Monday, April 12, 2010

More on Housing

I was asked a few questions on housing and how the next wave would possibly not be as bad because of the low rates. The subprime loans reset when rates were much higher back in 2007. It depends whether it is a reset or recast. Unfortunately the media gets this horrendously wrong when talking about it and Wall St. honestly doesn't do much better. This makes getting accurate information difficult because the terms are used interchangeably. So a reset does depend on interest rates. A recast mostly does not. The Option ARM was a nasty little creation that was useful in very unique circumstances but got rolled out for mass public consumption. To walk through an example, in 2006 you could buy a 300,000 house and put no money down. I believe the interest rate could be fixed or floating (if someone knows different please correct me) but the kicker is you could decide to only pay a portion of the interest payment. Sort of like paying the minimum on a credit card without causing you to be delinquent. Anything you didn't pay would be added to the principal of the loan. Talk about toxic.

So if you had this 300,000 mortgage and you owed say $1500 a month you could decide to pay $300 and the other $1200 would be added so that now your mortgage was $301,200. Usually the principal was capped at 15% above the original mortgage value so the mortgage couldn't balloon above $345,000 in our example.

This would not go on indifferently. At some point in the future (typically something like five years from the loan origination date) these loans are "recast." Because of the extra benefit of having an option the loans often times carried slightly higher interest rates when they are recast. When a recast occurs the option usually disappears. So instead you are required to make a $1200 payment instead of paying the $300 payment.

For those interested in looking further click on this link . On the right hand side click on the T2 partners presentation. It is "An Overview of the Housing and Credit Crises And Why There is More Pain to Come." It is 203 slides of everything what you want to know about housing. I would draw readers attention to slide 35 (the subprime resets that are mostly behind us), slide 46 (the Alt A resets that are ahead of us), slide 61 (the massive amount of hidden inventory) and most importantly slide 72 which shows how we are sitting between the two waves and the massive Option ARM wave that is coming.

Whitney unfortunately also does not differentiate between recast and reset.

The one silver lining is I have read speculation that the Option ARMs were so horrifically written that some of the home owners couldn't even make the $300 in my example and have already defaulted. As a result some of the wave has already occurred and been move forward. This is speculation and I haven't seen any numbers that quantified it.

Like I said though, regardless I do not believe this force will bring down the system again or cause a double dip because the government will ensure it won't. It will be a tailwind for all the forces that will cause the system to start to buckle and at a minimum keep a lid on prices for a long time to come. Housing is in horrific shape regardless of what anyone would tell you. It is simply being manipulated by the government like everything else.


Anonymous said...

I quote "Like I said though, regardless I do not believe this force will bring down the system again or cause a double dip because the government will ensure it won't". How will it do it? after all the artiluges made the situation has not improved at all and the reality has been hidden, so will there be a new Fannie?a new subsidy? a new quantitaive easing program? there is no room to spendthrift. so if after 4 years of peaking the real estate has not given signs of reactivation the recovery is based on fragile foundations. There is a new article by hussman that clarifies me that the 08 crisis was just the warmth

Justin said...

Thanks for the reply/explanation Kaspar.

Market Seer said...

All the things you mentioned is possible. QE, larger tax credits, etc. etc. I have no idea how the government will respond but the government has drawn the line in the sand that banks/housing will not cause us to collapse. This can go on until it can't. It can't once systemic forces push the government into the corner that will not allow the government to keep what it is doing (higher interest rates or market revulsion to more debt).

There is one caveat I mentioned in the post below. Someone like the Tea Party sweeps to power through the Republican party feeling like they have a mandate to stop all these programs. In that case the market and economy will collapse extremely quickly. Is this what needs to happen. Probably. We are probably (emphasis on the word probably) if we do and f'd if we don't. We have a stick of dynamite that is lit that all we can do is switch between both hands.