Tanta: Negative Amortization for UberNerds
Submitted by
CalculatedRisk on Sat, 03/17/2007 - 2:44pm (92 comments)
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great stuff. are they ever over 90% ltv at origination?
Tanta: Had the sub-prime underwriters simply qualified the applicants to the fully amortizing payment (say 6%) instead of the to the "minimum payment" only, we wouldn't even be hearing about this problem today.
Also, there really is never a good reason for a lender to accept an applicant's "stated income". It is so damn easy to prove one's real income, if if you are self-employed or commissioned. Self employed business owners do it all the time when the aplly for business loans.
wow...I actually followed most of this, but had never really considered the issue of charging interest on interest while the initial payments were being made. Generally, I only thought of that happening when less than the interest due each month was piling up and eventually becoming part of the recast and the larger loan balance.
What ive said here many times is made obvious yet again in this post, that many loans (most of subprime and possibly a majority of alt-As) were never feasible loan structures. THey are pretty much a guaranteed bankruptcy foreclosure tool, wherein the eventuality is avoided as long as prices keep going up, allowing the leaches to suck some more blood from borrowers on each of, for some, many refis.
This post does do one very important service though, which is to show that many of the people peddling this crap werent qualified to do so, and should be licensed before they can push investments onto people that they cannot even begin to help the investor understand the risk he or she was undertaking. But also, it points out that the vast majority of borrowers would be unable to understand the terms of the loan even if the broker were qualified to present the material. I know even with my background it takes a bit of study and quite a bit of spreadsheet work to figure out just how much trouble you can get yourself into. Even with the help of mighty Tanta's clear exposition, it requires considerable amounts of potent beverage to choke it all down, and not just one read through.
After this, I keep thinking, how did we get here? Ive been telling clients that this would happen at some point, but I was over a year early on the when, even if correct on the why. But what really was the trigger? I know in any financial mania, you need an ever larger sum of money to push the total amount invested to new collective values - scratch that - market prices, and that when the real money is not coming in the way you'd need it to to keep your part of the game running at full tilt, the logical place to turn is fraud. So I can understand that the recent early payment default (with a substantial rise in borrowers never even making one payment) problem could well be that fraud manifesting. But what else? Is it some of this neg-am problem that can't be rolled over because prices stopped going up? Clearly some is the job losses in the midwest and the impact of foreclosures there. THe problem I have is quantifying the amounts and understanding what has led to the subprime implosion - what are the real reasons these loans are being pushed back?
IF prices are already coming down almost across the board, then how does this not spread to alt-a, when so much of alt-a is made up of option arm, 0 $ down, interest only, etc. Is there neg-am in Alt A?
I really would like to send out a biatch slap to that nincompoop Greenspan. His latest senile babble really got under my skin with the "subprime problem goes away if house prices keep risi
re self-employed income verification, the lender can request the 1040 from the IRS; but if the lender just asks the borrower for a copy of the Schedule C, it's easy enough to put together a fake Schedule C, they have the free form on the IRS website, just type in the numbers and print.
I'm reading that minimum payment as $JJB.41 =(
Tanta,
That is a very impressive explanation. Few thoughts:
Keep up the good work, you crazy UberNerd you!
Getting tighter out there. From Ben's blog:
'Subprime' borrowers getting hurt
"Irene Pena is buying her first home, a three-bedroom house in San Pablo priced at about $500,000. She was scheduled to get the keys to her house this week, but instead she learned 10 days ago that her loan had fallen through because the lender changed its criteria."
"Pena's seeking 100 percent financing using a combination of a first and second mortgage, and applied for the loans using a 'stated income' process, because she cannot document her full income using pay stubs or W2 forms."
"Her real estate agent, Gema Smith in San Jose, said Pena's credit score is very good, but the lender denied the loan at the last minute because Pena works for a janitorial service and cleans houses as a side job. Smith said lenders are suddenly balking at making loans to workers who can't easily document their income, even when they have good credit scores. Two other adults in her household will be contributing to the mortgage, but they lack income documents, too."
"'I feel like I was discriminated against,' said Pena."
redfish: a good underwriter can see through a Schedule C righ to the entire return and ask for three months worth of bank statements to match deposits to monthly income declaration.
"'I feel like I was discriminated against,' said Pena."
I guess the last thing to go is the sense of entitlement.
"'I feel like I was discriminated against,' said Pena." - YOU WERE. "NO DOCUMENT" DISCRIMINATION. ABOUT TIME (if you really made the income you said, it would have been easy to prove....
Geoff, I do think the trigger or tipping point you're looking for has a lot of components. One I might add to your list is sort of a secondary effect of the EPDs. As you note, those were overwhelmingly fraudulent. But as investors discovered more and more of them, they began looking harder at loans originated by the same correspondent or broker that might not have been actual EPDs, but on a second (more attentive) look showed other violations of rep and warranty. So that resulted in even more repurchases. As I mentioned in an earlier thread, I also hear that some investors are reversing their normal due diligence selection methods. Usually, a buyer of loans will select a sample of loans for in-depth review based partly on random sampling, and partly on adverse sampling--specifically capturing loans in the sample with high LTVs, low FICOs, etc. The funny thing about that is how, over time, it lulls you into a false sense of security about the loans you buy, because the correspondents and brokers know that these visibly high-risk loans will get oversampled. They therefore tend to put the most effort into documenting those, actually forcing the appraiser to work hard, etc. But it's too tempting to let the ones that aren't obviously higher risk--the low LTV, high FICO ones--use the sloppy or fraudulent appraisal, have the missing documents, etc. So when the buyers "reversed" the due diligence sampling, all kinds of shit crawled out from under the rock.
That's something like the process of "spread" from subprime to Alt-A that we've been talking about; it really isn't a "spread" of anything except recognition of the problem. Once that happens, the repurchases, write-downs, warehouse undercollateralization ("margin calls") start, and suddenly overleveraged lenders are exploding because of overleveraged loans.
I do think it's hard for people in the mortgage business at times to understand, at a meaningful level, just how hard things like neg am are to understand to everyone else. It's like any other expert: your own area of expertise can seem obvious to you. I know in my own case that what keeps me honest about it is being forced to explain it to someone else; you can't just keep insisting that the problem is the students! These loans, insofar as they're worth anything, are for highly sophisticated people who manage complex personal assets. Turning them into a "mass market" product was sort of like deciding that Vicodin should no longer be prescription only, and putting it on the shelf next to the aspirin.
Thank you Ms. Tanta for allowing this layperson a glimpse into the netherworld of hi-tech mortgage engineering. I'm from an era that considered a 15 year fixed rate loan "exotic".
This really exposes the three headed monster of realtors, appraisers, and brokers. Without implied collusion and the above mentioned psycho pricing structure, the wheels would have come off much sooner.
Not to rush to the defense of the willfully ignorant, but I do recall receiving numerous credit offers for 0% during the latter days of Mr. Greenspan's tenure. It's not hard to imagine large segments of the population believing in a balance not accruing interest.
mmmmm.... vicodin.
Great post, Tanta. Thanks for the lesson.
ServiceFirst, loved your comment. I used to train loan officers for a living, and they were always a scream about stuff like this. ("You can't possibly think I'm going to tell my borrower all that, can you?" "But if you don't, we could go to jail." "OK, maybe I'll just do fixed rate loans." "That would be OK with me.")
I certainly agree that the Option ARMs and neg am generally were not a subprime product. This is the Alt-A and prime problem.
Were they being originated over 90%? Well, probably not very often, but I'm sure they were. The AHM "supplemental" disclosure we were looking at the other day showed that 25% of the OA loans in their held for sale pipeline had an LTV over 90%. So either they originated them over 90%, or in just the few short months the loans were in the sale pipeline they negatively amortized enough to round up to 91% (or AHM is holding them too long). But of course the real problem I have is that 90% is only meaningful insofar as the original appraisal was worth a shit. It's not like we don't have reason to wonder about that.
i'm going to re-read this and let my head "explode" one more time...
(will report back when i understand and when i will be willing to sign on the dotted line on the loadn document)
Awesome explanation! What got me onto this blog was a search to figure out what the heck a 7/1 IO arm really was. (I was getting a prequal about a year ago which, thankfully, I didn't actually use). I didn't really get it 'till now.
As for Neg/Am loans... I got the concept... but now I really get it. Yikes! I can't imagine folks who just were "assigned" these loans by a broker get it either.
As a random aside.. I happened to click this link ( http://tinyurl.com/2xk84m ) on a whim. The gibberish at the bottom actually made sense! "Recast".... it sounds so... manageable...
Anyway Tanta and CR.... Thanks!
vicodin=hydrocodone/acetaminophe
"It's not like we don't have reason to wonder about that." - It's always been an issue, but hasn't mattered since 1997 as values just went up and up and up which could easily mask errors and 'paid appraisals'.
On the other hand, an appraiser's first job is to bring it in at sale price on a purchase.
Not to rush to the defense of the willfully ignorant, but I do recall receiving numerous credit offers for 0% during the latter days of Mr. Greenspan's tenure. It's not hard to imagine large segments of the population believing in a balance not accruing interest.
Oh, and how about BestBuy offering 12 months "same as cash" on those computers? It was all over the place. After all, GM had to get into the mortgage business in part because it needed an offset to losing money on financing all its cars at 0%.
What's inexcusable is loan officers and brokers not figuring out that there must be a catch here somewhere.
Thanks Tanta for all you do here.
As I said before, while joe sixpack bears some responsibility, his betters are telling to take on these weird loans that just about need college level finance courses to explain.
The most eye-opening part is the point made in some comments (ServiceFirst and you, among others) that this is NOT a subprime issue. It is an alt-a and a prime issue and it has probably not yet even begun to surface in any meaningful way. But it must.
Tanta,
Do you think any of these loans have a provision for falling home values? Your example could reach 110% LTV with a 20% drop in home value. (This has happened in some parts of Florida already.)
GREAT explanation...it's actually very easy to follow when it is clearly explained...when I grow up I want to be a mortgage broker...
rt
mmmmm.... vicodin.
Great post, Tanta. Thanks for the lesson.
What is it with the Vicodin?
I just got butchered by the dentist after letting an abscess get out of control and now I'm all hopped up on Vicodin. I feel pretty normal but the black text on the screen has a slightly iridescent effect.
After reading this excellent description I think the problem would have been avoided if everybody had been given this text before applying for a pay option mortgage and afterwards filled a multiple choices test checking how much one had understood. If one had failed the test, then he or she was likely to default later. I think the probability of default would correlate with the result of this test better than with the FICO score.
ac: its the hydrocodone, can make some interesting visual effects occur!
Oh yeah, the appraisal, forgot about that. Those borrowers weren't planning on selling anytime soon, were they?
Whatever, and I just got an advertisement from a lender offering up to 4.5% YSP on a POA. Let's see, on a $600,000 starter home in Northern California that's... Woah! I can drive a fancy Benz all the way to... oh nevermind!
exactly, Bob_in_MA. You got a loan that has now climbed to a 110% loan, and then you realize that prices in your block have also declined 10%.
Now what?
Thank you for the detailed explanation. It was excellent.
I think this post is a fancy way of saying: if you can't afford to put 20% down and take out a 30-year fixed rate, then you can't afford the house.
Tanta, not to be picky, but why did your beginning balance of 89,631.38 on #3 rise back to 90,000.00 on #4?
CR, you really need a special section in the margin reserved for links to Tanta's killer "UberNerd" dissertations!
Do you think any of these loans have a provision for falling home values?
I surely hope not. The absolute last thing I would do in structuring a loan product is put the borrower at risk because of something so far outside their own control. It's bad enough on an ARM that you risk the underlying index value going up. And how would you really decide that? Using OFHEO? You know it would get down into requiring another appraisal, and who would pay for it? The whole product would fall apart. (Of course, that might not be such a bad thing . . . but still. The point is that a lender who is worried about falling home values needs to set its maximum LTV (including its neg am balance cap) appropriately up front, not try to change the LTV requirement after the fact.
rtalcott: it's not too late for you! It's not! Please see your doctor. You can talk about this urge to become a mortgage broker before it's too late.
ac, I'm actually a Percocet person myself, but Vicodin has its uses. I usually take one and then sleep for 18 hours, but if you want to get stoned and then read about neg am . . . to each her own.
Tanta, not to be picky, but why did your beginning balance of 89,631.38 on #3 rise back to 90,000.00 on #4?
Because my administrative assistant was taking Vicodin. That's my story and I'm sticking to it.
Sorry. Good catch.
...that many loans (most of subprime and possibly a majority of alt-As) were never feasible loan structures.
Well, yes and no. Prior to the boom, lots of people used ARMs with low qualifiers and negAm options and survived just fine. There is an expectation that people's income would rise over time, allowing them to get in low and then generally stay ahead of their monthly nut as it rises. NegAm served as a handy option to minimize outlays during temporary emergencies, too.
Of course, any semblance of responsible use of these programs flew out the window during the boom.
When money is falling from the sky, I don`t expect people in the streets to behave in an orderly manner.
The public will believe anything, so long as it is not founded on truth. Dame Edith Sitwell (1887 1964)
Tanta,
After thinking about this subject for another second, a question formed in my Saturday Night Brain (right after "what the hell am I doing on this St. Patrick's day talking mortgages on a web site?!")
Here it is: a while back, one AE told me that the market loves this OA product and that's why the lenders are pushing it like they are with aggressive yield spreads for brokers, and TV commercials. Clearly it makes for a great commercial, but do me a favor and share your knowledge, were these OA really that hot with investors? Could it be that that was because good credit risk borrowers were offered an essentially high-interest rate loans? But didn't anybody do any risk assessment at all? I mean, these loans have been floating around for a while, therefore accumulating some kind of track record. And they are still being pushed by the way. On the other hand if they are such good deal for the investors, what are you and I and everyone here so upset about? And did I just answer my own question?
ServiceFirst, the loans may have had a track record, but with better quality borrowers that were truly owner occupants. The goal posts got moved around quite a bit, the last few years.
Question -
Are SIVA/SISA loans to a prime borrower considered Alt-A?
Thanks
ServiceFirst, first of all, I'm here on a Saturday night St. Paddy's day because I am sick and have a note from my doctor (like ac). I assume the rest of you are just nerds.
My own first encounter with neg am was back in the roaring 80s, when fixed rates were trying to hit 20% and all kinds of crazy loans were invented. Anyone remember the old GPM (graduated payment mortgage, pronounced "gyp 'em")? The step loan? Neg am went through the S&Ls like a bad gastrointestinal virus. My own thrift took most of its losses in commercial, but the vast majority of the residential RE losses it took were on neg ams. The things are just toxic in an RE bust.
So what in the hell were we doing offering neg am when rates were so low? It's all because of unaffordable home prices, and incomes unable to keep up therewith. Did mortgage bankers not see the risk? Hell, those of us who came up through the thrifts would beg, plead, moan, cry, throw shit in meetings, it didn't matter. The answer to every objection was that David Lereah told us that home prices would never go down, so what risk?
And yes, investors liked it because you could, actually, talk a prime credit borrower into paying you 6.50% start rate on a freaking ARM.
I'm guessing that those rich YSPs are about to disappear. As I said, the thing about OAs is that you have to keep updating your models. The rating agencies and regulators, I believe, are about to force that to happen--they have to now--and suddenly the investor appetite for it will drop like a brick. And then there will be horror in the house prices in the bubble markets.
I would think that any stated income loan would be considered Alt A because Fannie/Freddie won't take anything that's not full doc.
Tanta - thankyou. And yes, I did not make it through the whole post because as you noted in there, at some point my head began exploding.
I bought my first home back in the horse and buggy days of lending- the mid 80's.
The bank filled out a passbook (very quaint!) which showed the schedule of the monthly payments on my loan, assuming I stuck with the 15 years and did not prepay.
As I recall, there were 2 columns, one showed the amount of my monthly mortgage payment that was going to pay off the interest on the loan, the other showed the amount that went to pay off the principle.
Seriously, any idiot could look at that document and know exactly what was going on now, next month and years hence with every penny they were paying on that monthly mortgage.
It was T-riffic!
Any chance of that ever happening again? Making things crystal clear to borrowers?
We're hearing a lot from politicians about bailouts now for FB's.
But we are hearing NOTHING from those same politicians about going back to truly sane, transparent mortgages that could prevent at least some of this nonsense in the future.
Again, thanks for the great post. It does the job of illuminating the problem quite clearly.
No Neg Ams? That would be when the excrement really hits the air-conditioning big time.
By the way, to Professor Foland and others like him who think that if you don't have 20% down you shouldn't be buying a home:
1. As all of us know by now, for most people, home is an investment, and what the 100% financing does, is just lets a lot more people have a hand in the cookie jar. Of course there are risks involved (more so for people who put 0% down), but while the values are going up up and away, that many more people get to take part in this adventure, and the smarter/luckier ones made out very well.
2. And for those for whom buying a home is part of an American dream, having to put 20% down frequently means NEVER owning a home.
I think this post is a fancy way of saying that "the risks involved in investing are proportional to the amount of education one does about the investment product"
Tanta, an excellent expose about a very sophisticated program which I, too, am familiar with.
May I offer a couple of notes:
-Interest Rate adjust monthly after the fixed period expires. For instance there are 1 Month MTA(12 month Moving Treasury Average of ) loans that have a 1% fully amortized rate for only the first month. After the first month, the interest rate adjust monthly based upon the sum of the variable index(5.01% MTA for March) and the margin which can range from 1.85-3.0%. So the current interest cost could currently be 6.86-8.0% on these monthly adjustables. The margin range is based upon when the loan was originated, credit scores, LTV, occupancy status, loan size, as well as other credit risk adders applied by capital markets for program outliers.
-Monthly minimum payments for 1 Month Option Arms can be increased or decreased by 1.075% each year. So a $1000/mth Minimum payment could increase to $1075/mth yr 2, $1156/mth yr 3, and so on.
-Neg Am Caps will range from 110%-125%. These vary based on LTV, loan size, occupany status and state.
-These loans are available as 30 or 40 yr amortization programs.
-I recall a lender who packaged an Interest Only Minimum payment program with this product.
-Qualifying ratios have been in the 4.5-4.95% range with AHM & the index+margin fully amortized with Wamu.
-Fixed period Option Arms, such as the 5/1 that you graciously described, carry a higher margin, higher life cap than do the 1 MTH MTA's
-1 Month MTA will refinance itself to a lower interest rate IF short term rates start going dow
"Are Option Arms Ever >90% LTV"?
(Westsidegeorge, you asked)
I recall AHM having this product for 100% LTV purchase, primary res & 2nd homes, full doc, 710+ficos,lender paid mortgage insurance.....Minimum payment was comparable to an interest only payment.
Here in california all you need to be a loan broker/officer is a real estate sales license.all the training i recieved on ARMS and option ARMS were at classes given by World Savings,and Indymac,and comments by people who had been in the biz for years,who loved the product,easy to sell and 3 points on the back end.oh,there was a good lunch with the seminars too.having spent some time as a senior collector at a bank,and mmmm having little faith in free lunches i took the time to go through the contracts calculator in hand.the fact that the first AE i encountered from World told me that if there was a problem with the income on a file,the underwriter would put it on his desk,he would call me,and we could fix it increased my curiousity...he told me it didn't increase their risk,they were tight on appraisals.you betcha.I never have done an option Arm,and very few exotics,at all.as far as understanding the product,i doubt that 2% of the loan brokers i have met understand the ARM.all they needed to hear was low payments and 3 points back...hey the boss said it is ok,and everybody is doing it.btw that AE is still there.
Wow. The mechanics are generally what I figured. What I didn't know, that you made very clear, is the fact that it's probably next to impossible to know where in the world these products stand collectively at any given time. This could all explode either sooner or later, but it will explode.
So there's this mortgage finance term, seasoning, that's used in connection with loans to describe the potential for failure of any given loan? Given the obscurity of pay option ARMs, when could one of these products even be called "seasoned" unless it's well past the pay option period?
I've only ever studied sub-prime MBS prospectus documents like http://www.sec.gov/Archives/edgar/data/1350715/000088237706000333/d426197_424b5.htm
to get the hang of how the ABS/MBS were put together, but one thing seemed to stand out to me - there had to be a level of homogeniety in the mortgages being pooled together for this tranching to make sense - else how do you get a handle on the overall default rate on the pool ?
This explanation in this post( thank you very much btw ) suggests that homogeneity is much more difficult for these types of mortgages - so DID somebody make MBS/ABS out of these types of loans at all? Any links to SEC docs would be great..
On a unrelated issue, for a lot of the MBS's I've looked at the reporting on their progress ( which would tell you how the payments, defaults are going ) stops after just a few months.. They just file a Form saying that the number of holder of record has dropped to less than 300 investors and so they no longer have to report so they don't. That's a lot of concentration going on then - with just a few people buying entire job lots of these tranches Who ARE these guys ( to quote that ancient movie - "Butch Cassidy and the Sundance Kid")
Thanks, any and all for any answers.
-K
A clear diagnosis of why enough of Alt-A and prime is also a disease infested horror show.
Only the smallest blemish is necessary on the facade of higher rated mortgage products for a reflection of the expectations of lender viability to come from the depths of sub-prime. Eye brows raised, awareness heightened, wallets closing! Warranted, maybe, maybe not, but that's the way to story will run.
Thanks be to ye, UberNerd T.
We've heard some pretty impressive stats on the dollar volume of expected ARM resets, but has anyone gotten any data on potential recasts?
Given the insane DTI ratios and extreme level of speculation (not to mention all those early defaults) it's safe to assume a huge number of borrowers will never send in a dime more than the Neg Am payment.
Geoff,
You're not the only one who wants to bitch slap Greenspan. After digesting what Randall Forsyth had to say, try Caroline Baum:
Greenspan Can Talk More. You Can Listen Less: Caroline Baum
By Caroline Baum
March 12 (Bloomberg) -- Greenspan's tenure at the Fed was devoted to the cult of his own personality. He nurtured his credibility at the expense of the institution's. Even his biggest supporters inside the Fed criticize him (off the record, of course) for that.
But no one seemed quite prepared for his larger-than-life presence as Fed chairman emeritus. Fans and detractors alike winced when, a week after leaving his government job, Greenspan talked about the economy and interest rates to a cozy gathering of top hedge fund clients hosted by Lehman Brothers.
By way of comparison, Greenspan's predecessor, Paul Volcker, refrained from commenting on the economy when he left the Fed in 1987 to become chairman of Wolfensohn & Co., an investment firm in New York.
All the criticism of Greenspan issuing forecasts that conflict with the Fed's rosier outlook misses one key point. He can talk all he wants. You don't have to listen.
Read the whole thing.
Why? Why? Why is Greenspan saying that things are grimmer than Bernanke is saying they are?
Why? Just ignorance? Stupidity?
Who benefits if Bernanke is forced to lower rates by Greenspan?
Tanta wrote regarding recast: "If it does happen, the loan must become a fully amortizing loanno more minimum payment allowed, all payments must be sufficient to pay all interest due and sufficient principal to amortize the loan over the remaining term."
That's the exact reason why these loans bring the "death" back to mortgages. Most of the people who have taken these out in the last four years have done so because they really couldn't afford the traditional, fully amortized payment. Once the next refi into a new Option ARM is stopped, many of these loans are equivalent to a 25 or 27 year fully amortized loan for 110% - 115% of the original loan, but with a higher interest rate. The idea that most of the borrowers can make those payments is ludicrous. Over 90% of the loans that do not get refinanced will default. These are really balloon loans. They are meant to be refinanced within two to three years at the outside.
The reason they were originally marketed is that they made great money for the lenders, brokers and realtors. They have never been tested in a flat market, and they will work out much worse than the neg-am 80's-era loans.
What has been tested are non-amortizing loans in various areas, and in my experience, once at least 10% of new purchases in an area or development are financed with non-amortizing loans, you can expect a drop in appreciation after 3-4 years in that area. One reason that there is so much fraud in Atlanta now is that I-O got popular in and around the metro area from about 1999, and by 2002-2003, the inevitable results emerged.
Caroline Baum accuses Greenspan of painting a less rosy picture of the American economy than the Federal Reserve. Read her column:
"Greenspan Can Talk More. You Can Listen Less: Caroline Baum
By Caroline Baum
March 12 (Bloomberg) -- ...Greenspan issuing forecasts that conflict with the Fed's rosier outlook..."
Much as I worship Tanta (from afar, of course, and with no use of the T(antra) word), detailed explanations of negative amortization loans, while they are genuinely interesting, do not capture the whole picture, nor the part of the picture that desperately needs to be captured at this moment in history.
Greenspan is jawboning Bernanke, in public, to lower rates: to inject one last shot of epinephrine (I comply with the policy of these comments to insert as many drug references as possible) into the dying carcass of the American economy, before it keels over, thrashes around for awhile, and dies.
Why?
Greenspan has always been a team player for the Bush Administration.
And the Bush Administration currently faces two problems: getting out of office before
a) the war in Iraq collapses
b) the economy collapses
Think of lowering interest rates right now as "the surge".
The Bush Administration got it's surge in Iraq, because Congress is so craven and benighted that it would give the Bush Administration...well, we'll let Jane Hamsher describe what Congress would give the Bush Administration, but, as a hint, the last word rhymes with "bummer".
Now, we get to see how benighted and craven Ben Bernanke is. My suspicion is that it will be one hell of a long time before Bernanke lowers rates.
But, like Congress, he's being set up, by the great team player of the Bush Administration, Alan Greenspan, to take the fall.
Interesting report from S&P about Japan's mortgage and real estate markets.
Poking around a little on YahooJapan, I find that condo prices in Japan now are about the same as in Chicago on a per-sq-ft basis, though mortgage rates have fallen to around 2.4%. Those who think the Fed can reinflate the real estate bubble by lowering interest rates are probably wrong. Once a glut of supply and falling prices kill the bubble psychology, it's very difficult to revive.
Hi, Love the blog and love Tanta's commentary. I live in the SF Bay Area. Sold my house in 2006 for a tidy profit and now sit in crappy rental... I have an MBA with a concentration in finance, so I follow this stuff religiously.
I feel like a tidal wave is about to crash over the Bay Area. Sales volume is declining rapidly (-25% YOY drops). Median is still up (slightly) but only nominally. The subprime implosion woke up some of the press, but they're still mostly asleep.
As subprime melts down, the sketch neighborhoods are cratering. East Bay (Oakland) and parts of San Jose are tanking. Lots of short sales & REOs are increasing dramatically.
The next chapter for us, is Alt-A. What has been lost on most is that we are unbelievably reliant on non-traditional products. Subprime is exposure is not abnormally high but 75-80% of loans originated in the last 2-3 years qualify as Alt-A or worse. And about 40% of refi's last year were into interest-only loans.
Question for the group: if subprime is tanking now, is it reasonable to assume that Alt-A crashes in 3 years?
Don't think you'll have to wait that long.
From Fannie's website:
"Cautionary Note Regarding Previously Reported Financial Results - On December 6, 2006, Fannie Mae filed its 2004 Form 10-K with the SEC. The filing provides consolidated financial statements for 2004, and a restatement of previously issued financial information for 2002 and 2003 and the first two quarters of 2004. As a result, investors and others should not rely on Fannie Mae's annual and quarterly financial statements issued prior to December 2004 nor should they rely on financial information issued prior to December 2004 that may be contained in Fannie Mae's earnings releases, Annual Reports, Form 10-Ks, Form 10-Qs, Information Statements and Quarterly Supplements, Form 8-Ks, Form 12b-25s , Monthly Summaries, and Business Activity Supplements. For more information, please see the Form 10-K we filed with the SEC on December 6, 2006."
What's going on there?
How much zillions of capital are at stake here?
Why has Congress urged Fannie to bring down there outstanding portfolio?
How come the shares are still allowed to trade freely on the normal market? How long did it take to move New Century shares to the pink sheets?
Who was in charge at the Fed when the problems with FNMA came out?
Has the current subprime situation anything to do with the situation at Fannies (and others)?
Why are the American people not better informed about this?
Too big to fail?
From the White House web site, August 2004:
"Simplifying Homebuying and Increasing Education. The President and HUD want to empower homebuyers by simplifying the home buying process so consumers can better understand and benefit from cost savings. The President also wants to expand financial education efforts so that families can understand what they need to do to become homeowners."
However, should those education efforts not come to fruition, citizens can get their education from a private web site three years later.
Tanta,
Thanks for another fine addition to the mortgage banking Tanthology.
From: Bob_in_MA: Do you think any of these loans have a provision for falling home values? Your example could reach 110% LTV with a 20% drop in home value. (This has happened in some parts of Florida already.
So roll the clock forward a bit. Lenders issuing these neg-am ARM products claim that PMI for any loans issued at greater that 80% LTV provides teflon coating.
What about in Bob's scenario?
If the lender forecloses with loan at 110, and sells at 80, does the PMI make him whole?
Yikes!! thank you so much Tanta for the Endumication..very good read and a very scary outlook.
I have friends in this situation...IO-ARM Sept 07 Reset..6.49% plus!! 5.6% LIBOR!!! I warned him about this and to much of my dismay..He looks at me like I have no idea what I am talking about...So one day last week I said to him " you need to get this place refied or your going to loose your house"...
by the way $332,000 bought at the top way overapraised house if I have ever seen one...I did a little research ,,,and using Zillow which has margin errors yes..he is upside down on his home as of this date..$259,900...so I am at the point now where i say nothing..cause when the shit hits the fan ...and it will in September...I will be standing there with my hands in my pocket saying to myself...I told you so....oh and here is the gravy he is a construction worker whi is laid off for the season...and as of this date...no upcoming call backs from the previous bulder as the have all pulled out...so yes he is screwed to put it bluntly.
I would not borrow money on loan terms I could not understand. I would need to reread this post several times and study it to understand the loan terms you describe. Adjustable Rate Mortgages were around 20 years age, they were called "ballons". Now they appear to be called "innovation".
People will do stupid things for "free money".
OldFart Mortgage, LTD. Is that the residential lend division of Crimson Permanent Assurance?
Concerning recasts and runaway neg-am valuations. You mentioned 110% of original balance and such but nothing about "mark to the lower of book or market." Are there provisions for loan modifications in the case of asset impairments as well?
The other "kickers" are that many of these loans were issued with an 80% first and 20% piggy back second. So they are 100% leveraged to begin with.
The 80% first was done to avoid PMI.
The 20% second is usually at a higher rate and increases at a faster payment rate than the first.
And with these programs no impounds for property taxes and insurance.
As a result, when these properties go into default because they can't meet the new payment, they can easily be 20- 30% upside down with just a 10% dimunition in value.
There's an important distinction that these pay option arms were typically not available to subprime borrowers. Also the debt-to-income ratios were never calculated at the minimum payments either.
The two biggest factors for these type of defaults are:
People who were shoved into these loans who shouldn't have.
People who thought that the value of their homes would keep going up and they wouldn't have to worry about it.
Lenders have now barred almost all the exit doors. Soon enough, well meaning regulators will bar the rest. There are no more loans for high-risk groups and high-risk loans. Any loan within a year of substantial reset should be written down to the realizable value of the real estate (foreclosure sale price less all costs of foreclosure, maintenance and sale). Any historical Reserve estimate is a Mother Goose story. The number of people with neg-Am, Alt-A, Sub-prime, etc. mortages who also have more than 1 months' pay in savings are....well, statistically they don't exist.
For the last 6 months, we've been hearing from various industry schills "mortgage resets are not a problem as we believe many people will simply refinance into a fixed mortgage.." Sure they will. They'll also pay off those credit cards, stop eating fattening food....
And forget the myth of refis into fixed rate mortgages.
During the last year fixed rate loans have been lower than the ARMs (APR basis). If they could have afforded a fully amortizing loan payment, and were not thinking of flipping, fixed rate would have been the loan of choice.
So the ARM made sense because the payments worked. And now they don't.
"Also, there really is never a good reason for a lender to accept an applicant's "stated income"."
Of course there is. If you want to earn an origination fee and you can't write a loan full-doc and you can stated/stated you do it. Why? Because your dollar comes when the loan funds.
There is an odd assumption that mortgage originators are being taken advantage of by borrowers, that 'liar loans' are a product of the borrower lying. The reality is that the originator may and probably is perfectly willing to guide you through the process. Most routine borrowers are not savvy enough to undertake mortgage fraud on their own, anyone who managed to negotiate Tanta's post understands this is not a game for amateurs.
Off the top of my head I am think of five players in a typical residential loan, Tanta could probably add some. And I only spent 9 months in the industry and that not writing loans, so I might miss some fine points of terminology. You have your borrower, you have your originator, you have your loan rep, you have your underwriter, you have your funding lender, you have your ultimate investor. Of those only the underwriter is really on the hook, and that only to the level of the underwriting standards. If the borrower, the originator, and the rep can make the paper look right the underwriter can check the box, the lender fund and then sell the loan, and the investor collect an above market rate.
Its a game. A game in which everyone wins if you can just write the loan.
Lenders are not blind pigs picking up acorns. They know exactly what the implications of funding a stated/stated loan. Because come what may the loan is securitized by the house, as long as the real estate market is rising lenders don't really have to care. People don't like to lose houses, and appreciation will cover the price of foreclosure anyway.
Until the market softens. Then the calculations change in a hurry. Which is what is happening now. The combination of leverage and appreciation is what makes it possible to make huge gains in real estate in an astonishing short period of time. Which is why people are willing to borrow 100% LTV on totally ficticious stated incomes. It is free money. Until it stops being free. Then reality can start to bite in a hurry.
Real estate essentially moved to a position akin to Wall Street before the Crash, margin lending went to zero and you were a fool not to take that loan from your broker and pay him a commission. Until the crash when both you and him could join hands and jump out of that window.
Lenders lent money stated/stated because they were making money doing so. Borrowers risked taking out stated/stated loans because they were making money doing so. None of this was irrational behavior. However much of it turned out to be market timing: New Century rolled the dice too long and looks to be losing the whole bankroll. Investors in Las Vegas condos likewise.
Money was there to be made. And a lot of pe
Exactly.
And now Senator Dodder wants to fleece the taxpayers to give these poor schlubs another couple of months' payments. He's simply paying back the money the banks and service firms gave his campaign with interest (and someone else's money).
OT,
Hapsburger, are you from Austria?
Thank you Tanta for this excellent post.
What I found especially interesting is the fact that lender can book unpaid interest as "noncash" income. As far as I understood, this is another boiler room that inflates paper profits and share values. Do you think this has contributed to the unraveling of sub-prime sector, or will have significant implications for the Alt-sector?
Ja. Wien.
Wien is beautiful. Stephansdom, unbelievable.
I had a girlfriend from Thal. I called her The Blonde Moneypit.
Maybe she didn't like the acronym (BM)?
We also lived in Graz for a bit. Don't think we've been thru Thal. Life is good here.
Looks like the markets are starting to expect the FED to cut interest rates. Should we expect the inflationary path then?
Fed May Lower Rates Three Times in 2007, Options Show (Update1) - Bloomberg.com
I love Europe, but here there's more of a correlation between what you put into life and what you get. People's lives seem more blueprinted outside North America. Just my take.
Tanta, as I understand it Neg Am loans can't be securitized but rather must be kept on the originator's books. Otherwise each time neg am payment occurred some party would have to come up with real cash to pay to investor.
Thanks for your wonderful work.
THE PARTY'S OVER
Borrowers, Beware
By James Grant
Borrowers, Beware - washingtonpost.com
lama - to each his own.
Given the current state of affairs in the good ole U. S. of A., I imagine there might be a growing caucus of those looking for a more 'blueprinted' way of life.
Don't think we can take a whole lot more of this 'freedom' thing.
Hapsburger,
By any chance do you know why German speaking countries (Germany, Austria, Switzerland) are perhaps the only countries in Europe with sane house prices? They look like an island on a sea of insanity. I know that it's because they had no recent boom/bubble but why?
Tanta, great post though I had to read it a few times! You squared the circle for me, thanks!
Warning-useless musing enroute...didn't take long to get "irresistable". (true sign of addiction).
As a rookie cop with two years under my belt in 1994, I was able to get a 95% first and a 5% second (when most others required the standard 20%). The first was at 7% interest. The second was a point higher. I obtained it through Calpers who used my city retirement as collateral on the second. I still had to pay PMI. I was newly married and the house was about 3X our combined income.
Well, we were due to be married in Sept and the house was closing in August. The loan rep called to give us the bad news that because we weren't married we wouldn't be approved for the loan.
Well, I wrote a letter describing our desire. We included all the information on the wedding, including paid receipts and even xeroxed copies of our wedding napkins proving that "it's gonna happen!"
A week later we were approved and we're still there.
I'd like to think a Tanta read that letter and made the call on the circumstances. I won't know.
I do know that recently a letter like that not only wouldn't be needed, but likely wouldn't be read since nobody is doing the legwork to look beyond FICO. When standards get back like the old days, will they, out of efficiency, cost savings, or amnesia, fail to put Tanta back to work taking a look beyond the numbers?
For people like me I hope so.
poszi-
good question.
I think it might be related to cultural issues and conservative banking practices in general.
People tend to pay in cash.
I haven't checked but I can't imagine a lending institution offering anything like a POA or neg am ARM here. Can't really imagine a customer asking for one either.
Much more old school. Hyper-inflation was not such long ago event.
They also have more public housing programs.
Plus, they actually still make stuff here. So maybe not such a need or desire (think memories of Weimar German) for the financial stimulants.
my 2 cents.
"By any chance do you know why German speaking countries (Germany, Austria, Switzerland) are perhaps the only countries in Europe with sane house prices? They look like an island on a sea of insanity. I know that it's because they had no recent boom/bubble but why?
+ the social state has to be financed by something xD thats whats sick in europe, the moment all cars here would turn to ethanol or other eco fuels, the Green governments which are soooo social to everyone would go bancrot because they would not be able to finance their social systems which are completely dependent on fosil fuel taxes.
poszi"
because after taxes, they dont have too much left to spend. in eu you have a sales tax around 19-25% on everything . and you know 6 dollar per gallon is absolutly normal for us europeans
i live in slovakia just beside austria. i dont know but since most of our banks are owned by austrian banks and since i can not see any exotic loans being offered in my country, maybe austrian banks are not that naive altough few weeks ago one of the banks started to offer stated income loan but i think it should be safe since the banks here have access to data from social security so they can verify how much income a person really earns.
During the last year fixed rate loans have been lower than the ARMs (APR basis). If they could have afforded a fully amortizing loan payment, and were not thinking of flipping, fixed rate would have been the loan of choice.
So the ARM made sense because the payments worked. And now they don't.
=-----------------
For real I have been saying this since day one...Why the Toxic Loan on such a major risk...IE: Sub-prime borrower...Was this part of the plan??... To let this sort of a mess get to the point at where it is at the moment...well there has to be a plan..Any heads up for tomorrow ?
Hapsburger,
No offense about Europe. I've had only good memories there both at work and play. I don't think I worked in Europe for more than 3 months total, so maybe I'm not qualified to have an informed opinion anyway.
Why no run up in prices in Germany?
For the same reason there was no run up in Japan - the economy has struggled for the last 10 years.
Cultural and tax explanations are plainly false - there's been a high run up in Spain, France, and the Netherlands, to name just a few countries that have similar cultural and governmental norms.
Lurker,
Neg Am loans (and POAs) are widely securitized. When accrued interest is not paid and is added to the principal balance of the loan, interest cash flows are obviously reduced as a result. Principal payments on the pool of loans is used to pay the intersest due on the issued bonds, with priority determined in the waterfall.
Tanta,
there seems to be a lack of understanding of securitiztion and abs in the comments section. for your next ubernerd post, maybe consider a discussion of the securitization process. you writes better than me, plus i'm lazy.
don't forget aobut the simulatenous seconds originated w/ neg am loans!!!
financial ubernerdism is so hot.
Thanks. Learned alot!
I love the internet!
Thanks Tanta!
Gddamn the pusherman! ( and what else are they? )
20% down anyone? As of 11-10-07 Cash will be very shortly be crowned.
( I took your advice and read this with 2 drinks! )
Great post. Very insightful. A dumbed-down, highly simplified explanation for NegAm loans that I've used is to think of them like credit cards. You can pay it off each month or run up a balance. You pay interest on the balance and interest on the interest if you keep making minimum payments. And your interest rate resets at a higher amount just as your balance may be exploding.
Is that a fair way of simplifying things. Have a post on my blog, optionARMageddon.com about the balance sheet at BankUnited Financail. Great than 50% of their loan book is accumulating negative amortization.
[I'm not a loan officer, just a guy interested in this stuff]
Very interesting discovery to day for me but bad english and bad US system comprehension (and two more drinks...) cause my 3 QUESTIONS: Q1)) Here minimum PMT is the result of what calculation on 90,000? Q2)) Case 1,95% : I understand 'scheduled principal ?reduction' of $184.16 with 0 shortfall. Case 6,5%: OK for (accrued/principal?) interest $484.5; but I don't understand HOW you introduce the column named scheduled principal ?reduction? (is it the complement of fully amortizing?) and how you obtain $82.41 (for exemple) on month 4 on second table. Then I am OK for adding them to 586.9$ and shortfall is the difference with min. PMT: 236.5$. Q3)): what values do you add to arrive to a total of$399.29 (to add back at 90,000 to have the ending Value of 89,600.71)?
Thank you for your help to better comprehension. JG