Interesting al-ARM

In order to enhance cognition, it would be good practice for one to consider all the merits of potential weakness in a belief that one holds. Here, I would like to discuss the effects of the second phase of the mortgage crisis which I personally believe will derive from Option-ARMs, Alt-A and commercial real estate. Counter-arguments include:

1. There is an increasing belief that given how low-interest rates have fallen, it would nullify the effects of recasts.

My view on this point is that low rates will mitigate the effects but not so much because the main problems will be coming instead from negative home equity and the repayment of principal. Interest is just one small portion of the whole payment mechanics.

2. The second and more credible argument is that many of Option ARM homeowners will have defaulted long before the recasts. Payments reset occur after 5 years or when the debt grows to a preset amount typically 110 to 120 percent of the original principal. It is believed that almost 40% of these homeowners are already delinquent and many will start missing payments beforehand.

This is valid point and deserves some attention. If 40% of these homeowners are already delinquent, there's still 60% out there which have yet to go. It would also mean that the heavy blow up is sooner than we think it would be. Perhaps more towards a single peak rather than a double wave. Thus the peak would more probably happen in 2010 rather than 2011.

3. Alt-A comprises of people with better credit rating.

These are very much liar loans and just another nicer name for subprime in any case. These loans were made during a time when people are incentivised to lie about their credit score, have houses as proof of social status and when everyone else is doing the same thing. Nothing much you can argue about that.

4. US Government's effort to rework mortgages.

This is not going to have as much impact as many believe it to have. It is slow, inefficient, bureaucratic and mis-incentivised. In other words, you are not going to have a lot of bang for your buck in this programme.

5. These exotic loans are locality specific with a disproportionate amount coming from California

What these means is that not the entire banking industry and not all consumers will be dramatically affected. A dispropotionate few will be dramatically affected much more than others. This is where it gets scary, if the effects were to be spread out and the pain shared throughout an entire industry or country, it is still not so bad. However, if the effects were to be concentrated on one single area then we might actually see some interesting things.