[Marxism] Worst is yet to come on mortgage crash

Louis Proyect lnp3 at panix.com
Wed Aug 1 13:17:25 MDT 2007

NY Times, August 1, 2007
Economic Scene
Keep Your Eyes on Adjustable-Rate Mortgages

Two years ago, when the housing market was roaring along, I called a 
mortgage broker on the West Coast and asked for some help. I told him 
that I wanted to interview some recent home buyers who had taken out an 
adjustable-rate mortgage — one of the big drivers of the boom — and he 
was nice enough to pass along a short list of names.

One of the buyers was a business consultant in her 40s. She told me 
about her charming new house and the fact that she expected it to be a 
good investment, even if it had cost a bit more than she wanted to 
spend. Then I asked about her adjustable-rate mortgage.

“I don’t have an adjustable rate,” she said.

Confused, I called the broker again to see what was going on. A little 
while later, I got a sheepish e-mail message from him explaining that 
her loan did, in fact, have an adjustable rate. She just hadn’t realized it.

Now, I think this was an honest misunderstanding in which the broker 
believed that he had explained the terms of the loans more clearly than 
he had. And the mortgage ended up being a good one for the buyer anyway: 
she recently decided to move to a new area and sold the house before her 
rate jumped.

But the fact that this confusion could have occurred neatly captures the 
ridiculous state of the home buying business in 2005 and 2006. The 
fallout is going to last a long time. House prices will need years to 
work off their irrational values, more people are going to lose their 
homes and Wall Street can probably look forward to some more nasty 

In fact, the mortgage meltdown has arrived at something of a turning 
point. So far, most of the loans gone bad were among the worst of the 
worst. Some were based on outright fraud, either by the lender or the 
borrower. In many cases, buyers were never going to be able to make 
their monthly payments and were instead banking on a rapid appreciation 
in home values.

But the pool of people falling behind on their house payments is 
starting to widen beyond this initial group, and adjustable-rate 
mortgages are the main reason. Starting in the spring of 2005, these 
mortgages began to get a lot more popular, largely because regular 
mortgages no longer allowed many buyers to afford the house they wanted.

They turned instead to a mortgage that had an artificially low interest 
rate for an initial period, before resetting to a higher rate. When the 
higher rate kicks in, the monthly mortgage bill typically jumps by 
hundreds of dollars. The initial period often lasted two years, and two 
plus 2005 equals right about now.

The peak month for the resetting of mortgages will come this October, 
according to Credit Suisse, when more than $50 billion in mortgages will 
switch to a new rate for the first time. The level will remain above $30 
billion a month through September 2008. In all, the interest rates on 
about $1 trillion worth of mortgages, or 12 percent of the nation’s 
total, will reset for the first time this year or next. A couple of 
years ago, by comparison, only a marginal amount of mortgage debt — a 
few billion dollars — was resetting each month.

So all the carnage in the mortgage market thus far has come even before 
the bulk of mortgages have reset. “The worst is not over in the subprime 
mortgage market,” analysts at JPMorgan recently wrote to the firm’s 
clients. “The reason for our pessimism is that loans originated in late 
2005 and all of 2006, the period that saw peak origination volumes and 
sharply decreased underwriting quality, are only now starting to reset 
in large numbers.”

It isn’t hard to figure out what will happen when buyers who were 
already stretching to afford a house are faced with suddenly higher 
payments. Many will manage. They will cut back on other spending, or 
they will refinance their mortgage and get a new one they can afford. 
Others, like the buyer I interviewed two years ago, probably planned all 
along on selling their homes after a few years. For them, the 
artificially low initial rate was a no-lose proposition.

But there are also likely to be a shocking number of people who lose 
their homes. From 1994 to 2005, some 3.2 million households were able to 
buy homes thanks to subprime mortgages or other such loans, according to 
an analysis by Moody’s Economy.com. About 1.7 million of them will 
probably lose their homes to foreclosure when all is said and done. More 
than half of the homeownership gains from subprime mortgages will be erased.

The flood of those homes onto the market will further depress house 
prices. So will the newfound conservatism of mortgage lenders, which 
will make it harder for tomorrow’s buyers to get a mortgage. (Thank 
goodness.) The S.& P./Case-Shiller index of home prices covering 10 
major cities has fallen about 3 percent since its peak last summer. Two 
or three years from now, JPMorgan predicts, the index will have fallen 
15 to 20 percent. Adjusting for inflation, the decline will be worse.

The big unknown is whether the housing bust will cause a recession or a 
bear market. Most people who have looked closely at the mortgage market 
argue that the answer is no and that the damage will be contained. 
Subprime loans still make up a distinct minority of the mortgage market. 
Over all, only 3.4 percent of mortgage holders are currently behind on 
their payments. And as Victoria Averbukh, a former mortgage analyst at 
Deutsche Bank now teaching at Cornell, points out, “The housing market 
is still a limited portion of the U.S. economy.” Consumer spending has 
slowed recently, but is still fairly strong. Corporate balance sheets 
and the job market seem fine.

Rationally, the argument for optimism is pretty compelling: the 
economy’s strengths do look big enough to overcome its weaknesses. Yet 
even many of the optimists confess to an uncomfortable amount of 
uncertainty. There has never been a real estate bubble like the one of 
the last decade. So it’s impossible to know what the bust will bring, 
especially when there are still so many mortgages that are about to get 
a lot more expensive.

E-mail: Leonhardt at nytimes.com

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