Marginal Utility

by Ken Houghton

After I tried (with a hint of irony) to say something nice about RWR (and Tom corrected me*), John McCain undermines all that goodwill with another mailing:

While many of us are aggravated and displeased when we see exactly how much of our hard-earned money goes to the federal government - if one of my Democratic opponents is elected in November, you can be certain your tax rate will increase across the board. [emphasis his]

Hmmm; increasing deficits (ameliorated only slightly by a Social Security Trust Fund surplus that even Andrew Samwick is now defending), an ever-more-costly war (some of which is "off balance sheet" [think derivatives], so the actual deficit is ever higher), and more than a 2% difference between income (read: taxes) and outflows that have increased at greater than the rate of inflation only for defense for all of the Discretionary Spending. (And if cactus at AngryBear updates this post,*** I suspect the differences will be even worse.)

But I'll hold out hope, John; after all, you're a Straight Talker. What's your plan?

I believe today, as I have always believed, in small government, fiscal discipline and low taxes. I believe that tax cuts work best when accompanied by lower spending. And I make the promise to you that if elected president, I plan to make the present tax cuts permanent, lower corporate rates from 35% to 25% and end the Alternative Minimum Tax, which will affect millions of middle class families.

Let's see:

1. "make the present tax cuts permanent": I assume this means the 2001 and 2003 cuts that were scheduled to "sunset" in ten years because even then—with a trend toward paying off deficits and Saint Alan talking about the Evil that would be a Sovereign Wealth Fund—our representatives and Senators knew they would be too costly on an Infinite (or even Extended) Time Horizon. So monies that are in the baseline CBO projection, for instance, would not be there. Need taxes, or cuts in spending.
   
2. lower corporate rates from 35% to 25%: Well, as pgl pointed out last year, it would be absurd to assume that the actual corporate tax rate is at 35% now.**** But, once again, baseline projection monies are no longer there. Need taxes, or cuts in spending.
   
3. "end the Alternative Minimum Tax"—this is the first year in a few that I wasn't hit by the AMT. But this is also, definitionally, the first time in a few years that our Gross Income was less than about 250% of the national average. And this is outright elimination. (The CBO released a report this month [PDF] that projects the 10-year cost of just indexing the AMT to inflation of $700B.) So this is a major loss of revenue, without any noticeable income

So that's three proposals: all tax cuts without a single revenue source in sight. And I'm not betting that John "we'll spend 100 years in Iraq, but don't worry, only 95 of them will be as an active fighting force" McCain is going to reverse the GWB trend in increasing defense spending at greater-than-inflation rates.

The kicker? There's only one way to cause this miracle to happen:

But I cannot succeed in my efforts without your immediate financial support. [I spare you the link]

So the only way not to pay taxes is to pay tribute to a man who plans to increase deficits in a major way, crowding out entrepreneurial activity and further impairing growth.

Makes me long for the days when RR appointed David Stockman to run the OMB. At least then we got Straight Talk from a Republican.

*This may be what I get from believing my accountant, who may well have confused 1986 and 1996.** Though it remains remotely possible that Reagan did start the ball rolling to some small extent:

Most Americans already escape the tax by either rolling over, or deferring, their capital gain when they buy a more expensive house, or by taking a one-time exemption for up to $125,000 in gains allowed for those 55 and older.

So it's possible that Reagan initiated it, while Clinton both eliminated the age restriction and raised the limit. But that's probably not the way to bet.

**We are both of an age where that happens. Having heard the, er, update of Kurtis Blow's classic "Basketball" last weekend on Radio Disney, I suggest that the decay of memory and the "memory of decay" is natural.

***I thought he had, but I can't find it on a quick use of The Google (TM Sadly No!).

****If we do the math, taking the 39.3% overall corporate tax rate here and the proportions documented by the CBO here***** [PDF; 1.6% of GDP for Federal; 2.1% for all], we would conclude that the effective Federal corporate tax rate is currently 39.3% * 1.6/2.1 or 29.9%. So take heart, John; we're halfway there and you haven't done anything yet.

****I am comparing a 2004 ratio with 2006 data, but since the Tax Foundation indicates a difference of 0.1% between 2001 and 2006, this does not seem unreasonable.

Labels: Bushonomics, defense, deficit, Personal Finance Advice of Alan Greenspan, Republican Party

by Ken Houghton

Consider this the counterpoint to yesterday's "they played without me" post.

Every once in a while, there is a statement that is so egregiously offensively wrong that it demands a blogspot. But, since after today I have something in common with Barkley Rosser's eldest daughter, I'm buried.

Fortunately, Felix came through with bells on.*

The statement, by the way, is:

Some argue that adjustable rate mortgage (ARM) originations fueled the bubble. Yet the ARM's share of total originations is a very weak forecaster of home prices, implying ARMs, although a source of cheap financing, are not a determinant of home prices. If ARMs were not available from 2001 to 2004, home purchases presumably would have been financed with long term debt, which was also very affordable.

You can guess the source.

*The only thing he leaves out is that Alan Greenspan himself encouraged people to take out ARMs, just as he started tightening. Of course, as with Himself being 100% in bonds (at his age) in 1996, just before he started loosening, this is purely coincident.

Labels: Housing Bubble, mortgage, Personal Finance Advice of Alan Greenspan, PortfolioMarketMovers

by Tom Bozzo

Here's another update to a recent post, in which I sought to figure out what was in the recent efforts by out monetary policymakers to deal with the housing troubles for me — relatively responsible borrower who still (probably) has a fair amount of home equity. Initially, the answer seemed to be Sod All, but that's changed a little, as you can see from the updated graph:



I've shown the FRB announcements of the Term Securities Lending Facility and of the approval of the BSC/JPMorgan Chase deal. Particularly after the latter, the 30-year rates (on a zero-point cash-out refi with 80% LTV) appear to have dropped around 37.5 bp from the previous range; let's call the sustained drop for someone who can afford a 15-year amortization 25 bp. So there's a little something for Main Street, though these rates aren't near the historic lows that are sometimes credited as a "fundamental" factor behind the house price run-up (in my not-so-extended family, there's at least one 15-year mortgage where the first digit of the rate is a 4).

Whether this will turn out to be worth more to the public than MBS losses flowing through the Fed to the Treasury remains to be seen.

Labels: High Finance, monetary policy, Personal Finance Advice of Alan Greenspan

by Tom Bozzo

The last few nights, I've been enjoying Roger Lowenstein's When Genius Failed: The Rise and Fall of Long-Term Capital Management. At least, I've been marveling at its parallels with the present crisis — not principally because of JM's latest round — in-between thinking that I might sleep better were I reading "Call of Cthulhu" as a chaser to a late-night screening of Alien.

The density of Famous Last Words and Unheeded Cautionary Lessons is too high as to make a comprehensive review possible (yet 'nobody' saw the current crisis coming), but here are a few favorites:

Removal of these financing constraints [margin rules] would promote the safety and soundness of broker-dealers by permitting more financing alternatives and hence more effective liquidity management... In the case of broker-dealers, the Federal Reserve Board sees no public policy purpose in overseeing their securities credit.

That's Alan Greenspan, testifying to Congress in 1995.

[Fama] argued that Black Monday had been a rational adjustment to a (one-day?) change in underlying corporate values. On the other hand, Lawrence Summers... told the Wall Street Journal after the crash, "The efficient market hypothesis is the most remarkable error in the history of economic theory." (p. 74)

And that's saying something?!

Almost imperceptibly, the Street had bought into a massive faith game, in which each bank had become knitted to its neighbor through a web of contractual obligations requiring little or no down payment... "Credit limits for customers are an essential tool for credit risk management," [The New York Fed] warned. [emphasis in original]

Shockingly, the warning was in a letter to Wall Street banks, not business undergrads.

Writing in the prestigious Journal of Finance, Andrei Shleifer of Harvard and Robert W. Vishny of Chicago presciently warned that an arbitrage firm of Long-Term's type could be overwhelmed if "noise traders" pushed prices away from true value... [T]hey predicted that, in such a case, arbitrageurs would "experience an adverse price shock" and be forced to liquidate at market lows. Merton... pooh-poohed the notion that markets could be overwhelmed. (p. 111)

Merrill's willingness to finance its client was part of a pervasive climate of financial laxity, palpable in Wall Street's eagerness to underwrite emerging markets. (p. 130)

Let's play "substitute the asset category!

The comforting notion that global financial cops would always be there to put matters right was now exposed as a fallacy. This time, there was no rescue by the IMF, no hurried bailout by Robert Rubin or the Group of Seven Western powers... It "punctured a moral hazard bubble" that had been inflating expectations... Investors, at first singly and then en masse, concluded that no emerging market was safe. In seventy years, Russia's Communists had not succeeded in dealing markets such a telling blow as did its deadbeat capitalists. (p. 144)

Most of us survived 1998, but we'll see if our deadbeat capitalists can one-up their Russian counterparts...

Labels: hedge funds, High Finance, Personal Finance Advice of Alan Greenspan

by Tom Bozzo

AutoWeek has a window on the stressed consumer with a report that the automobile financing mix is moving towards leasing. This is because buyers are having a hard time affording car payments on conventional loans, even with the extremely long financing terms that are becoming more prevalent:

"These 84-month loans--the percentage is rising dramatically and it's just unhealthy," [California dealer Dave] Conant told Automotive News. "It's horrible for the buyer and it's not good for the industry."

The level of 7-year loans isn't high — at Toyota's financing arm, it's reportedly 4% of business (up from zero at the start of 2007, though) — but the mean is 64 months, up from 61 in 2003. The W$J's periodic info graphic on fast-selling cars (sorry, no link) recently indicated that six years is the mode even for such vehicles as the Nissan Rogue, an entry-level small-car-based crossover priced in the low twenties.

You'd normally expect the current free-money environment to be relatively good for loan financing over leasing. That makes it relatively cheap for the manufacturers' captive financing companies to offer those low rate deals to move metal. Buyers who expect to hold onto their cars for a good part of their useful lives should prefer to buy. [*] Even luxury makes accustomed to leasing much or most of their output saw big shifts towards conventional purchases in 2003-04, as a graphic accompanying the AW article shows for the case of BMW.

The catch is that the last few years' sales efforts have put a great many people into new cars with upside-down loans. Hence this sort of solution:

a hypothetical customer could roll $150 or $200 a month of negative equity from a previous vehicle loan into the lease and still have an affordable monthly payment.

Maybe it beats a visit from the repo man, but yikes. Assuming a 36-month lease term, the dealer would be looking at someone coming in with several thousand dollars' negative equity on some MOR car. Considering their resale values, this would include just about anyone who financed a domestic-make car with little down and an average term or longer. In any event, add that to the conventional payment on the average new car, and you're looking at the lease payment on a 5'er or thereabouts, which most of the motoring public can't actually afford.

This sort of workout may put some people in cars now, and back on the market in 3-4 years, but even so it puts the manufacturers in the position of assuming the risk that the leased cars will be worth their contracted residual values at turn-in time. [**] I was under the impression that a contributing factor to the lower emphasis on leasing was because some lessors did a bad job forecasting the wholesale market and got burnt. Right now, my impression is that the U.S. automobile product mix is badly out of line with a reasonable expectation of future fuel prices, not to mention the possibility that crazy libruls might try to regulate greenhouse gas emissions, raising more than a little possibility, in my eyes, that nobody in the used-car market in '11 or '12 will actually want a 20-mpg small crossover.


[*] There's nothing wrong with leasing per se; indeed, as someone who's tended to switch cars at relatively high frequency, I lease my current car. [***] At market-rate terms (i.e., without incentives towards one mode or the other), you'd normally expect a lease for a given term to have about the same cost to the buyer as a loan-financed purchase with a trade in at the end of the hypothetical lease term.

[**] If the car happens to be worth sufficiently more than the residual value to cover transaction costs, the lessee should exercise the (standard) purchase option and pocket the gains from resale.

[***] This was, in no small part, intended to keep me out of car dealerships for 3 years. The only problem is that my bike-commuting experiment was too successful, and I'd have been willing to downsize earlier.

Labels: Personal Finance Advice of Alan Greenspan, Trains Planes and Automobiles

by Tom Bozzo

OK, we will get an $1,800 loan that mostly will be paid back by the children. Otherwise, though, we're (knock on wood) not only in no danger of foreclosure but even ought still to have a fair amount of equity in the old homestead. So we're not exactly in line for any pending handouts to strapped homeowners. But at least we ought to be able to refinance on attractive terms, no?

As it happens, no. Or at least, not yet.

Since the Fed's interventions have gone into high gear — this really being an uncontained crisis and all — I've been tracking mortgage rate quotes from our bank. While they're not necessarily the lowest-price lender around, it so happens that we currently pay them (or their successors in interest) a weighted average interest rate of around 6% before taxes on our home-related debt, which is mostly the fixed-rate first mortgage. There was, maybe, one day since I started looking when we theoretically could have done a refi for a lower rate than we're paying now. Since then, not so much, as seen from the last 20 days of data (this is for a cash-out refi with ~80% CLTV, no points):



So, as you can see, we've had $400 billion in actual and/or promised unconventional Fed intervention, and a refi would cost me 50 bp more than I'm currently paying. Perhaps more to the point, what I'd pay today, post-intervention, is 25 bp more for a 30-year loan (37.5 bp more for the 15-year) than I'd have paid had I for some reason correctly picked the last three weeks' trough.

Happily, I do have an option to convert the HELOC to a fixed rate, which I expect soon will be at the contractual minimum (lower than the first mortgage!), for a nominal fee. So I suppose I'll be able to thank Chairman Ben for something.

Labels: monetary policy, Personal Finance Advice of Alan Greenspan

by Tom Bozzo

Deeply buried in a story on the continuing Northern Rock bank run in Britain:

In an interview published Monday in The Daily Telegraph, former U.S. Federal Reserve Board chairman Alan Greenspan warned that Britain was susceptible to some of the problems now roiling the U.S. real estate market.

"Britain is more exposed than we are — in the sense that you have a good deal more adjustable-rate mortgages," he said.

Some of us do recall that Greenspan was hawking ARMs to U.S. house buyers not too long ago — and not long at all before the Fed Funds target rate began its latest upward march.

Meanwhile, it might not get such prominent play over here, but the UK's housing bubble-like event makes the U.S. housing situation look trivial by comparison.

To make an exchange rate-free comparison, the average house price in the US is in the ballpark of 4.5 times average household income. The average price in the UK is around 7 times UK average household income. So the average house price the UK would need to fall 36 percent just to get to the same not-necessarily-sustainable position, relative to income, of the US.

This sort of thing makes the UK look like a huge subprime bomb waiting to go off, since lending excessive amounts of money to the hitherto-creditworthy has many of the risks of lending to the relatively uncreditworthy. Good luck, Bank of England!

Labels: Housing Bubble, Personal Finance Advice of Alan Greenspan

by Ken Houghton

I believe Michael Shedlock misstates Ben Bernanke's conception of the causes and factors of the Depression, but Bernanke's nuances are not well served by his prose.

Unfortunately, the substance of the analysis is spot-on:

Bailing out the markets on options expiry open.... What's not to like about that? Taking risky collateral and being willing to roll it over forever.... What's not to like about that? (For more on this topic please see Now we know who and why.)

The short version of the second link is that Citigroup, JPMC, and BofA are all subsidizing their brokerage mismanagementsoperations with your and my Federally-insured checking and savings deposits, but its worth the read.

His faith in Ron Paul and doubts about the function of the Federal Reserve are misplaced at best, but how can one object to a clear statement of reason:

No Mr. Bernanke, It's most assuredly NOT "worth considering at this juncture whether the private and public sectors, separately or in collaboration, could help the situation by developing a broader range of mortgage products which are appropriate for low-and moderate-income borrowers, including those seeking to refinance." [italics Mish's]

What Bernanke means by this is setting up a way for the bank to profit from your home's appreciation (if that ever happens again—which it will, some places). Apparently, the method that has been heavily used for the past six years—MEW and refinancing—has not made them enough money.

And Craig Newmark wondered why people wouldn't think BofA, with a dividend yield of 5.4%, is a buy.

Labels: Housing Bubble, Personal Finance Advice of Alan Greenspan

by Ken Houghton

There has been much discussion (often heated enough to cover Tom's household energy needs) about "marking to model." (Tanta at CR has been especially good on this issue.)

I have no conceptual problem with marking to model so long as (1) actual trading prices are not significantly different from the model and (2) the model used is consistent.

Apparently, the SEC is starting to share that last concern:

U.S. regulators are scrutinizing the books of Wall Street's largest investment banks amid questions they are hiding losses from subprime mortgages, people familiar with the inquiry said.

The Securities and Exchange Commission wants to see whether firms are calculating the value of subprime-mortgage assets on their books the same way they calculate those values for their brokerage clients, such as hedge funds.

Note that the same method doesn't require the same price. But especially assets that are Held for Sale (HFS) are supposed to be marked with the best information available. This may not have been happening:

Wall Street banks are in a sensitive period as turmoil in U.S. mortgage markets generate losses for investors and push some lenders into bankruptcy. Yet few investment banks have disclosed significant subprime losses in recent periods.

The scrutiny may also help pinpoint whether hedge funds accurately report their results to investors, the Journal reported, citing an unnamed source. Regulatory checks into how firms calculate values of certain assets could boost the accuracy of performance reports to investors. [emphasis mine]

The first rule of reporting losses is that you can survive if you detail the entire problem upfront. If you report an $8 million loss the first day and $4 million more the next, you'll run into more problems than if you report $12 million on Day 1.

Liquidity and Transparency: they're not just for text books any more.

Labels: hedge funds, High Finance, Moral Hazard, Personal Finance Advice of Alan Greenspan, principal/agent problems, subprime

by Tom Bozzo

• My employer unfortunately resembles this NYT story about small businesses that face skyrocketing health insurance premiums after employees suffer serious illnesses. This year, we have been enjoying a 36 percent increase — following several years of "only" 10 percent-ish annual increases — after our insurer complained they weren't making money (or enough money?) off our group. There were a couple serious, but fortunately treatable, illnesses and a couple other surgeries in our history. The company's baby boomlet reportedly was not a factor, though the Times's Milt Freudenheim reports that is not universally the case.
  
• I would contrast this with the behavior of our auto insurer after last year's big hail storm knocked about $8,000 worth of dings in the cars: they paid the claims and there was no effect on our auto premiums. It's almost like they were insuring us!
• A theme you hear from conservative "policy" circles is that it's supposedly undesirable to bundle catastrophic-care insurance with provision of routine health care. This idea even sometimes afflicts the usually sensible, not just Heritage Foundation hacks and George W. Bush. From our perspective, we might be able to evaluate such claims better if we were really getting insurance instead of something that works like a group health savings account with overdraft "protection." Insurance is not so insurance-like when your premiums rise after the fact to cover the cost of what you're supposedly insuring against. At a minimum, the risk pooling for small groups like us appears to be inadequate.
  
• Also, there is nothing especially odd about bundling preventive and catastrophic care, insofar as the former can mitigate or delay the latter. An issue that is arguably underplayed by the other side is that private insurers can't capture the full benefits of preventive care. That implies that there's a positive externality, and that the "market" would under-provide preventive care. Moreover, while the usual spectre is unnecessary diagnostic testing to keep the trial lawyers at bay, a recent experience makes me wonder how much unnecessary care actually is provided to convince insurers' claims-denial apparatuses that people really are sick.
• Here are two favorable reports regarding members of the Illinois congressional delegation:
• First, in a piece buried a few pages into Saturday's business section, the estimable David Cay Johnston reports Rahm Emmanuel appropriately doubting a committee staff letter suggesting that the main culprits for capital-gains tax cheating are people in the 10 and 15 percent tax brackets. People with lower-middle class incomes take so little of the capital gains pie — some $15 billion out of $471 billion — to make it believable that the extent of their frauds could be the low-hanging fruit for legislative attention when the "tax gap" is measured in the hundreds of billions of dollars annually. Johnston's incredulity is as evident as good journalistic practice would allow. One possibility is possible that the committee staff has put its finger on a narrow problem, "The dollar amounts of underreported capital gains income from securities transactions." As Johnston describes in Perfectly Legal (which could use an update but which remains required reading on means of gaming the tax code), reporting of gains related to S-corporations and parnerships is a far bigger deal.
• Also, good for Barack Obama for saying the obvious — at the Detroit Economic Club — regarding the need for stricter U.S. fuel economy standards. Just recently, the domestic Three of the Big Four had been exhibiting their full can't-do spirit, with GM's Bob Lutz complaining that it would cost them $5,000-6,000 per car to meet a 35 mpg standard by 2020. At least for "cars" (as distinct for the purposes of U.S. regulations from vehicles classified as "trucks"), there's no reason to think that 35 mpg couldn't be reached for less than half Lutz's figure with existing technologies. Perhaps using Big Tobacco as the model of candor isn't the greatest idea. Members of the Michigan delegation inclined to continue to run interference for the industry, from the Democratic side of the aisle on behalf of union auto manufacturing jobs, might consider what Michigan automaking employment might be like had the GM, Ford, and Chrysler product lines more resembled those of Honda and Toyota rather than those which the cheap-oil illusion gave them.
  
• Last, Vanguard's John Brennan takes on the research purporting to show that Americans save adequately for their retirement, observing that over- and under-saving have asymmetric consequences. I gotta say I find the result to be too counterintuitive. Is it a problem that lots of people are going around saying, "If only I drank another beer back in college, I could have $10 less in my savings today"?! I blame the intertemporal utility maximization model. I don't necessarily mind the method of comparing actual behavior to some characterization of an optimum, but there's an obvious market imperfection in that our future selves can't freely negotiate with our current or past selves, etc. Maybe there's research that addresses this, but anyway I'd want to be convinced that it didn't matter.
  

Labels: Economics, Health Care, Personal Finance Advice of Alan Greenspan, Random Bullets

by Tom Bozzo

Dr. Black points us to Prof. Roubini who approvingly quotes a Washington Post article (also linked by Prof. DeLong, who makes an interesting point on when lenders should renegotiate vs. foreclose on defaulted loans) which indeed is a good primer on the types of loans that have been causing all the late fuss. Here's the Post's Stephen Pearlstein, along with some bracketing snark:

Here goes: Which of these products do you think makes sense?

(a) The "balloon mortgage," in which the borrower pays only interest for 10 years before a big lump-sum payment is due.

(b) The "liar loan," in which the borrower is asked merely to state his annual income, without presenting any documentation.

(c) The "option ARM" loan, in which the borrower can pay less than the agreed-upon interest and principal payment, simply by adding to the outstanding balance of the loan.

(d) The "piggyback loan," in which a combination of a first and second mortgage eliminates the need for any down payment.

(e) The "teaser loan," which qualifies a borrower for a loan based on an artificially low initial interest rate, even though he or she doesn't have sufficient income to make the monthly payments when the interest rate is reset in two years.

(f) The "stretch loan," in which the borrower has to commit more than 50 percent of gross income to make the monthly payments.

(g) All of the above.

If you answered (g), congratulations! Not only do you qualify for a job as a mortgage banker, but you may also have a future as a Wall Street investment banker and a bank regulator.

No, folks, I'm not making this up.

I would have to object to the inclusion of item (d), the borrow-most-of-the-down-payment loan, and to some extent (a), in the "would you believe it?" list. (*) My reaction is, in part, based on experience — we bought our first house with 5% down. (**) Apart from not having a traditional down payment in the bank, affordability of the old house ($160,000 — sigh) wasn't an issue.

We were, for sure, a bigger risk to the bank than someone who had an extra $24,000 lying around, but that risk was not uninsurable, and indeed we paid an insurance premium for a while. What sort of economist would object to such an arrangement as a matter of principle?

As for the piggyback loan, their role in this sort of arrangment is that the interest on the down payment loan (treated as a second mortgage) is deductible for U.S. income tax purposes, whereas the mortgage insurance premiums are not. Suitably chose, the higher interest rate on the second mortgage can make the lender just at least as well off as under the mortgage insurance regime (***), while being able to attract a few more buyers via the tax savings angle. In short, the piggyback loan product is a tax-favored equivalent to the economically unobjectionable mortgage insurance regime. Among the newer-fangled mortgages, this is the least worthy of tut-tutting.

Conceptually, there's nothing particularly magical about putting 20% down on a house; as a practical matter, it's darn hard for people such as first-time buyers without sizeable trust funds to scrape up that sort of cash. With even the lucky well-educated emerging from school, typically, with sizeable debt as a byproduct of cost-shifting, and with St. Alan — via Digby — suggesting that lower wage growth for the fortunate skilled (except, presumably, himself) would make the world a better place it doesn't look to be getting any easier.

I don't think there's any doubt that lenders went more than a little insane, some of the loan products cited by Pearlstein are barely distinguishable from fraud (b), and others even under better circumstances would slowly boil a good number of their takers alive (c, e, and f). Still, it shouldn't be forgotten that creative financing, up to a point, can be good for you, and some of the objections have more than a little whiff of elitism if not moralism.

-------------------------------

(*) Balloon mortgages may make sense for someone with sterling credit who knows that they'll leave a house before the balloon payment comes due (e.g., because of work-related transfers).

(**) We took out an ARM at that, as in the spring of 2000 the likely direction of interest rates was as obvious as such things get. Through the magic of the bubble's run-up and the amortization of the 15-year fixed-rate mortgage that eventually superseded the ARM, the equity on that house became a slightly-more-than-20% down payment on the "new" house.

(***) Whether or not the lender actually buys the mortgage insurance with the money isn't the buyer's problem.

Labels: Economics, Housing Bubble, mortgage, Personal Finance Advice of Alan Greenspan

by Tom Bozzo

Yesterday's Wall Street Journal 'style section' featured an article on the coming adjustable-rate mortgage storm — borrowers scrambling, and increasingly failing, to get out of the "creative" mortgages they took to make their peak-of-the-bubble purchases look affordable. (See Calculated Risk for the big picture.)

The ingredients are predictable: borrowing more than the house is worth (take your pick of fantasy valuations or outright appraisal fraud for the enabling technology), prepayment penalties (whether unwisely accepted or shoved down the borrower's throat), and lenders exercising damage control by tightening lending standards.

What blew me away was one of the anecdotes: a borrower was considering taking out an auto loan to pay the mortgage down to a point at which it could be refinanced, presumably now at only about 100% of some more-realistic valuation. I've had a tough time figuring out how that could be worthwhile other than as a sign of buyer's remorse on the "creative" ARM. After all, if recession looms larger among the usual macroeconomic risks, holding an ARM that's due to reset isn't necessarily a bad thing. If anything, the rush for the ARM exits (with nearly half of resetting ARMs to be refinanced, per the W$J excerpt at Calculated Risk) should be a pie in the face to housing analysts who suggested, in the not-too-distant-past, that the explosion of creative financing was Just Fine and Dandy because everyone rationally weighed the risks vs. conventional mortgages.

Labels: Housing Bubble, Personal Finance Advice of Alan Greenspan