Reality May Change

But the Internet is forever.

It’s been over  two and a half years since the mortgage research group at Credit Suisse published this chart:

Mortgage resets projected using Jan, 2007 data

Here are a few of the places you can find this chart being used to support conclusions about the economy:

The IMF’s 2nd half 2007 global economic review.

Around the same time in the fall of 2007,, an excellent source for professionals in the housing finance business, also brought it to our attention.

Then it took off, and careened around the financial blogosphere, to be used and abused as each cyberpublisher saw fit.

At least Mish Shedlock showed he got the joke on April Fool’s Day of 2008He used the same chart as supplied by a fright-merchant in the newsletter business, but to make an entirely different point.

Mish looked at the actual rates for 1 year Constant Maturity Treasury and for LIBOR, and came to the conclusion that half or more of the ARMs would reset to lower interest rates if rates stayed were they were in the spring of 2008.  But rates kept heading down, so that nearly 100% of the loans were looking at rates being lowered by the time the 2009 and 2010 mortgage resets rolled around, and 1-yr CMT and LIBOR were plumbing new depths.

“Market oracle” David Haas warned us of disaster in October of 2008, using the same chart with the same data behind it.

On the other hand, some see opportunity in their projections for financial carnage.  Check out this pitch for a distressed mortgage opportunities fund open to  Joe Sixpack with only $20,000 minimum investment.

Here’s the alarm being raised in May of 2009 by Banker Office (online magazine)

Clusterstock’s Chart of the Day for the autumnal equinox, September 21, 2009 stayed with the looming disaster theme.

In seekingalpha’s editor’s pick for today, November 10, 2009, the same chart is used as part of the rationale that we should fear a Eurodollar bubble.

So what did we learn from the show tonight, Craig?

  1. That old stale data with an impressive looking chart can have a life of its own.
  2. That commentators will make any point they want to make, no matter what the chart looks like.
  3. That people will still screech about an ARM mortgage reset crisis even though half the mortgage loans in the original data don’t exist anymore, and those that do exist  are seeing their mortgages reset from a mid 4% average rate down to just 3% or so.



10 Responses to Reality May Change

  1. W.Kinsolving says:

    How’d you do this! I love it! I so hope it embarrasses them all!

  2. W.Kinsolving says:

    Um, it says this was posted at 9:07 PM today, but I read it at 4:50 PM, not that it makes any difference.

  3. egor says:

    Those who used the Credit Suisse chart to talk about ARM resets didn’t get it — while Mish is another story. But, from my limited understanding, the problem with residential mortgages now is they are recast, not reset (at the lower rate).

    Those with out-sized mortgages, especially those which were “pick-a-pay” negative amortization notes, face a day of reckoning should indebtedness rise, property values fall, or both … leading to a recast covenant trigger (LTV alarms). Assuming the debtor can get a new note, at the now lower rate, they won’t find a deal like they did 3-5 years ago.

    The payment will be higher, reflecting reality on the ground (pun) today. The lender may (look shocked at this) even expect the borrower to have some skin in the game. Think: down-payment (how quaint).

    JMO … we see light, but have no idea how long is the tunnel.


    ps – for those who like to see the source, the chart which went viral is from page 8 in:

    Chapter 1 : Assessing Risks To Global Financial Stability (51 page PDF)

    • hhill51 says:

      While it’s true that a few pay-option ARMs are as you describe, I think it was less than 5% of them.

      The vast majority started out as 70% or 75% LTV.

      The California bubble in particular was fueled by people with high FICO scores who had some cash from their prior home to put as down payments, and then a lot of them got “piggyback seconds” so they only really paid 10% down.

      That 10% disappeared in the first round of price declines, and of course, in the negative amortization. Most of the forced recasting of option ARMs was due to hard limits on how far they could negam, typically to 115% of original balance. It was not actually tied to the overall LTV. The 70% LTV loans basically grew to 115% of their balance, which is not so coincindentally right around 80% “original” LTV.

      If the houses had held their value, the loans probably could have survived. That was certainly true for the remarkable 25 year run of World Savings (Golden West) as the specialists in these loans. Herb and Marian Sandler took out over $2 billion in cash when First Union (later Wachovia, and later still Wells Fargo) bought them out and ended up with well over $100 billion in pay-option ARMs.

      • egor says:

        HHill – thx for your considered reply. I’m trying to decipher meaning. Do you then believe the now aged Credit Suisse chart done for IMF (was it in 2007-2008?) that went viral is now moot, since most of the pick-a-pay (mostly negam) recasts have already run the court house step route?

        Color me doubtful. Instead I ponder various forms of government intrusion (return of mark to make believe, foreclosure moratoriums, work-outs, GSE deed > rent, $8k credits, etc.) and surmise there are refracting waves yet to wash over the market(s).

        The new(est) mortgage relief program – HAMP – is a huge unknown, since the government hasn’t spoken on what work-arounds have been made permanent. Rumors abound that many / most are failing. Government silence is not comforting in that regard.

        Given your estimate that just a few pay option ARMs were problematic … is that market decline -> consumption decline -> business decline -> employment decline -> [rinse and repeat].

        Another poster declared Mish a perma-bear. Despite the wild ride ^ from SPX 667, I don’t feel we have solved much of anything here or abroad hope the next wave in RE is just a ripple.

        Time will tell. BR, Egor

        ps – your blog is now a daily. Thx for sharing.

  4. Joe says:

    So for once Mish got something right on his perma-bear blog? It’s hard to believe he described a positive outcome from data that could have easily been interpreted as apocalyptic. As it has been everywhere else.

    Since you are familiar with mortgages etc. in the US, what would you say how long the life span of the average mortgage is in the US? I assume the vast majority of mortgages are prepaid as homeowners sell their houses and move on. I know this process could have currently been interrupted by the price swoon. Do you also have an idea how well the government-sponsored mortgage mods work right now? From my ordinary citizen perspective I perceive the market swoon as over and a new raise has started, but a key to this as in the earl 1990s is to avoid foreclosures to swamp the market. They should be phased in over a longer period of time to ensure smooth absorption. At the time that was done by the RTC. Can the mods do the same now?

    Thanks, Joe

    • hhill51 says:

      You are correct that lower mortgage rates usually leads to refinancing, but half the mortgage lending business is gone, and the other half is cowering in terror even though they only make loans that can be guaranteed by the gubmint.

      Right now, a reasonable guess at average life for a new fixed-rate mortgage might be around 7 years. In “normal” times with decent real estate turnover and people buying houses for trade-up reasons, five years might be more like it.

      From a price perspective, 7 yr average life means each point of interest rate increase for the mortgage rate translates into nearly 5 points of price loss (ie, today’s GNMA 5’s will lose 5 points of value if mortgage rates rise 1%.) There is an absolute maximum (around 110% of the face amount) that fixed-rate MBS can trade at, because low rates do give the borrowers incentive to refinance. ARMs tend to top out around 105%, which is where new GNMA ARMs are trading today.

      I was workiing on a “cheat sheet” to evaluate the principal risk for the amREITs if long rates go higher, if short rates go higher, and if spreads (yield premium) goes higher when the Fed stops buying everything in sight next March. Hopefully I will post it later this evening.

  5. egor says:

    HHill – there must be a reply limit. I was verbose and the blog “engine” delivered a truncated msg (cutting from the middle for some reason)? The cut read:

    Given your estimate that just a few pay option ARMs were problematic … is that market decline -> consumption decline -> business decline -> employment decline -> [rinse and repeat].


    No worries, just FYI, Egor

    • hhill51 says:

      Egor –

      No, I’m definitely not saying that only a few Opt-ARMs were problematic. Most of them are.

      But the problem comes from being no-doc 720 FICO loans, not from being high LTV…. What has happened that took them out (en masse, by the way) is the same thing that destroyed FNM and FRE, where 80 LTV full doc loans were the rule.

      Half the lending capacity got zapped. Half the potential buyers of houses can’t qualify for loans today, so they aren’t buying. The super-flaky 20% of the market that had subprime liar loans just got the avalanche started, but the deadly mountainside of snow was the rest of the market, including especially the “prime” 80 LTV loans where nobody lied, and household income prudently covered the debt service.

      Check out my early post called Black Ice. This really was at least twice as bad as it needed to be. IMO, without the leveraged pressure of CDS and short sellers, the financials would have absorbed the truly bad lending losses, housing would have gone flat nationwide or maybe down 5% to 10%, and eventually (five to seven years) household incomes would have caught up with housing prices. Unfortunately, there was accelerant in this fire.

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