Wednesday, December 31, 2008

The Second Wave?

Receiving much attention the past week or so was a report aired by CBS 60 Minutes indicating that the next wave of foreclosures would be coming as a result of ALT-A and Option ARM’s. ALT-A loans were mainly used by the self-employed, and individuals with undocumented income to purchase a home at more traditional terms and rates, providing either asset verification, or partial income verification.

Option ARM loans generally had a low teaser rate, which determined your pay rate, but also had a charge rate, which determined the actual interest cost charged, the difference being added to your balance. Golden West, out of sunny California is generally credited with the creation of the Option ARM. They were successful through many real estate cycles, by employing a rigorous underwriting process, and significant due diligence on their contracted appraisers. It has been said that if the subject property was near a high-power transmission line, or freight train track, your loan would not be approved.

The report goes on to give examples of shoddy mortgages falling within these classes, and how the level of defaults will meet or exceed the current carnage in the subprime asset class. Whether or not they are correct is yet to be seen, and is as good a guess as any. However, the causes will be very different. The defaults will be driven by normal default scenarios involving job loss, disability, and rapid deterioration in home values. To paint them as similar to sub-prime is incorrect, as sub-prime were as easy to get funded as a freshman applying for a credit card on campus. These loans, like many other asset classes are more of a victim of the times, rather then their own demise.

And as always, just like a river, those seeking credit will find the path of least resistance ($ WSJ Subscription required). Or maybe a redesign is in order?

Llenrock Group

No comments: