Another Picture Worth a Thousand Words: The Coming Mortgage Default Tsunami
At the chance of sounding like a broken record, I must talk again about the coming problems we’re going to have on the housing and banking fronts. The chart above is extremely disconcerting. It depicts the coming wave of option payment ARM mortgage resets. Option payment ARM’s allowed folks to effectively pick a payment; a pre-determined minimum, an interest only payment or a fully amortizing payment. These choices were only available for the first few years of the life of the mortgage before resetting to a fully amortizing payment (i.e. a “regular” mortgage payment). Most people who opted for these selected the minimum or interest only payment and once the payment resets, their monthly payment will grow dramatically. Some project that the average increase will be in the neighborhood of 60%. So, if someone is making a $ 1,000 monthly payment, their payment upon reset would be $ 1,600. To make matters worst this payment spike will occur on a home that’s probably already underwater. Massive defaults are just simply unavoidable and that means a continued desultory housing market and more problems with the banks. Hopefully, they’ve set aside enough of their profits to cover the upcoming losses and leave the taxpayer out of it.
The sea of light blue bars in the chart that spike around the last quarter of 2011 depict the peak volume of these resets. The resets have already started and will get progressively worst as the months go forward. There are about $ 500-750 billion of these types of mortgages issued between 2004 to 2007 with the bulk of them being in the former bubble areas—California, Florida, Arizona and Nevada.
Interestingly enough, the government’s foreclosure prevention plan is failing to prevent them. According to Bloomberg, a significant percentage of people wind up defaulting even on modified mortgages due to the job situation and modifications not including some sort of meaningful reduction of principal. Of course, the banks are loath to reduce principal as that means they have to take a financial hit. Here’s where the government really just needed to get out of the way. The only way this thing is going to get resolved is to allow market forces to discipline all players, homeowners and banks alike, by clearing the excess.
The bottom line is that there’s big trouble on the immediate horizon and few people sounding the alarm.