Option ARMs and Recast Shock Syndrome: Toxic Financial Products are Imploding on Schedule

[RedEarth]

from Dr. Housing Bubble:

California’s credit rating is now the lowest in the country as the state’s rating was just downgraded. On top of that great news, the option ARM spigot is now open. We’ve been warning about the financial destruction that option ARMs would cause once they started recasting in full fury. Well now we do not have to speculate. These loans are imploding like their subprime siblings. The curious notion that option ARMs were “prime” products rested on the fact that these loans were made to folks with higher FICO scores. This is simply absurd. I knew people making $30,000 a year with 700+ scores. Does that warrant a person like this buying a $500,000 home? I keep remembering an article that I highlighted on May 3rd, 2007 where someone making $14,000 a year was able to qualify for a $720,000 loan. The real estate agent told the buyers that they would be able to refinance the loan with more affordable terms. Listen, you can offer them a 0 percent 50 year mortgage and the math still wouldn’t work.

.....charts on the link below........

We’ve only started the first round and it is game over. In total approximately $750 billion of option ARMs were originated from 2004 to 2007. What is even more troubling is that 55% of borrowers with option ARMs owe more than their actual home is worth. And this data is conservative since it comes from the banking sector which didn’t even see the recession coming even while they were standing knee deep in it.

Now here is where the data becomes more recent. As of December of 2008, a stunning 28% of option ARMs were delinquent or in some stage of foreclosure. We haven’t even seen the major recasts and already over 1 in 4 of these loans is imploding. Can you say subprime redux?

In recent reports I have been seeing that people are saying this won’t be as bad as subprime since just over half of subprime loans were delinquent or in foreclosure in December. To those people I say, come back in December of 2009 and it will be a very different ball game. 50 percent is optimistic for the option ARM game.

.....

a) You have a couple making $100,000 buy a home in California for $600,000 with an option ARM in 2005. Let us run the numbers:



Not bad. We have a $600,000 home for only $1,995 a month. Now, we aren’t factoring taxes and insurance which will probably add another $625 a month. So let us see how our budget looks:

Monthly Net Pay: $6,010

PITI: $2,620

Okay, so we’re okay with the current payment. But let us now fast forward to today:

(b) The same couple is now making $70,000 because of cut backs and the employment situation in the state. The home is now worth $350,000 and the payment has jumped up since it is 2009. What does the crystal ball show us?

Monthly Net Pay: $4,499

PITI: $3,876 (with average 63% jump on PI)

Game over.

It is simple as that. So these people are flying under the radar right now. And this is assuming that the income is still coming in. So technically these people are still current on their teaser rate because in many cases this is probably cheaper than renting. But once the rate recasts, all of a sudden you get recast shock syndrome (RSS). At that point, you moonwalk away and that is why we are already seeing a default rate of 28%. We will see 70% plus of the current loans implode (that is, if the government doesn’t jump in with some other cockamamie idea). And instead of running some complex macro economic analysis, just look at the above numbers. Anyone can see that this was going to happen and those that are “shocked” to see 28% defaults already are simply smoking delusional crack laced with happy go-lucky real estate PCP.

So this is where we now stand. California and Florida have the majority of these option ARMs and they will have to deal with the brunt of these loans. The irony is these loans are good until they go RSS and then it is missed payment after missed payment. Get those ruby slippers ready because there is going to be some serious moonwalking from option ARMs in 2009.

http://www.doctorhousingbubble.com/option-arms-and-recast-shock-syndrome-toxic-financial-products-are-imploding-on-schedule-examining-the-impact-on-california/

[dixiegrrrrl]

1. And this has been predicted all along...is the Goverment blind????

[Ikonoklast]

2. This is the second hammer waiting to fall.

Real estate is nowhere near the bottom as these ARM's that were financed at the absolute top of the market have yet to get fixed.

This is a ticking time bomb, and I see nothing that will stop it from blowing up.

This graph scares me, bad.

[RedEarth]

5. Another hammer that is falling now is commerical real estate

...then we can also add auto, credit card, student loans...we're not even close to the bottom yet.

by CalculatedRisk on 2/05/2009 02:40:00 PM
From Bloomberg: Moody’s to Review $302.6 Billion in Commercial Debt (hat tip Bob_in_MA, Brian for the post title!)

Moody’s Investors Service is reviewing the ratings of $302.6 billion in commercial mortgage-backed securities as real-estate values drop and property owners fall behind on payments.

The review encompasses 52 percent of outstanding U.S. commercial mortgage-backed debt ranked by Moody’s ...
And so it begins for CMBS. First the reviews, then the downgrades, followed by the bank write-downs, and then more reviews ...

http://www.calculatedriskblog.com/2009/02/cmbs-on-chopping-block.html

...a few more from Calcutlated Risk...

Fed's Yellen: Economic Outlook and Community Banks

From San Francisco Fed President Janet Yellen: The Economic Outlook for 2009 and Community Banks. A few excerpt on a common topic: CRE and non-residential investment:

Nonresidential construction declined modestly at the end of last year but, surprisingly enough, has not yet shown the steep declines that have been expected for some time. However, such declines are almost surely imminent. With business activity slowing and new buildings coming on line, vacancy rates on office, industrial, and retail space are all on the rise. For developers, financing is indeed extremely hard to get. The market for commercial mortgage-backed securities has all but dried up. Banks and other traditional lenders have also become less willing to extend funding. It’s no wonder that my contacts are talking about substantial cutbacks on new projects and planned capital improvements on existing buildings.
...
Many community banks have significant commercial real estate concentrations, and these loans are a particular concern in the current environment. At present, the performance of such loans has deteriorated only mildly. But, as I suggested earlier, we can’t count on that situation to continue, since the downturn in commercial real estate construction is just getting started and is likely to be quite challenging.

http://www.calculatedriskblog.com/2009/02/feds-yellen-economic-outlook-and.html

Bank Failures and Commercial Real Estate
by CalculatedRisk on 1/23/2009 02:44:00 AM
As I've noted several times most regional banks avoided the residential real estate market (because they couldn't compete) and instead focused on CRE and C&D (construction & development) lending. This exposed many regional banks to excessive CRE and C&D loan concentrations, and now that CRE will implode in 2009, many of these banks will be in serious jeopardy.

Eric Dash at the NY Times has some details: Smaller Banks’ Losses Expected to Bring Mergers

Most of these banks were never big players in credit cards, subprime mortgages or credit-default swaps. But they were major lenders to commercial real estate developers, home builders and small corporations. As the recession tightens, losses have started to surge.

“There will not be the shock and awe factor” of the big bank losses, said Nancy A. Bush, a longtime banking analyst. But “small and midsize banks are up to their eyeballs in commercial real estate related to residential development and business loans. We are going to see a reckoning with how bad that got” in 2009.

http://www.calculatedriskblog.com/2009/01/bank-failures-and-commercial-real.html

[roamer65]

6. Suze Orman said we wouldn't be out of this mess until 2014 or so.

She must have seen this graph.:yoiks:

[TroubleMan]

3. A guy I work with had his mortgage jump from about $1000/month to about $4000/month.

He had to get rid of the house.

[Warpy]

4. This is why I'm telling people not to sweat the

GOP and Blue Dog gutting of the stimulus package: it won't work even if it's perfect.

The economy will continue to go down the pan at least until August, 2010, which is when the rug got pulled out from under outfits like Countrywide and their liar loans at the peak of the bubble markets in various parts of the country.

Since the Blue Dogs and GOP are responsible for gutting everything Obama is proposing, they'll be easy targets in 2010, and that's a good thing for the possibility of long range recovery planning.

[CoffeeCat]

7. We were pressured to do this "creative financing."

Nearly four years ago, my husband and I began looking for a home. We were stunned by the experience.

It started with our realtor who encouraged us to "buy more house" because of "today's amazing financing options!".
We were told that we could do a "3-2-1 buy down" or "pay interest only for the first several years" or "go with
an ARM" and get a really low interest rate and a low payment."

Our realtor did this!

We finally found a house. A really nice house that was priced low because the sellers were in a desperate situation.
We didn't buy "more house" as our realtor encouraged.

Then, we sat down to do the financing with the mortgage broker. When we told her we wanted a conventional, fixed-rate
mortgage, she looked at us like we were nuts. "Are you SURE you don't want to take advantage of these amazing financing
opportunities? You could have such low payments." We remained firm and she treated us like we were stupid and unsophisticated.

This broker didn't even have the paper work to do the conventional mortgage. She had to go look for it. She stumbled through
it--because her "just do the ARM!" sales pitch usually worked and she sold so much of this creative financing.

I've told this story before, but I think it bears repeating. Many, many people were pressured into taking these loans and
many first-time home buyers were snookered into believing that this was smart financing.

It's unjust what has happened. And it's not just the banks. Realtors, who wanted to make bigger sales--encouraged
people to buy these huge homes. I can't take you how awful it was--standing in a beautiful 5 BR house, with granite,
sweeping staircases, floor-to-ceiling windows, 2 fireplaces, media room, etc--and to be told--"You can do this! Your
payment would only be $1,100 for the first five years!"

Sure, we would have loved to have lived in a house like that, but we resisted. But it was horrible that the bait was
even put in front of us!

After we signed the conventional mortgage--my husband and I slumped in our car. We could barely catch our breath.
We knew what would happen when those mortgages reset. We've been preparing for economic Armageddon ever since, and
this was four years ago.

It's revolting what the corporations have done to the PEOPLE of this country, and what they've done to our
economy as a whole! It's criminal!