2008 December 18 Thursday
Alt-A And Option ARM Mortgage Resets Coming

While lots of sub-prime mortgages have failed after their mortgages reset to higher interest rates far above what their holders could ever afford most of the Alt-A and option ARM resets are still coming up and will bring a second big wave of mortgage defaults.

Just look at a projection from the investment bank of Credit Suisse: there are the billions of dollars in sub-prime mortgages that reset last year and this year. But what hasn't hit yet are Alt-A and option ARM resets, when homeowners will pay higher interest rates in the next three years. We're at the beginning of a second wave.

"How big is the potential damage from the Alt As compared to what we just saw in the sub-primes?" Pelley asks.

"Well, the sub-prime is, was approaching $1 trillion, the Alt-A is about $1 trillion. And then you have option ARMs on top of that. That's probably another $500 billion to $600 billion on top of that," Tilson says.

Asked how many of these option ARMs he imagines are going to fail, Tilson says, "Well north of 50 percent. My gut would be 70 percent of these option ARMs will default."

Politicians in Washington DC are trying to find a way to put Humpty Dumpty back together again. Basically, they want to reflate the bubble. But lots of people who were granted mortgages never should have gotten mortgages in the first place. Trying to renegotiate their mortgages is pointless and just delays the inevitable. The housing price-to-rent ratio and price-to-income ratio have to return to historical trends.

Credit card holders losing their jobs are going to cause a big increase in credit card losses by banks.

Innovest said that credit-card charge-offs could hit $18.6 billion in the first quarter of next year, and $96 billion by the end of the year, forcing banks to search for other ways to generate revenue from customers.

Unpaid Balances

Delinquencies tend to follow unemployment, which were 554,000 first-time claims in the week ended Dec. 13, near a 26- year high reached the week before. Net worth for U.S. households and nonprofit groups fell $2.81 trillion from July to September, the most since tracking began in 1952. That means consumers are more strapped for cash, contributing to a slowdown in spending, which accounts for two-thirds of the economy.

Share |      By Randall Parker at 2008 December 18 11:36 PM  Economics Housing

tmcgreivy said at December 19, 2008 1:55 PM:

Just think about what you've written here. You tell me what the problem is right now: inflation of deflation? Paying anything back right now, even if it is at 0% interest, is the real problem since real interest rates are actually negative right now. It is not the resets to LOWER rates that are killing people, it is having ANY debt at all right now at a time when all asset classes but cash are collapsing. This post is garbage and should be pulled from your blog.

Randall Parker said at December 19, 2008 5:25 PM:


I do not think inflation or deflation overall is a problem right now. The deflation we have now is small. The Core CPI (excludes food and fuel) still shows 2% inflation. But food prices have stopped rising (which is good) and energy prices have dropped (which is also good).

November's decline in the overall index was largely due to a 17% decline in energy prices and, specifically, a nearly 30% collapse in gasoline prices. However, excluding the food and energy components, the core index was flat for the month, despite a 0.6% decline in new vehicle prices, in line with dismal auto sales numbers reported in the last couple of months by all automakers. Several key categories (apparel, entertainment, medical care, shelter costs) all showed moderate increases, suggesting the absence of any broad-based downward pressure on prices.


2. A generally more reliable measure of inflation (although less popular in terms of broader public perceptions) is the core CPI, which, by excluding the two most volatile components of the index, also tends to be dramatically more stable over time. True, the core index has also drifted lower since July but at a much more measured pace, 2% last month, down from 2.5%. Changes in the core index are very incremental on a month-to-month basis, so it is unlikely that it will slip into negative territory any time soon. In all likelihood, the economy will have already started showing signs of life by the time such a slow-moving downtrend brings the core CPI close to the feared zero mark.

You also bring up interest rates. I say: what interest rates? We've got plenty to choose from. You can earn 4% at American Savings Bank on a regular savings account. CD rates are still healthily positive. Credit card rates are rising. Rates in new mortgages have declined but are still above 5%

The benchmark 30-year fixed-rate home mortgage in the U.S. fell to a national average of 5.17% this week, the lowest since Freddie Mac began its weekly rate survey in 1971.

US Treasuries are only near 0 for short term rates.

Resets to higher rates are mainly hitting those who got mortgages they never should have gotten in the first place. Lots of people have debt they can pay just fine right now because they have the incomes needed to make the payments.

Randall Parker said at December 19, 2008 6:17 PM:

Regards Mike Shedlock's argument: He doesn't supply a quantitative breakdown of what types ARMs people have. I've read such a breakdown a week or two ago somewhere. The article (which I wish I could find again) quoted what percentage of ARMs are tied to LIBOR and to other indexes.

Also, for some types of mortgages people started out not paying any principal. Their teasers allowed them to just pay interest. So their resets amount to starting to pay principal as well.

We also need to know what the margins are on the loans as well as which index they are tied to. A LIBOR tie will result in higher interest rates than a Treasury tie.

Thai said at December 19, 2008 8:25 PM:

Randall, I guess at some level we may be saying the same thing- my point is the ARM reset issue is not a problem AND if anything is actually helping things out (if it is doing anything at all). If ARMS were not resetting but instead continued to remain at their origination levels (say 2.5 years ago), the problem would be even worse than it is today. Resets are likely helping and will in all likelihood go down further- but they simply can't go down low enough to offset this devastating deflation.

And LIBOR is dropping (though it is unbelievably ugly when compared vs. real interest rates... Say LIBOR is 2.4% today (it was over 4 just one year ago) AND deflation is running in excess of 10% (I Just made that number up for illustrative purposes, it is hard to say what the real rate of deflation is right now but it definitely high), then borrower would be paying a VERY nasty real interest rate of (say) 12.4%. Real interest rates this high will quickly impoverish even the richest of people in debt; an investor's 'skill' would need to be WAY in excess of 5 standard deviations from the norm to earn returns this high when adjusted for risk. So if you know ANYONE who thinks they can afford debt in this current environment, they are foolish when they adjust that debt for risk. You will definitely meet a few who will end up being correct in this bet, but make no mistake, they are only a few.

And yes, Inflation is (shall we say) 'holding up' (barely), but remember this is ONLY because the Fed promised approx. 8 Trillion in new cash to banks/brokerage houses all running a 'wee bit' short right now and has interest rates at o and is threatening 'quantitative easing' and why they are asking for authority to issue their own debt (to mop up all this cash they are producing).s

And FYI my name is "Thai" (like the country Thailand). My folks met in Thailand and named me "Thai".

Randall Parker said at December 20, 2008 7:25 PM:


ARM resets: Whether they are helping or hurting depends majorly on what fraction of the people started out with teaser rates. I know some did because I keep reading stories about Jane Smith in Jonesville who can't afford to make payments now that her initial teaser rate has expired.

Realist said at January 25, 2009 11:43 AM:

Hallo hallo, this guy speaks the REALITY!!! Wake up!

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