Big picture of The growing mortgage default crisis. Countrywide

Apr.30, 2008 in Market Outlook

“In the good old days, that was the best loan we had at Countrywide…” John Sipes told the Wall Street Journal. He was reminiscing about Countrywide’s “Fast and Easy” loan (aka “liar loans”), which allowed homebuyers to get a mortgage without any supporting documentation of their incomes. Originally, lenders made these loans only to folks who could provide a 10% down payment and based them only on fixed interest rates. But before too long, lenders were making “Fast and Easy” loans with only 5% down and an adjustable rate. These loans were like embossed invitations to criminals: Please defraud us.

Who in his right mind would make a loan to someone with hardly any down payment or any proof he could repay it? And what kind of a bank advertises its underwriting as “Fast and Easy”? The kind of bank that can turn around and immediately sell its liar loans at a profit to a ready and willing agency of the federal government – Fannie Mae. Fannie bought these “prime” loans eagerly during 2003-2006, with full knowledge of the underwriting. But now, Fannie is calling Countrywide’s actions fraudulent because “Fast and Easy” loans are 50% more likely to default than documented loans. Congressman Barney Frank’s idea to “solve” the mortgage crisis is to let Fannie buy even more mortgages…

The actions of all the parties in this fiasco strains credulity. It’s surprisingly difficult to figure out who was more greedy and stupid, the lenders, the borrowers, or the mortgage agencies (Fannie Mae and Freddie Mac). And liar loans weren’t even the most preposterous mortgages. Many loans were made to borrowers who could positively not afford the debt service. For these buyers, who were known not to be able to afford their mortgages, a new type of mortgage was created, an “option” adjustable rate mortgage (ARM). The “option” was to pay or not to pay your monthly interest and principal obligation. If you chose not to pay your mortgage, the interest you did not pay would be added onto your existing mortgage, up until you owed 125% of the value of your home, at which point you would have to begin making a vastly higher monthly payment.

It won’t surprise you to learn that folks who don’t pay their mortgages usually can’t pay their mortgages. And a growing mortgage balance doesn’t make them any more likely to pay or be able to pay. In fact, owing far more than a home is worth makes it vastly more likely for a mortgage to go into default. Nevertheless, roughly 50% of Washington Mutual’s “prime” mortgage portfolio is made up of option ARMs. So far, about 10% of these loans have gone bad. Far more will spoil when payments actually become due in 2009 and 2010. Keep these facts in mind when you hear the government talking about the good people who are “losing their homes” to ARM resets. When it comes to option ARMs, the people never actually owned anything, except a mortgage they clearly couldn’t afford. These are the folks our government now wants to bail out. It’s a new kind of socialism: stupidism.”

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