Wednesday, April 06, 2005

ARMs Madness Continues

I've posted a lot of adjustable rate stories, but I hope to keep pushing the issue as long as stories like this AP bit are published. Titled "More Are Seeking Adjustable-Rate Mortgages", it reports on the trend with a dash of concern but overall is a feel-good whitewash.

"The Mortgage Bankers Association says adjustable-rate mortgages have accounted for more than a third of home lending activity in recent weeks. Families look to ARMs to keep their early monthly mortgage payments low. But because the rates on their loans can move up with the market, sometimes adjusting monthly, families risk having to pay considerably higher payments in the future."

"I think consumers are approaching home mortgages the way they approach buying cars, focusing just on the lowest possible payment. It's understandable, given the extremely high housing prices we're seeing across the country." Hello! It is crazy to take out ARMs in a rising rate environment! Especially for houses that are probably over-valued.

Here's the dash; "Hsieh worries that as ARMs proliferate, home buyers may be exposed to risks they don't fully understand. 'The older generation remembers when interest rates were in the teens and remembers how much that can hurt when you have an adjustable-rate mortgage,' he said. 'The younger generation has only known the low interest rates, in the single digits, since the mid-1990s. There could be a sharp learning curve here.'" Thanks to the reader for the link.

14 Comments:

At 3:41 PM, Blogger John Law said...

I read yesterday about how if an ARM on a 250,000 loan went up the max(2%) in a year the yearly payments would be up $3,600 the first year. so if that happened 2 years in a row it would be $7,200 more the 2nd year, and $14,400 a year the 3rd year. does that sound right? can you imagine a few years into a mortgage and these people are paying $14,400 a year more than when they started!

 
At 3:51 PM, Blogger Ben Jones said...

Hey John,
They believe the RE hype that buyers will surround them with bushels of money. Can you imagine the default rates when this turns sour?
Thank you for your thoughtful posts..Ben

 
At 3:58 PM, Blogger John Law said...

I seriously believe, when this is all done, there are going to be many many companies that go down. big one's too. hedge funds, pension funds. I shutter. the US is one big finance bubble. everyone wants to be a bank. everyone wants to be a hedge fund. companies who you would never think would have loses probably will.

two more must read links from today:

Corporate loans were once tightly held by banks. But over the last decade or so, the riskiest form of the business, known as leveraged lending, has been transformed to an actively traded market. Besides hedge funds, other large buyers of these loans now include managers of pools of loans known as collateralized loan obligations, which are sold to insurance companies and the like.
http://www.nytimes.com/2005/04/06/business/06place.html?

While most people think of GM as a car company 80% of its 2004 earnings came from GMAC, its financial division.  While the auto divisions posted losses the finance division provided all of the profits.  GMAC doesn't just do auto financing; in fact the majority comes from consumer credit, insurance and mortgage financing.  This division provided GM with most of its profitability.  Just as with GM, the financial industry was responsible for 50% of corporate profitability in the US. With rising interest rates and the prospect of increasing defaults by overleveraged consumers this is likely to change dramatically in the near future.

http://www.financialsense.com/fsu/editorials/bms/2005/0406.html

ben- this blog is great, finally I can post my views w/o people thinking I'm crazy! I mean christ, you people are anti-federal reserve and seem to be gold/silver people! nice.

 
At 6:34 PM, Anonymous Jim in Venice said...

This is my first post, but I wanted to chime in and say how much I enjoy this blog...

In January, my fiancee and I were a day away from making an offer on a condo in LA with an ARM. Fortunately, a delay caused by a two week business trip made us reconsider. Since then I've been with you guys - we'll buy the same condo for half the price in a couple years. In the meantime, we're sticking our down payment money in 3 year CD's with E*Trade at ~4 percent interest (well over what the real estate market will make the next 3 years!!!)

Unbelieveable about the $14,400 a year increase. Really makes you stop and think about what these crazy buyers are doing.

Keep up the good work!

 
At 6:58 PM, Blogger mspenelope said...

4/6/05

Jim,
Are you sure you want to tie up your money for that length of time
.....for only 4%? Plenty other places offering 3.5 for much less time.
Are you locking it in for three years because you think the rates are going to go down?
Haven't you noticed that every couple of months or so the rates being offered keep inching up?
Besides....you do want to be ready when the fun begins....no?
;o )

 
At 7:19 PM, Blogger Ben Jones said...

John,
(there are going to be many many companies that go down)

I'm afraid your right. The consumer will pull back on spending with obvious effect on the economy.

(Corporate loans were once tightly held by banks. But over the last decade or so, the riskiest form of the business, known as leveraged lending, has been transformed to an actively traded market)

I have a post on another blog about that. It is something like 50% of corporate profits.

Jim,
(a day away from making an offer on a condo in LA with an ARM)

Caution is definitely called for in LA. Thanks for posting! Ben

Ms. P.
(you do want to be ready when the fun begins)
Thats what I'm interested in!

Thanks all..Ben

 
At 9:15 PM, Blogger John Law said...

here is the rub, how do you know when to buy? down 20%, 30% or 90%? it was posted on here how RE in Japan has been falling for 15 years. I don't want to buy a house in 3 years and have it fall for another 12, unless I'm locking in a portion of serious gains in other investments.

I worried that as this nation ages, the boomers are going to sell their vacation homes and their primary residence. remember, the next generation of buyers are less numerous than the boomers. I fear the same for US stocks and bonds.

 
At 10:19 PM, Anonymous Anonymous said...

The foreclosures are starting because of interest rates. They are up 50% over last month.

http://www.inman.com/inmannews.aspx?ID=45616

 
At 10:26 PM, Anonymous Anonymous said...

here is the rub, how do you know when to buy? down 20%, 30% or 90%? it was posted on here how RE in Japan has been falling for 15 years. I don't want to buy a house in 3 years and have it fall for another 12, unless I'm locking in a portion of serious gains in other investments.

I don't think it is going to take years to shake out this market. I think that most of the decline will happen in the first year and the next 10 will be flat, if it goes that long. I think this because of the high leverage that has been employed, the massive amount of speculation and the fact that the US is going to go into recession. People are going to be flat out broke when real estate starts falling.

I worried that as this nation ages, the boomers are going to sell their vacation homes and their primary residence. remember, the next generation of buyers are less numerous than the boomers. I fear the same for US stocks and bonds.

I fear the same thing for housing, but not for stocks and bonds. We all only need one house and thus there will be a surplus, but we can all hold many, many, stocks and bonds.

I do expect the price of stocks and bonds to fall because of generally more selling when the BBs retire. They need income ! However, that is what stop losses are for. I do expect P/Es to fall. Think about it: for the last 20 years BBs have been socking money into savings plans and stocks and now they are going to start drawing it out to live on. Before they were net purchasers and now they will be net sellers. It could be a long term tough market. But all that means is lower P/Es, which generally means better dividends. One can experience wealth growth with low or high P/E stocks. Back in the 60s the P/Es were really low.

 
At 11:08 PM, Anonymous Anonymous said...

Unsold houses are starting to pile up in some areas:
http://online.wsj.com/article/0,,SB111283477034900337,00.html?mod=todays_us_personal_journal

 
At 11:09 PM, Anonymous Anonymous said...

Chinese required to pay off mortgage before selling their house !

http://biz.yahoo.com/ap/050407/china_real_estate.html?.v=2

This is done to cool down their housing market.

 
At 11:12 PM, Anonymous Anonymous said...

I'm impressed. They've got a ton of ways to defeat speculative trading of RE in that article. Way to go, China, for being proactive. Why couldn't our leaders do at least some of these things to prevent a bubble ?

 
At 8:55 AM, Blogger Dave F. said...

here is the rub, how do you know when to buy? down 20%, 30% or 90%? it was posted on here how RE in Japan has been falling for 15 years. I don't want to buy a house in 3 years and have it fall for another 12, unless I'm locking in a portion of serious gains in other investments.

John, I basically agree with Anonymous on this. While Japan has been called the mother of all real estate bubbles, there are some significant differences between Japan and the US, which will make our bubble deflate much faster than Japan’s.

1.)The US is a consumer economy and our rate of savings in nowhere near where Japan’s is. Essentially, people have been using their house as an atm machine by living off of their credit cards and doing refi’s every year to wipe out the credit cards and then running up the credit cards in an endless cycle. This works as long as real estate continues to go up and rates stay very low. As Ben has pointed out a couple of times, even flat appreciation spells lots of trouble for all of the people doing this. There could be waves of foreclosures and a giant glut of real estate on the market. This will lead to accelerated depreciation as the bubble starts working in reverse.
2.)While Japan had some interesting mortgage products like the 100 year loan, Japan’s bubble was created long before the securitization and derivative monster that has developed in the US in the last several years. This monster is unlike any that have come before and is essentially a machine that can feed itself. As Doug Nolan has pointed out, the current loan securitization and derivative mechanism allows Wall Street to essentially increase more demand for it’s products the harder and more creatively that it works. Not good.
3.)Japan hasn’t relied as heavily upon foreign investment in their currency, although their rates have basically been low for a long time. The second the Asian’s start getting tired of financing our gigantic debt with all of their savings, we could be looking at significantly higher rates in a short timeframe. This environment is very different than Japan’s situation.

While there are some similarities between our real estate bubble and Japan’s, there are also many differences, which make ours much worse and much more volatile.

 
At 6:10 PM, Anonymous hellboy said...

To Dave F.:

You should buy when you can 1. afford the payment and 2. still make the payment even if you loose your job, ie make sure you have a low payment. That's the way I tend to think about it. Everything else kind of doesn't matter if you plan to be around for a while.

On ARM loans; I read an article on CNN a day or so ago( sorry no link, If I can find I will post )that seemed to suggest that ARM loans are only 20% of the total of all the loans in the US. This is certainly nowhere near the 50% or 80% numbers being thrown around for places like CA. Goldman Sachs also had a piece on ARM loans that suggested much the same thing as the CNN article. Maybe they are not as big a problem as lots of us think?

 

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