Monthly payments on option ARMs reset after an initial low- rate period, usually five years, and researchers at CoreLogic Inc. in Santa Ana, California, estimated in 2009 that such recasts would peak at 54,000 a month in August of this year. In a 2006 cover story in BusinessWeek magazine titled "Nightmare Mortgages," George McCarthy, a housing economist at the Ford Foundation in New York, compared the looming resets to a neutron bomb.
"It's going to kill all the people but leave the houses standing," he said at the time. What he and other analysts didn't anticipate was that so many option ARMs would go bad before resetting, and that interest rates would stay low enough to minimize the impact of the adjustments on borrowers like Jones who are making their payments. Still, a model developed by JPMorgan Chase & Co. analysts predicts that 70 percent of remaining option-ARM loans that were bundled into bonds will eventually default.
'Disaster Already Happened'
About $600 billion of the loans were made from 2005 through 2007, according to industry newsletter Inside Mortgage Finance. Of those packaged into bonds, some 20 percent have been liquidated at losses to investors, and almost half of the remaining ones are at least 30 days delinquent, in foreclosure or have been seized by lenders, according to data from JPMorgan.
"It's not that option ARMs weren't a bad way to finance homes, it's just that the disaster already happened before the resets," McCarthy said in a telephone interview last week. The prospect of fewer defaults is a plus for the housing market, which was burdened by 2.2 million foreclosed homes as of Dec. 31, according to data from Lender Processing Services Inc. in Jacksonville, Florida. The S&P/Case-Shiller index of home values in 20 cities fell 1.6 percent in November from a year earlier, the biggest decrease since December 2009, the group said Jan. 25. The gauge remains 30 percent below its 2006 high.
Eoin Treacy's view
I have long believed that since the Option ARM reset schedule was so widely
known that it was unlikely to have the same effect as the crash in subprime
mortgages from 2008. (Also see Comment of the Day on December
10th 2009). I have occasionally referred to this tendency as the market's
equivalent of Heisenberg's Uncertainty Principle in that the more people who
know about a potential problem, the less likely it is to occur.
Sentiment towards the US housing market remains at a bearish extreme. However, the pace of foreclosures appears to have hit at least a medium-term peak. The Case Shiller 10 Index has stabilised above 150 over the last 18 months and, while it is still early, a sustained move below that level would be required to question the base formation development hypothesis. Taken in conjunction with current low interest rates, affordability is still close to an historic high.
Higher short-term interest rates will be a headwind for the still fragile housing market when they begin to rise. 10-Year Treasury yields hit an accelerated low in late 2008, retested it in September 2010 and continue to rally towards the psychological 4% level. A sustained move below 3.4% would be required to question potential for some additional upside while a move above 4%, held for more than a week or two, would reaffirm a return to dominance for bond bears.