In the ongoing bust or adjustment debate over the housing market, I sided with the busters. It was largely instinctive, based on what I sensed of the parallels between the NASDAQ bubble in the late 90s and the housing market more recently. Of course, there were and are plenty of economists and real estate agents out there promising a soft-landing. But then there were plenty of people willing to believe that the Dow would hit 36,000. And the thing about this housing boom, there's a lot more at stake.
The most telling visual for me was a map the New York Times' ran last year showing the massive growth in ARMs across the country over the last 5 years. This article in business week explains the perils in this:
Nightmare Mortgages As the subtitle says, "the trap has sprung." Sooner even than I thought. The most damning revelation from the article:
Option ARMs were created in 1981 and for years were marketed to well-heeled home buyers who wanted the option of making low payments most months and then paying off a big chunk all at once. For them, option ARMs offered flexibility.
So how did these unusual loans get into the hands of so many ordinary folks? The sequence of events was orderly and even rational, at least within a flawed system. In the early years of the housing boom, falling interest rates made safe fixed-rate loans attractive to borrowers. As home prices soared, banks pushed adjustable-rate loans with lower initial payments. When those got too pricey, banks hawked loans that required only interest payments for the first few years. And then they flogged option ARMs -- not as financial-planning tools for the wealthy but as affordability tools for the masses. Banks tapped an army of unregulated mortgage brokers to do what needed to be done to keep the money flowing, even if it meant putting dangerous loans in the hands of people who couldn't handle or didn't understand the risk. And Wall Street greased the skids by taking on much of the new risk banks were creating.
Now the signs of excess are crystal clear. Up to 80% of all option ARM borrowers make only the minimum payment each month, according to Fitch Ratings. The rest of the money gets added to the balance of the mortgage, a situation known as negative amortization. And once balances grow to a certain amount, the loans automatically reset at far higher payments. Most of these borrowers aren't paying down their loans; they're underpaying them up.
And what was crystal clear to anyone who's brushed up against the mortgage industry recently:
To get the deals done, banks have turned increasingly to unregulated mortgage brokers, who now account for 80% of all mortgage originations, double what it was 10 years ago, according to the National Association of Mortgage Brokers.
We know a lot of the loose investment money after the dot-com bust went into housing. Where will all the loose money go after the housing bust? One possibility, I suppose, is there won't be a lot of loose money. At least among the middle classes.
One final point I find intriguing. One of the signs of the overvaluation of the housing market was the discrepancy between monthly mortgages rates and rental rates. So even as the housing market burns, we can expect rental rates to go up for all those people looking for a new place to live after their mortgage forecloses or simply becomes unbearable.
