Today's Housing Problems Make Take Decades to be resolved

This housing bubble is going to take decades to work through the system.

I am more and more convinced that today's housing problems aren't going away anything soon.

I have an employee in my company who recently bought / overpaid for a house.  Since his income cannot possibly service interest, the bank offered him a reverse amortizing loan, whereby not only does he not need to pay down principal for the first 15 years, but he doesn't even need to make full interest payment.  Instead, the outstanding loan balance moves up by a little bit each month so that the outstanding balance is 15% higher in 2022 than today.  It is a 30 year mortgage and the principal payments are quite burdensome in years 16-30.  In addition, they have permitted him to encumber the house further with a high yield equity line of credit.

I like the guy and I hope he makes it, but I cannot believe that these types of mortgages have been handed out.  For the purchaser / borrower, the bank has provided the opportunity to live beyond their means for the first 15 years, backed by a bet that real estate will be higher in 15 years so that the purchaser / borrower can sell or refinance the property then.  There is also the expectation and hope on the part of the purchaser that their fortunes will improve over the next 15 years so that whatever the property market looks like, it will be possible at the very least to stay in the home.  However, for the lender / counterparty, this strikes me as an untenable bet.  Banks have provided the opportunity for many to live beyond their means.  For those that can do it for 15 years, there could very well be a mortgage default then until real estate has moved dramatically higher.  If I believe the media, this guy is not the only one to enter a deal like this and the banks have taken on dramatic risk throughout the spectrum that is going to take years to be assessed.

Everybody is speaking about the coming ARM reset cycle as being a turning point in the housing market.   With these types of 15 year deals still have closed in the first half of 2007 and a housing market which is only beginning to show signs of cracking (and which usually runs in long cycles), I believe that this will take decades to work itself off.  In this case, it is probably going to take 15 years before the bank knows if the borrow would be able to service the loan balance were it not an abnormally amortizing situation.

One other thought - a lot has been made of who should bear the burden of stupid loans like this that go bad.  I saw Bill Seidman, CNBC's chief commentator, said that their should be no bail out as that is the only way that the banks will learn not to do this again.  I would submit that everything runs in cycles and that there will be another massive housing bubble caused by the same type of lending in 20 years, and if you don't have some relief, the borrowers will be screwed, the bank shareholders will be screwed, and the bank executives will walk away as fat cats anyway.

Ari Socolow
Ari Socolow: Ari Socolow is the Chief Economist and Editor-in-Chief at BestCashCow. He is particularly interested in issues relating to financial literacy and bank transparency. Since co-founding this website in 2005, Ari has been frequently cited in the media as an expert on local and national savings accounts, CD products, mortgage and loan products and credit card rewards products.

Comments

  • JRodgers

    November 02, 2007

    This will bottom at some point in 2008. Most of the troubled ARMs that are discussed in the post above were actually originated in 2002 and 2003. Sure, some people will always have problems, but the peak in foreclosures in going to come in 2008.

  • JRubinstein

    October 16, 2007

    Agree with Christy. It is going to take a while, but not decades.

  • ChristySchien

    October 14, 2007

    I don't know if it is going to take decades as the example that you site is still extreme. The bigger issue is the ARMs that were originated that go out for the most part for 3 to 5 years so we should start to see some stabilization by 2011 if not before.

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