The idea of just handing the keys back and walking away from a house worth less than the loan made against it tends to catch the imagination. Hence fears that the expiry of initial fixed rates on Alt-A loans could result in another wave of foreclosures, just as the pain in the sub-prime segment appears to be peaking.
Yet there are reasons for cautious optimism. Alt-A borrowers have better credit records than sub-prime debtors, and the pool of Alt-A mortgage backed securities is smaller - about $600bn for loans made between 2005 and 2007, compared with about $1,000bn for sub-prime. Home owners will not necessarily default just because plummeting home prices have left them with negative equity. Research by the Boston Federal Reserve examining house price falls in the early 1990s found that while negative equity was a necessary condition of foreclosures, borrowers also had to run into cashflow difficulties before losing their homes.
Will they? Many of the Alt-A mortgages were made with interest rates typically set at between 5.5-7.5 per cent for those with a fixed period of 12 months or more. These then "reset" to adjustable rates. With wholesale interest rates currently low, those resetting will see little shift in their interest cost. Instead, it is the end of "interest-only" periods that will be most painful. New research by CreditSights out this week, however, suggests principal re-payments kick in within the first three years in only 4 per cent of 2005-origin Alt-A mortgages and in only 1 per cent of those of 2006 vintage. That is a significant ripple, but not a wave.
After every bubble, there's generally a sort of an anti-bubble--when analysts start looking for reasons that this is, like, the worst crisis ever. The worries about Alt-A mortgages seem to me to be largely part of this fever. "Everything in the future will be exactly like everything that just happened" is what got us into this mess in the first place . . .
The worries about Alt-A mortgages seem to me to be largely part of this fever
It's not Alt-A loans but option-arms that are so toxic. There are about $500 billion of them, in subprime, Alt-A(concentrated here) and prime. Most of these will see a doubling of the minimum payments, and since 80% of the owners are paying the minimum payment (it's less than the interest) the loans will be at 110%, 115% or 125% of LTV of the original appraised value. These are people who are struggling making the minimum payment, who will end up resetting to paying a fully-amortized payment on a higher loan value, from a payment that doesn't even cover interest.. The resets are happening faster than expected, because when you get to a specific LTV (110%, 115% or 125%) the loan automatically resets.
They are right when saying it's not Alt-A specifically, since not all option-arms are Alt-A and not all Alt-A are option-arms. That however, is missing the point because what people really mean is that losses in the option-arms are enough to bring major banks to insolvency.
The FT is full of it.
Alt-A is going to default at rates never before seen for supposedly "prime" borrowers.
Reflections on Alt-A:
"...Residential mortgage lending never, of course, limited itself to considering creditworthiness; we always had "Three C's": creditworthiness, capacity, and collateral. "Capacity" meant establishing that the borrower had sufficient current income or other assets to carry the debt payments. "Collateral" meant establishing that the house was worth at least the loan amount--that it fully secured the debt. [...]
"In the old model of the Three C's, a loan had to meet minimum requirements for each C in order to get made. We didn't do two out of three. The only lenders who ever did one out of three were precisely those "hard money" lenders, who cared only about the value of the collateral. This was because they mostly planned on repossessing it. Institutional lenders' business plan still involved making your money by getting paid back in dollars for the loans you made, not by taking title to real estate and selling it. [...]
"Alt-A is sort of a weird mirror-image of subprime lending. If subprime was traditionally about borrowers with good capacity and collateral but bad credit history, Alt-A was about borrowers with a good credit history but pretty iffy capacity and collateral. That is to say, while subprime makes some amount of sense, Alt-A never made any sense. It is a child of the bubble. [...]
"Alt-A, we are regularly told, is a kind of loan for people with good credit but weak capacity or collateral. It overwhelmingly involved the kind of "affordability product" like ARMs and interest only and negative amortization and 40-year or 50-year terms that "ramps" payment streams. [...] Alt-A was and has always been about maximizing consumption, whether of housing or of all the other consumer goods you can spend "MEW" on. If subprime was supposed to be about taking a bad-credit borrower and working him back into a good-credit borrower, Alt-A was about taking a good-credit borrower and loading him up with enough debt to make him eventually subprime.
"The utter fraudulence of the whole idea of Alt-A involves the suggestion that people who have managed debt in the past that was offered to them in the past on conservative "prime" terms must therefore be capable of managing debt in the future that is offered to them on lax terms. FICOs or traditional credit analyses are good predictors of future credit performance, but only if the usual terms of credit-granting are similar in the past and in the future. Think of it this way: subprime borrowers had proven that they couldn't carry 50 pounds, so the subprime lenders found a way to restructure their debts so that they were only carrying 40. Alt-A lenders took a lot of people who had proven they could carry 50 pounds and used that fact to justify adding another 50 pounds to the burden.
"This has not worked out well.
"The "Alt" in Alt-A is short for "alternative." Alt-A is one of the purest examples of a "new paradigm" thingy you can find. The conceit of Alt-A is that there is another way to approach "prime" lending that is equivalent in risk (assuming risk-based pricing) but--amazing!--way more painless. Toss out verifications of income and assets, and you are no longer evaluating capacity. Toss out down payments and careful formal appraisals and analysis of sales contracts and you are no longer evaluating collateral. But lookit that FICO! [...]
"The thing is, as long as the flipping of speculative purchases worked--and it did for several years--[Alt-A] worked. Meaning, those Alt-A loans prepaid quite quickly with no losses. That masked the reality of Alt-A--that it was largely a way for people to take on more debt than they ever had before--for quite some time.
"Of course we all know now--I happen to think a lot of us knew then--that Alt-A is chock-full o' fraud. My point is that even without excessive "stated income" or appraisal fraud, the Alt-A model was essentially doomed. "Alt-A" is the kind of lending you would only do after a real estate bust, not during a real estate boom..."
Solar Lad:
Bingo!! Considering how much "B-52" is propping up the financial markets as it is, just because Alt-A is a smaller problem isn't exactly something to be celebrated.
... in the early 1990s found that while negative equity was a necessary condition of foreclosures, borrowers also had to run into cashflow difficulties before losing their homes.
This is the problem, the borrowers had cashflow difficulties when the loans were made. We have the typical reasons for foreclosures still happening, death, divorce etc., but the record rate of foreclosures suggests something else has happened. The foreclosures in the 1990's weren't caused by banks lending people money with no capacity to pay it back, but the current foreclosures are.
Or panic...
The issue with defaults has never been about credit record; it’s about risk-layering, and you’d expect the financial markets to understand this by now. Take a borrower with poor credit history, add in an adjustable-rate loan, DTI underwritten at the teaser, stated-income underwriting, and so forth and you’ve got a layer cake of risk with so many layers in it that it’s a wonder it could ever stand to begin with. Alt-A borrowers face similar risk-layering, including piggybacked second liens and stated income borrowing, among others.
When it comes to RMBS, it’s not about the sheer volume of securities issued; it’s about the credit enhancement that exists to protect investors once collateral defaults occur. And comparing Alt-A issues to subprime, it’s no contest: Alt-A is so much thinner in its padding for losses that a lower default rate could hurt investors in Alt-A deals far worse than anything we saw in subprime. The only saving grace here is reach; because Alt-A deals didn’t yield what subprime did, fewer got pulled into CDO issues.
There are large chunks of Alt-A that didn’t get securitized, but instead were held in portfolio for the interest income benefits: and that would be your option ARMs. Which means that while mushrooming defaults may not hit RMBS investors, they will hit the loan portfolios of more than a few commercial banks.
Taken together, the above suggests that if anything, we should be as much concerned about where Alt-A heads over the course of the next 12 months as we have been about subprime. (And, even with subprime, it’s worth noting that many defaults staved off by low interest rates haven’t escaped the guillotine for good, since most continue to re-adjust every six months. If rates increase, subprime defaults will likely ratchet forward again).
Joe~
you could at least credit Housing Wire, since you apparently know how to cut and paste very well
Haven't you consistently underestimated the problems in the mortgage markets? So why should we listen this time?
Not to worry? From the WSJ on Fannie's Q2 results (H/T Calculated Risk):"Fannie Mae swung to a second-quarter loss as the largest buyer of home loans booked $5.35 billion in credit-costs from boosting loss provisions and charge-offs. ... eliminating higher-risk loans -- namely newly originated Alt-A acquisitions ... As of June 30, Alt-A mortgage loans represented 11% of Fannie's total mortgage book of business and 50% of its second-quarter credit losses."
It would be interesting if people who made predictions had to live with the consequences of their predictions like credit risks have to live with the consequences of their defaults.
FYI
AltA were not "underwritten at the teaser" - loans were underwritten at the fully indexed rate - See my post on MM over the weekend about the myth of teaser rates
Also, these screeds assume all AltA's are interest only (many were). The IO feature is usually (deliberately) timed not to coincide with the "roll: date of the ARM loan. for example, a 3/1 ARM will adjust from its 3 year fixed rate to floating after 3 years, and the principal - mandatory -repayment does not kick in until year 5; for a 5/1 the principal repayment does not kick in into 10 years into the loan, and so forth. This was done to avoid payment shock
As I wrote over the weekend: most AltA loans will reset to a low rate, often lower than the initial fixed rate! Surprise! LIBOR is about 2.5, and the margin is 2.25 so an AltA from the summer of 2005 will reset 4.75% - breath-taking, huh?
This, by the way, is not true for "pay-option ARMs" AltA and subprime, but then some people are in deep shit
So, no, not all AltA borrowers are doomed. Many of them may have gone out and wracked up a bunch of Credcard debt AFTER they got their loans, but that is their own problem. They should go to the poor house.
The sky is not falling
I don't think it has anything to do with the type of loan. If you are 20% underwater on a typical $750,000 California tract home, and you suddenly have to move, you have two choices: a) bring a huge check to the closing (assuming you can sell at all) and kiss your savings goodbye, or b) walk away and take the hit to your credit rating.
So the difference this time in the worst bubble areas is the simple magnitude of the loss. The type of loan and the credit rating could affect people who want to stay in their homes, but it doesn't affect the people who want to (or need to) move. And there are a lot of those people!
AltA were not "underwritten at the teaser" - loans were underwritten at the fully indexed rate - See my post on MM over the weekend about the myth of teaser rates
She's way off base here, Alt-A includes many types of products. She really has shown little understanding of the mortgage industry the last few years. What Alt-A loans are loans given to people with high FICOs, but no verification of income or reasonable collateral on the loan. The result is 100% financing, I/O loans and neg-am loans. The neg-am loans have a minimum payment, that's the very definition of the teaser rate. It's so low that it doesn't cover the interest, so the loan value increases. They do have very specific uses, and are good for them, but they were handed to people who had no business receiving one. Also, housing is a long-term loan so giving people a low rate for a short amount of time and then having it reset higher is a major problem. Especially on loans where there is no documentation of income.
So, no, not all AltA borrowers are doomed.
Agreed, but a small amount of borrowers can cause bank failures with non-performing loans. There isn't going to be payment shock, but how many people can even afford modest payment increases? A negative savings rate suggests that small payment increases will push many people over the brink. We've already required a massive government bailout and the neg-am loans and I/O loans have barely started to re-set.
Re: If you are 20% underwater on a typical $750,000 California tract home, and you suddenly have to move, you have two choices:
There are two additional choices:
1. A short sale
2. Renting the house out.
Re: There isn't going to be payment shock, but how many people can even afford modest payment increases?
Since ARM rates are tied to the Fed funds rate, will there even be a reset upwards? That factor appears to be keeping other ARMs from "exploding" why not Alt A's too?
JonF, the short sale may not wreck your credit rating, but it's still a loss to the bank. Probably not as bad a loss as the foreclosure. And in a widely declining market, how many short sales can the bank process? Can the homeowner even get the attention of the bank in time to move due to job change, etc.
As for renting, some of these mortgage payments are double what the house would rent for. If you are moving, can you afford the loss on the old house in addition to payments on a new one?
Re: Can the homeowner even get the attention of the bank in time to move due to job change, etc.
A problem, I agree, but one that also applies to selling the house at all in today's market.
I happen to know someone who was in the situation you describe-- having to move for a job and stuck with a house. This was in Michigan, not California, but the housing market is in very bad shape in Michigan too. Anyway, their (temporary) solution was for his wife (still employed in Michigan) to remain behind while he moved in with his sister in North Carolina. Finally, they rented the house, for the amount of the house payment, and his wife joined him and they found their own housing. Two years later they are still renting (they did have to evict one tenant for not payment of rent) and the house has still not sold. Obviously this is a major hassle fo them, but it does sho that people have options and that they will not simply walk away from mortgages.
Since ARM rates are tied to the Fed funds rate, will there even be a reset upwards?
Alt-A refers to a loan to somebody with good credit, but no proof of capacity and not much collateral (typically a down payment). It encompasses a wide range of loan products. It's not that Alt-A is that bad when everyone is honest, but it was used so people could lie about their income and qualify for more home than they could afford.
Neg am loans are going to reset upwards, because the design is for the minimum payment amounts to increase each year. Unfortunately, the loans were made with too large of a spread from minimum payment amount to real interest, at a time of low interest rates, so they have little chance of catching up. At a certain LTV the loan automatically converts into a fully-amortized loan. Now instead of a payment that doesn't cover interest, you have a standard P+I loan amortized over the life. Neg-am loans did have some specific uses, but they were used incorrectly and we're seeing the result.
Not all ARMs are tied to the fed funds rate, and the fed funds rate isn't the only factor driving mortgage interest rates. It's true many ARMs would reset lower right now, but that could certainly change in the next year. I/O loans also eventually convert from I/O to I/O + principal.
...people have options and [they] will not simply walk away from mortgages.
Most won't, that's true. However, "most" isn't good enough, since:
A) A higher percentage will than was the case during any other crisis in the past 65 years.
B) The recent housing mania was wider-spread and reached higher absurdity than ANY OTHER American housing boom over the past 110 years, even including the infamous "Florida swamp land" rush of the Roaring Twenties, per professor Robert Schiller of Yale.
C) The bad paper isn't just held by banks anymore; it's spread throughout the world, and is widely held by American pension funds, insurance companies, and gov't "rainy day" funds.
It's been over 75 years since America has last seen what's about to happen over the next five years.
Most ARMs will reset lower
most ARMs are indexed to 1YR TREASURY and 1 or 3 month LIBOR plus a fixed margin. Both of these indexes are down sharply from 2-4 years ago
Neg AM loans generally will reset upwards though.
People do have the option of making higher payments
Agree with SOlar Lad though, this will be very bad before it is done
The problem is not the mortgages, it is the house prices. The people who were even good credits paid too much for houses
The question to be asked is how many of the alt-A loans, particularly those with low initial payment options, went to speculators. As we rolled up towards the peak of the boom, it seemed that more and more of the purchases were going to speculators. We saw that in the condo lineups in Florida on opening sale day. We saw developers and home builders trying to actually dampen down speculation by insisting on a recapture of profits in sales of less than one year.Getting into the flipping and home speculation business made many a successful tv show for cable.
So one would guess that a lot of alt-A loans went to people with good credit who really didn't want to answer a lot of questions and take a lot of time over paperwork when there was money to be made. And my guess is that many of these people have enough equity elsewhere in their lives where bankruptcy and jingle mail aren't really options that they can pursue.
So do we know how many of the alt-A loans went to speculators?
And my guess is that many of these people have enough equity elsewhere in their lives where bankruptcy and jingle mail aren't really options that they can pursue.
I have a feeling that somebody that has to do a stated income with zero down loan to speculate in the real estate market, doesn't have that many assets. It's not that they didn't want to take the time, it's because if income was verified the loan would never have been funded due to lack of income. Some states also have non-recourse mortgages, so banks can't go after the person.
Resetting higher/lower also depends on the loan re-set timeline. Most assumptions go with a 5-year reset. The LIBOR is down sharply from 2005, 2006 and 2007, but up from 2001, 2002, 2003 and 2004. 2003 saw the lowest LIBOR. The resets over this year and the next are going to be from lower rates to higher rates. It's not until we start to get into the loans origination in the end of 2004 will rates reset lower.
Daddy bought the flat for you, cash, amirite?
AltA is not a separate bubble. It was all of a piece with subprime which was part of a much larger bubble which involved the entire credit system. Unless you don't know it the credit system is capitalism. The credit system means the credit market. The most important market of all is the credit market.
Into this great 'free market' stepped Greenspan who relentlessly suppressed interest rates. Strangely it became gospel that one man controlled the market and this was lauded by champions of 'free markets'. I guess I have to point out that one man, one institution, controlling a market is the opposite of a free market. This gigantic logical flaw totally escaped even the most ardent free market ideologs because they were getting rich.
Now our free market champions are in the process of making the US Treasury a subsidiary of the great Wall Street banks and broker dealers. (not the other way around. The meme is around that Wall Street is being nationalized. The proper way to view it is that the Treaury is being privatize) In order to save the system, their system, the US taxpayers are going to take on about a trillion dollars worth of bad paper from the GSE's.
Re: Agree with SOlar Lad though, this will be very bad before it is done
The parallel for this isn't the US in the 1930s-- it's Japan in the 1990s, where a huge (and ridiculously overinflated) real estate bubble collapsed and hobbled their economy for years. The Great Depression happened to a radically different economy and a radically different nation. Barring catastrophe on an almost cosmic scale (nuclear war, that sort of thing) that isn't going to repeat. But a stagnant economy that sputters effectlessly for years can and probably will be our fate. Of course much depends on what happens politically in the next year.