The Rude Awakening
Laguna Beach, California
Friday, December 22, 2006 - Prophesy from a Rock Legend,
- Get into the Reserve,
- Why the Housing Market Will Make the Entire Economy Sick.
Eric Fry, reporting from the land delinquent mortgages and broken dreams… "Five to one, baby, one in five. No one here gets out alive!"
When a raspy-throated Jim Morrison bellowed those lyrics on the 1968 Doors' album, "Waiting for the Sun," his drug-addled mind was certainly not focused on the California mortgage market. Nevertheless, his foreboding lyrics may have contained a prophetic message. One-in-five is exactly the number of California mortgage borrowers who obtained a risky, "negative amortization" loan in 2005. One-in-five is also the number of existing subprime mortgages that are hurtling toward foreclosure, according to the Center for Responsible Lending. As a result of these figures, one-in-five is about the probability that the U.S. economy will NOT enter recession in late 2007 or 2008. Already, the holders of subprime loans are defaulting in large numbers. If, therefore, interest rates rise, or home prices fail to rebound, or economic conditions worsen - or all three at once - very few sub-prime mortgage holders will get out alive. In fact, neither will the housing market or the U.S. economy. ------- Special Investment Report------- Want to Get Your Favorite Agora Newsletter for Free for Life? 11 Days Left to get into the Reserve! Your private invitation is about to expire on January 2, 2007, so act now so you can grab each and every one of Agora Financial's profitable picks for as long as you want… Read on to learn more… --------------------------------------------------- The Housing Crash of 2008
By Eric J. Fry
"Amortization" is a big, five-syllable word that many homeowners cannot define. When you put the word "negative" in front of it, you get, "negative amortization" - a confusing, eight-syllable phrase that many homeowners cannot understand. And when you tack the word "mortgage" to the end of this confusing phrase, you get a very risky loan that many homeowners cannot re-pay.
Because negative amortization (neg-am) mortgages have become increasingly popular, and because delinquency rates on all forms of high-risk mortgages are becoming alarmingly high, the "recovering" housing market might soon suffer a debilitating relapse. A very sick housing market would also infect the entire U.S. economy. Negative amortization mortgages, which also go by the name of "pay-option" mortgages, permit borrowers to pay less than their entire monthly payment. Whatever amount the borrower chooses not to pay can be added to the loan balance (up to a point). Whenever the borrower pays less than the full monthly payment, the unpaid balance on the mortgage increases, instead of decreases. In other words the loan-amortization runs in reverse. Hence the name, "negative-amortization" loans. As recently as three years ago, neg-am mortgages were little more than curiosities, kind of like vegetarian meatloaf or "organic" cigarettes. In 2003, fewer than one in a hundred people buying a home or refinancing a mortgage in California used a neg-am loan, according to First American LoanPerformance. Last year however, one in five California borrowers relied on neg-am financing, and year-to-date in 2006, a whopping one in three borrowers have opted to take out a neg-am mortgage. In theory, the growing popularity of neg-am mortgages testifies to the marvels of financial innovation. In practice, however, the growing popularity of neg-am mortgages testifies to the desperation of homebuyers and/or the desparation of mortgage lenders. Whatever the root causes, the growth of neg-am mortgage issuance is probably a disaster in the making. Neg-am financing, by virtue of its very structure, contains the seeds of its own undoing. These loans enable individuals to "buy" homes they cannot really afford, then to continue borrowing against this unaffordable asset. Inevitably, as the mortgage balance grows bigger, the unaffordable house becomes even more unaffordable. Consider the case of Will Hertzberg, a distressed homeowner in Southern California. "Every day, Will Hertzberg owns a little less of his three-bedroom house in Corona," a fascinating story from the Los Angeles Times reports. "Like hundreds of thousands of other homeowners around the state, Hertzberg has a mortgage that lets him choose how much he pays each month. Like many of them, he always chooses to pay as little as possible. For the moment, this allows the 56-year-old Hertzberg to continue living in his tract home despite being only marginally employed. But his debt is swelling, and his mortgage company controls his fate. 'I am rather screwed,' he said." Hertzberg is not the only home-owner who is feeling "rather screwed" these days. "Foreclosures in October topped 115,000, 42% higher than a year earlier," observes James Grant, editor of Grant's Interest Rate Observer. "And, to date in 2006, according to RealtyTrac, more than one million properties have been started on the foreclosure conveyor belt, 27% more than in the same span in 2005." Subprime loans - of which neg-am loans are the most treacherous - are leading the charge toward rising delinquencies and foreclosures. Subprime loans, as their name implies, refer to loans held by borrowers who cannot qualify for traditional mortgages. Hence, subprime loans are held by the least credit-worthy borrowers. 
Not so long ago, subprime loans represented a small sliver of the overall mortgage market. But today they represent a whopping 23%. What's bad for subprime borrowers, therefore, is bad for the entire housing market. And what's beginning to happen to subprime borrowers is quite bad indeed. "We project that one out of five (actually 19%) subprime mortgages originated during the past two years will end in foreclosure," a just released report from the Center for Responsible Lending (CRL) predicts. "This rate is nearly double the projected rate of subprime loans made in 2002, and it exceeds the worst foreclosure experience in the modern mortgage market, which occurred during the 'Oil Patch' disaster off the 1980s." [To see this eye-opening report in its entirety, click here: http://www.responsiblelending.org/pdfs/FC-paper-12-19-new-cover-1.pdf] "Foreclosure rates will increase significantly in many markets as housing appreciation slows or reverses," the CRL's report continues. "As a result, we project that 2.2 million borrowers will lose their homes and up to $164 billion of wealth in the process." 
"The past housing boom masked the high proportion of homeowners who have struggled with subprime loans," the report explains. "For many borrowers, strong house price growth increased the amount of equity in their homes and enabled them to re-finance their mortgages despite being behind on the monthly payments. When these distressed prepayments are added to the foreclosure rate, the total "failure rate" for subprime loans approached 25%." This shockingly high "failure rate" stems directly from the shockingly imprudent lending practices of the late-stage housing boom. A few years ago, as home prices began escalating sharply, mortgage lenders devised ever-more-creative - and dangerous - ways for homebuyers to purchase homes they could not genuinely afford. Hence, exotic loans evolved from 5-year adjustable-rate mortgages (ARMs), to one-year ARMs, to interest-only loans, to no-equity loans, to pay-option loans etc. - each variation more dangerous than the predecessor. All of these "flexible" loans provided some version of low initial payments, followed by much larger payments "down the road." "Essentially," the Times concludes, "[these types of] loans are bets that good things will happen. Maybe the mortgage holder will get a big raise, or sell a script to Hollywood, or inherit a chunk of change…At a minimum, the borrower is betting the housing market will be better in a few years than it is today. If the house goes up in value, it will be possible to refinance and the day of reckoning can be put off once again." But good things don't always happen…especially when desperation requires them. "Homeownership has become like auto leasing, where the price of the car doesn't matter," explains Rick Soukoulis, chief executive of LoanCity, a San Jose lender that funded $7 billion in mortgages in 2005. "All that matters is the size of your monthly payment." Unfortunately, for many neg-am mortgage holders, the size of the total monthly payment is simply unaffordable. But this grim reality will not become widely apparent until sometime in 2007 or early 2008. Will Hertzberg, for example, does not face his final day of reckoning until 2008, even if he pays only the minimum payment each month. Remember, sub-prime financing did not become a sizeable portion of total mortgage lending - and neg-am financing did not become a sizeable portion of total subprime lending - until two years ago. A few of the unfortunates who drowned in their subprime debts are bobbing to the surface already. But many more are certain to appear as the recent bulge of subprime loans ages. "I guess we are a bit surprised at how fast this has unraveled," says Tom Zimmerman, head of UBS asset-backed security research, according to a Dow Jones Newswire bulletin. "While it's not a secret that subprime has performed pretty disastrously so far. I must say we were a bit surprised by the magnitude with which the loans deteriorated this year." Zimmerman's colleague at UBS, David Liu, relates that the 2006 vintage of subprime loan collateral is about as bad as it gets. "2004 [collateral] is worse than 2003," Liu observed in a recent presentation, "and 2005 [is] worse than 2004; 2006 is on track to be one of the worst ever (along with 200-01)." In other words, a worsening housing market may already be baked in the cake. "Just how many of these homeowners will end up in trouble is the big unknown for the housing market and the economy," the L.A. Times muses. "Although many economists expect the loans to prompt a certain degree of turmoil, they don't think it would cause a recession. [Will] Hertzberg is much bleaker. He's become a connoisseur of doom, a subscriber to websites and newsletters that predict the economy is headed for both recession and inflation. The bears' speculation: A rapid increase in foreclosures will flood the market with cheap homes, putting all of real estate into a tailspin. That would push up unemployment among builders, lenders, home improvement warehouses and furniture stores. That, in turn, would stall the economy, which is already slowing." Hmmm…sounds plausible…if not likely. -------- The Housing Collapse -------- "The Only Two Investment Strategies I'll Follow This Year…" The world's most respected market analyst just revealed the two best investments for 2007…and the ONLY two money moves he intends to make over the next 12 months… | 
