Tuesday, August 01, 2006

Daily Reckoning: ARMS and Interest Rates

The Daily Reckoning: ARMs and Interest Rates

"I sing of ARMs and the Man..."
Virgil's Aeneid

We don't really have that much more to sing about ARMs, dear readers, but we just couldn't resist the headline.

Still, now that we think about it, our cautionary tale is likely to end just as bloodily as any epic poem we've read. Imagine what would happen if mortgages were adjusted upwards to rates anywhere near 10% - or any where near where they were 25 years ago?

That is why the Bernanke Fed cannot really fight inflation or stagflation the way Paul Volcker once did. Too many homeowners wouldn't be able to afford it. ARMS were meant to give marginal borrowers flexibility. Instead, they have locked both the borrowers and the Fed itselfinto...well, leg-irons. The borrowers have no margin. Most cannot affordeven the slightest boost in their payments. And with such boosts now automatic, the Fed can only react to inflation threats by prevaricating.

According to David Rosenberg at Merrill, discretionary items are now rising at a 5% annual rate - far beyond Ben Bernanke's target. But what can he do?

ARMs were supposed to be a way to realize the American dream of homeownership. But, like much else in American life, that dream too has been hollowed out.

The Daily Reckoning is a an excellent read. Currently, they are very bearish.


  1. Currently, they are very bearish

    Currently!? You jest. I have every one of their emailed newsletters for the last three years sitting in my 'DailyReckoning' folder in Outlook and not one of them isn't bearish I assure you.

  2. "The Daily Reckoning is a an excellent read. Currently, they are very bearish."

    Currently, they are short on facts too. But despite this, since they're perma-bears, they'll be right on housing for 2-3 of every 12-15 year real estate cycle. Not a winning strategy in my opinion.

  3. The Sun will eventually explode and then contract into a dwarf star. So, eventually the doomsdayers will be able to say "I told you so".

  4. There is another reason to be bearish on housing. The rapture is right around the corner. When it happens, demand will fall tremendously. For those left behind there will be no need to buy housing. They will take possession of those cribz left vacant by the righteous.

  5. So, eventually the doomsdayers will be able to say "I told you so".

    In all fairness, precisely the same thing could be said about bulls during a bear market. Eventually, they will be right.

    In order to be meaningful you have to decide whether the naysayers were right for the reasons they claimed. In this case, The Daily Reckoning is right.

    But now that they are right it is all too easy to try and redeem some self-respect by discrediting them by saying "eventually all doomsayers will be right".

  6. But aren't ARMs capped? I.e., they contain language to the effect of " ... and under no circumstances can increase by more than 4 percentage points than the intial rate ... " (i.e., 5% loan can go to 5% + 4% = 9%). Since borrowers get qualified on this capped amount, it would make sense that the capped amount couldn't have been more than a reasonable increment over the intial interest rate ... Hence, the thread's very basis is debunked. (Sorry, David).

  7. "Most cannot afford even the slightest boost in their payments"

    Says who?

    That's a gratuitous assertion and it can be dismissed as gratuitously as it is claimed: Yes, they can.

    The problem with most of the 'ARM rate jump' analysis is that it seems to assume that the incomes of the the ARM holders are static. Typically, a mortgage payemnt is (at most) 1/3 of monthly income. If the payment jumps 50% then the payment becomes 1/2 of the monthly income at the date the loan was approved. If, in 3 years, ( a common ARM term) income were to rise 10%, the new payment would be 45% of monthly income. Before taxes.

    Consider the tax effect. At the 25% rate the 17% of monthly income increase in interest expense would equal to a 4% increase in after tax income. The new monthly payment becomes more like 41%.

    My numbers are not meant to be inclusive of all situations, only a rough example of the fallacy within the the rate jump catastrophe analysis.

  8. The bubbleheads truly believe that every homeowner has an ARM and can't afford an adustment. They further believe that every homeowner uses their home as an ATM and has no equity or savings.

    Statistics would indicate that renters are more likely to have no savings (and obviously no equity).

    Bubbleheads NEED to believe their own propaganda - it is their only hope for a crash. Then they believe that they will be unscathed by the economic fall-out. Only homeowners will be out of work.

  9. 'But aren't ARMs capped?'

    Yes, this will help with damage control. still would not like to see that type of reset on my ARM (if i had one)

  10. 'I'm particularly curious about VA_Investor.'

    put yourself in his shoes...he bought low and plans to fund his retirement with the rental income from his properties. a bubble benefits him in the short term because people will more likely rent and wait out the next several years. perfect for his situation. 1 - he wil admit that there is a downturn 2 - i can see his motivation to be posting on this site 3 - he does like to talk about himself (had to throw a jab in)

  11. This comment has been removed by a blog administrator.

  12. Chip said:
    "Intelligent people who value their own time do not bother with mucking around in the lives of those whose views do not match theirs."

    Ok Chip, if this statement --- the very basis of your argument as to why those of us who disagree with the Bubblehead faith should not be posting here --- is true, then why are you bothering mucking around in Va_Investor's life and his motivations? Your reasoning sounds suspiciously of the type meant to silence dissent. The kind often used by the blind-faithful of any creed who dare not hear spoken anything counter to the beliefs that they must so believe irrespective of any and all evidence to the contrary. I guess the truth is scary for you, huh?

  13. Intelligent people do not start posting at 5:30 am and end 12 hours later, as one self-proclaimed expert on this blog did this past Sunday.

  14. Because somebody is bullish on housing does not preclude them to seek out opposing opinions. Part of the problem with your average Joe is that they generally seek information from sources that only confirm their worldview -- that can be from real estate to republican/democracts, etc. Obviously this site has a clear slant, but that doesn't mean there isn't value. I generally disagree with the level of negativity here on the housing market, but I find this site informative and entertaining. Yet if all I read were bubble sites (or all real estate cheerleading), I would miss other valid and important information. As they say with investing, diversify your portfolio of information sources, and you'll be in much better shape.

  15. I am re-posting since this is relavant to the ARM discussion.

    Georgianna Velardi, a broker at Century 21 Petrey Real Estate in Long Beach, said she had recently seen more sellers looking for a way out of high mortgage payments.

    A couple in their late 30’s came in to price their three-bedroom ranch. The interest rate on their mortgage had risen to 9.5 percent, from 3.5 percent three years ago. They didn’t have the equity or good credit to qualify for refinancing at a lower rate. To make matters worse, on July 1 the City of Long Beach raised property taxes 25 percent. “They needed to get out because they were so overwhelmed,” Ms. Velardi said.

    ...from Long Island Rude Awakening
    From the NY Times (courtesy nnjbubble.blogspot): Taking the Measure of the Market

    How can this be? Everyone knows that all the banks use a worst-case-scenario method, right?

    That will be the real shocker to some of these folks. Unable or unwilling to pay the higher (floating) mortgage they will go to the bank to re-fi at a fixed rate, only to be told that they don't qualify.

  16. "Unable or unwilling"

    The two terms are very different.

  17. Anonymous said...
    ""Unable or unwilling"

    The two terms are very different."

    And I would guess that this statement applies to most bubbleheads. It is not that they are unable to purchase, but that they are unwilling to purchase. As many of them have discovered. By foregoing the future benefit of locked in payments down the road (and possibly no payments way down the road), they can buy more today with their money by renting. Just like these folks who opted to get a benefit up front in the way of a well-below-market interest rate, in exchange for putting off the day of reckoning.

  18. "Since borrowers get qualified on this capped amount"

    Wrong answer. Ever heard of no doc loans? Go check out AFB for the 411.

  19. "And I would guess that this statement applies to most bubbleheads. It is not that they are unable to purchase, but that they are unwilling to purchase."

    Common human trait to validate one's decisions by claiming superior ability, intelligence, foresight, or virtue to those with whom one disagrees, and obvious on both sides of the debate. Market forces and governmental policy over time will reveal which side is right (or lucky). Right now, the weight of evidence is against those who believe that (a) the year 2000 was the beginning of a normal RE upcycle (as if there is such a thing), or (b) there was a "structural" change in the real estate market that justified buying at any time.

  20. anon,

    If there are no "cycles", how do you explain the previous ones?

  21. "It is not that they are unable to purchase, but that they are unwilling to purchase." -- Lance

    Maybe some, but as a first-time buyer, the prices are far outside of my reach. Sure, I could buy, but I refuse to move my family of 4 into the one bedroom condo I could afford on a 30 year fixed. So I rent.

    Assumptions made about some "bubbleheads" are vastly over-reaching. I simply see a product that is not worth what the owner says it is. Since I'm the one buying, and I can afford to walk away, I have no problem saying so.


  22. First, I disagree with Chip. I'm sometimes glad Investor posts, because now and then Investor says something worth reading. I welcome the intelligent pro-housing commenter, rare as they may be. And Investor occasionally offers something worth hearing. We should all welcome opposing viewpoints from sensible reality-based people.

    Investor's an interesting case. Now and then he/she offers some penetrating analysis, but then he/she also veers sometimes into weird rants against "bubbleheads".

    I think Investor kinda secretly wishes he/she sold more of their DC holdings in 2005, and has a hard time dealing with those regrets. Sure, his/her cash flow is still great because he/she bought mostly during non-bubble periods when housing prices made sense. And I know Investor has said they expected DC prices to level after 2003. But Investor decided to hold onto the cash flow instead of selling some places in 2005, which is great, but Investor's a little scared that they may have lost juicy profits with their decision, especially if those bubbleheads turn out to be right.

    So Investor comes on here, occasionally says something bright, but also tries to put down the bubbleheads, because Investor secretly fears that the Bubbleheads were right. Investor would find that very embarrassing, because a lot of his/her self-esteem is based on believing that he/she is finanacially savvier than everybody else.

    So that's why you'll find Investor occasionally pulling that "ooh, I'm too finanacially superior to care what you bubbleheads think" crap, even though Investor disproves that by posting here a lot and replying to everybody. Investor cares, and cares a lot, and is secretly scared that the Bubbleheads were and are actually right. Again, even if the bublheads are right, Investor does fine finanacially, but it would gall Investor to think that they could have been even better off financially if they'd listened to bubbleheads in 2005.

  23. Can report only that I'm being very careful about loan-to-value ratios now. I imagine the banks are doing the same. I just increased someone's loan to about 60% of what the asking price for the property would be, and I was nervous even about that. Knowing that next year's price could be down quite a bit. I assume my bahavior promotes the deflation the bubbleheads are looking for... and it would suit me personally very well since I just sold the only home I actually OWN.

  24. Sarah in Ballston wrote:

    "And if banks qualify buyers on the basis of the 'worst case' scenario, how is it that people are able to 'afford' so much more using an ARM than a with a fixed-rate 30 year mortgage? How about all the people I know with incomes less than $50,000 being 'qualified' for half-million dollar houses? Do you think they would qualify with a fixed rate"

    Umm, they qualified for a half-million dollar house because they had $300,000 in equity from their previous home?