My article last week in the Dispatch that looked at this year's crest in the final wave of residential mortgage resets drew several reader comments. One reader in particular questioned a basic premise in my argument, and then followed it up with some evidence to support their skeptical view of my conclusion. Both the reader's question and offered evidence expose a common, yet dangerous, human trait: making decisions based on conclusions drawn from evaluating symptoms.
The reader, a real estate professional in the Washington, D.C. area, asked, "Of the mortgage resets still to come, how can you be sure they are going to reset at higher rates, thus putting downward pressure on the market? Do you have evidence to make that claim, or is that an assumption you're making?"
The reader is correct on one point: I did make an assumption, but not about the evidence. I assumed that my audience already knew this. I'm not sure if this is a "shame on me" or "shame on you" situation.
To start, the question assumes that a traditional adjustable-rate mortgage scenario and mortgage climate applied at the time the loans originated. Yet, if we think back to the heady days of 2006, the top in the real estate bubble, a scenario emerges for securing financing and closing the sale that is anything but traditional. Please consider:
- Introductory teaser rates were used to qualify those who could not otherwise do so. These rates were typically 3% to 4%, well below today's rates.
- "Pick your payment" loans were used to qualify potential buyers. In many cases, the monthly payment will rise independent of whether or not the rate of interest rises.
- Interest-only loans. This is a similar situation to #2; monthly mortgage payments can and will rise even if the interest rate falls as the borrower must now make interest and principal payments.
- Private Mortgage Insurance (PMI). It is no secret that the mortgage industry is suffering from elevated loan losses due to short sales, REOs, foreclosures, strategic defaults, and personal bankruptcies. This was not the case in 2006. Today, a borrower who reenters the credit market and who must carry PMI will find that it costs significantly more than before the housing crisis. Last year, the FHA raised both the up-front fee percentage and the annual rate.
- Many of these loans do not require the borrower to reenter the credit market and secure a new loan. The reset terms are stated in the loan contract, and the reset rate is always higher, thus the monthly loan payment will be higher.
- Many of the borrowers who relied on short-term gimmicks with the payment amount and interest rate to qualify were likely not good credit risks from the get-go. In our current economic conditions, it is a certainty that many of them are deeper in debt, financially struggling, with a credit history that has deteriorated, and now find that their credit score has suffered.
And that leads to my last point. To qualify for today's low mortgage interest rates requires two basic things: a 20% down payment or 20% equity in the property, and a credit score well above 700. Not many of these resets will likely be happening to borrowers that meet these two conditions. And of course a job with a decent wage is a must - something that roughly 20% of Americans do not have when judged by the more accurate U6 measure of unemployment.
The reader's final comment and conclusion: all of the people the reader knew had completed mortgage resets into a new loan with a lower rate. And the number of foreclosures in the reader's area are dramatically declining.
But the reader is almost certainly referring to the number of foreclosures currently on the market. That is not an accurate appraisal of overall foreclosure activity as it fails to consider the shadow inventory held by banks and other lenders. And, as my previous article points out, the housing rescue schemes implemented by the government, and other delaying tactics and factors, have simply pushed foreclosure activity into future years.
Subjective conclusions based on a biased outlook about perceived symptoms. People see what they need to see when they need to see it. And here, the reader sees only successful new loans and foreclosures as a soon-to-be non-issue. No surprise a real estate professional thinks that the turnaround is underway in housing, or at least that the bottom is in.
In reality, questionable loan origination practices were used to keep the housing party going, and now homeowners must face the music. The totality of government amend-extend-pretend programs cannot stop the process. Mortgage defaults are in the pipeline. The day of reckoning cannot be avoided, it can only be delayed.
The same process scales to the problems facing the U.S. economy, the dollar, government debt, and the Fed's balance sheet. Decisions were made, programs put in place, and maneuvers undertaken that all took aim at the symptoms of past actions. But the causes remain, and the consequences are in the pipeline and will be felt, one way or the other.
Do not be fooled. The causes of the symptoms have not been remedied. All government solutions have thus far been like consulting a dermatologist for a case of gangrene - they made everything look better, while the real problems fester just beneath the surface.
Source: Casey's Daily Dispatch
