Heard on NPR today that S&P warned investors about some newly popular kind of crazy mortgage where the homeowner gets to choose each month how much he pays, and, if he pays less than the normal mortgage amount, the extra is added to his mortgage. And I thought interest-only loans were a sign that mortgage companies had gone out of their collective minds!
Also read that in D.C., 50% of all loans this year are interest-only. When (if?) prices decline sharply, I feel sorry for whoever owns these loans, because some decent fraction of the mortgage holders are going to walk away from their six-figure paper losses, either because they can't afford the adjustable-rate increases, or simply because they'd rather saddle someone else with their loss.
And federal regulators are starting to put pressure on banks and mortgage companies to rein in their wild loans.
Finally, there is www.condoflip.com, launched in Miami (where 80% of condos are being bought by speculators), and coming soon to a city near you. Certainly a sign of the housing apocalypse.
Having missed out on the housing boom, I'd like to profit from the coming bust. LEAP puts on homebuilder stocks (which have increased by hundreds of percent over the last five years) seem very attractive to me. Which publicly traded builders are most exposed to the most overheated markets (Boston, Vegas, Miami, D.C., Boston, etc.?)
UPDATE: New York Times last week: "American homeowners have made a trillion-dollar bet that mortgage rates will remain near record lows for at least few more years ... Deutsche Bank analysis shows only about $80 billion, or 1 percent of mortgage debt this year will switch to adjustable rate based largely on prevailing interest rates; some $300 billion of mortgage debt will be similarly adjusted in 2006; portion will soar in 2007, with $1 trillion of nation's mortgage debt--or about 12 percent of it--switching to adjustable payments."
http://www.physicsweb.org/articles/news/9/6/4/1
"House prices are rising so fast in 22 US states that they have created a "bubble" that could burst in the middle of next year according to two physicists (physics/0506027). The same team previously predicted that the UK housing market would crash in mid-2004."
Bubbles are caused when people buy because the price is rising, and start to ignore the investment yield (the one thing that DOES control the price.
50% of people paying interest only loans does sound kind of worrying, but then you really need to look at historical levels in order to get a real sense of what it means.
Option ARMs are a bad idea, but the correct way of handling them would be to reuire extra dilligence and collateral for the financial institutions that issue them.
There is an interest problem with the loan market. The problem is regarding who is bearing the risk when loans go south. You're typical loan works as such: You go a loan broker. He only cares about whether he can sell your loan to a bank or not, and what rates do during the 30-90 days or so that you have a rate lock. He sells your loan to a bank, that does the real billing. But they take all of your principal payment, and all but a little bit of your interest and sell it off, either to Fannie Mae, Freddy Mac, or some private bank. Even if they don't, they probably do the same thing the agencies do next, and that is create pass throughs and structured deals, where the risk of not paying is yet again passed to a new buyer. These instruments are bought by money markets, pension funds, foriegn investors, and to some degree by the banks again. Generally defaults make a pretty small effect on the value of these instuments, far outstripped by the massive uncertainty caused by the likely chance of someone refinancing.
The consequence is that under normal cercumstances, it isn't that big a deal in the grand scheme of things when someone defaults on a mortgage, and no one is that worried whether you are at risk for that or not.
Still a significate amount of defaults, which could easily be caused by a bunch of people holding mortgages they can't afford on houses they can't sell, would have a pretty negative effect on the mortgage security market, which is the market that really directs what rate the bank can afford to give you.
Unless they have an well-founded understanding that the price they receive when they sell and move on will be at least close to what they paid, this isn't particularly reassuring. Doubtless many people do have such an understanding, but whether it is well-founded is the worrisome question, no?
I agree on the bubble in many markets. I would be careful on the public homebuilders however. I am not saying the LEAPS won't work, but how they would react to a housing slump is rather unpredictable. While their growth may slow, they are pretty cheap if the growth doesn't actually fall, and a housing slump may allow most of them to pick up marketshare and further consolidate a very fragmented, even if declining, market and still grow earnings. Of course worry might send them lower anyway. Of course those concentrated in the frothiest areas may still get hit hard. Definitely not a sure play even if the housing market rolls over. Long term they are very well positioned even if the market slows so get out quick if it works.
Robert,
I agree with some of what you say, but lack of margin loans is not correct. In essence a morgtgage is a margin loan, which is why rising home prices have been so lucrative, leverage multiplies profits. They unfortunately multiply losses. Our housing market is highly leveraged. Still, your other points are why the housing market can carry more leverage than a stock market.
I agree with your point. I think most people assume that they will be able to cover their loan when they move on (and most suspect a profit) and if they can't, problems will ensue. But its a chicken/egg thing. For those variable rate mortgages to become a problem the market has to sag first. Then they might exacerbate the decline. By themselves, I think risky mortgages are a sideshow to the big picture. Info that supply is high and demand is low in the housing market would scare me more than these statistics about variable mortgages.
Here's my concern: Can't government intervention on behalf of homeowners fill-in the bubble?
Hypothetical: The New York bubble bursts. Housing prices start to drop. Mortgage defaults begin. All of the folks who bought apartments in the last two years start to whine and complain. The developers with dozens of multi-million dollar buildings going up around town call Bloomberg on his cell. And...
Presto, chango, 20,000 existing units get rent stabilized, and prices start going up again.
Note, as said by a post above, that the builders might not decline too much if they can keep building and selling. If you see a bubble coming, as I do, the builders won't be able to build and sell when it hits. Why? Mortgage rates will skyrocket with the many forclosures. I can't afford a mortgage now in LA, can you imagine how outpriced things will be when rates rise?
Any idea where I can purchase LEAPS online?
Thanks
--Fred