroleum prices and the ensuing stagflation in consumable goods.

One of my concerns is that the mortgage crisis will have a divergent effect upon the average cost of rented apartments. If the banks won't give you a home mortgage, where do you go? Many folks may find themselves pinned against the wall, fending off opportunistic landlords who know they can squeeze an extra $100 per month from each lease because tenants have no better options.

Screw renting, squatting is where it's at!

But seriously, I don't think that it'll lead to rent gouging. Owners are just as desperate to rent as they are to sell.

I think I read it in the weekly, and it was particular to Chicago...I THINK, but it said that nearly 10% of the housing and rental market was vacant. That's a lot of empty houses and apartments, and I'm sure the number isn't too far off in other places around the country.

The owners are freaking out. "Rent? Sell? Just give me some goddamn money!"

Hey, at least you folks have rent control laws over there. I'm currently moving house (in Singapore) because my greedy landlord is raising rent by 30% this year

As for what Night Phoenix think what the hell should or could be done, it is difficult to say. My personal take is the asset deflation of American homes is healthy. Eventually, they are going to go right back up, so what Arainach said is true - it is an excellent time to buy a house. When? No idea, as the posted article pointed out, things may get far, far worse.

Now, what you CAN do. You want to make sure that you have a good credit rating, and that you can actually afford to pay off that mortgage, when you decide to buy that house. The basic premise of subprime was a bunch of folks buying homes they could not afford, but temporarily could because of low 2-year 'introductory' rates.

Though for those of us who buy a house for cheap now, you'll probably have to stick with it a while before it sees any value increase. And that's really what bit people in the ass with that stupid sellers market. People buying selling several houses and reselling them back in order to make profit. Ah greed.

Though one thing is for sure, this will be a great buyer's market. I would love to have a house.

We've only just begun to see people start ditching their houses. We have a lot more turbulence to look forward to. Despite the wild glee on Wall Street this past week that the worst is over. Best thing to do right now if you're looking to buy is absolutely nothing. Trying to catch a falling knife is a good way to lose your head.

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Of course, all those people stuck between rising mortgages and falling prices are free to follow Paulson's advice: Keep making payments on an outsized mortgage, and take a bullet for the greater economic good.

Take one for the team? Fuck Paulson. People have no moral obligation to ruin themselves for the general health of the economy. They should do what's right for themselves and their families.

The mere fact that this is mentioned as a remedy make's me want to spend my 600 USD tax rebate check on booze.

Originally Posted by Watts

The mere fact that this is mentioned as a remedy make's me want to spend my 600 USD tax rebate check on booze.

One of the last products that you actually can buy American, ironically.

That, and guns. I think the whole country would be better off if everyone spent their $600 check on guns & booze. Both are of very high value in a barter economy which may be coming after people can't afford food anymore. Everything that I've read about on the sub-prime crisis indicates, to me, that most investment banks that even touched these things are gonna be insolvent. I mean look at the shit going down... we've got the Carlye Group tanking, Bear Sterns almost crashing the economy (thanks fed for accepting worthless bonds as collateral for your loans), and inflation is just freaking going crazy thanks to all this money being pumped into the system. I wonder which is worse, a depression based on deflation or inflation?

Originally Posted by Arainach

One of the last products that you actually can buy American, ironically.

Too late to be bitter about NAFTA. We could always just elect another Clinton so those neo-liberals can destroy whatever is left. To be "fair and balanced" though, I doubt any presidential candidate will ever use the "p" word. It'd be so politically unpopular.

Oops, wrong forum!(?)

Originally Posted by Nehmi

Everything that I've read about on the sub-prime crisis indicates, to me, that most investment banks that even touched these things are gonna be insolvent. I mean look at the shit going down... we've got the Carlye Group tanking, Bear Sterns almost crashing the economy (thanks fed for accepting worthless bonds as collateral for your loans), and inflation is just freaking going crazy thanks to all this money being pumped into the system.

I think the major investment banks are already insolvent. Citibank blew through it's sugar money they got from the Saudi's. Now they're pissed. So pissed off they refuse to raise oil production. That, or they can't. Take your pick.

The whole point of the Fed's bailout was to prevent the destruction of the derivatives market. Which according to old-2007-Watts would cause a global economic catastrophe. That guy was so full of shit though. Gold over 800 USD? Hah, more like over 900. I was so optimistic then.

Originally Posted by Nehmi

I wonder which is worse, a depression based on deflation or inflation?

Ask the Germans.

I love how all these idiots think it's really a "buyers market".

If you ask me, it's a "stay the fuck away from houses" market.

We're running out of oil. People are being laid off and companies are going under because of this. Soon we'll be in an economic depression!

But no, go right ahead and purchase a house. It's smart because pricing is down! You won't lose your house just like everyone else!

Smart!

Originally Posted by Vestin

I love how all these idiots think it's really a "buyers market".

If you ask me, it's a "stay the fuck away from houses" market.

We're running out of oil. People are being laid off and companies are going under because of this. Soon we'll be in an economic depression!

But no, go right ahead and purchase a house. It's smart because pricing is down! You won't lose your house just like everyone else!

Smart!

I choose to blame myself for this post. Somebody moderate me for inciting panic.

Calm down guy, depressions don't exactly happen overnight. It take's a long grueling economic decline. The Great Depression just didn't happen with the stock market crash of '29.

Originally Posted by Vestin

I love how all these idiots think it's really a "buyers market".

If you ask me, it's a "stay the fuck away from houses" market.

We're running out of oil. People are being laid off and companies are going under because of this. Soon we'll be in an economic depression!

But no, go right ahead and purchase a house. It's smart because pricing is down! You won't lose your house just like everyone else!

Smart!

People are losing their house because they bought houses they couldn't afford. The variable APR gave them the illusion they could for a short term, but anyone with a brain could have seen it was infeasible. House prices are plummeting, and they will go back up. As long as you're not expecting to move in the next 10 years minimum (probably closer to 15-20), it's an amazing buyer's market.