Stashed away amid the tons of paperwork generated each day in Washington -- reading what no one argues is a threat to Shakespeare -- is HUD's 2007 Budget Summary , a document which ought to make a lot of people take notice.
"Congress recognizes that today's high cost loans negatively impact consumers, communities, and the economy. To address the problem, Congress is considering legislation to regulate these types of loans and the lenders who originate them. HUD proposes to amend the National Housing Act to give FHA the tools to offer alternatives to high cost loans by supporting privately originated mortgages to nonprime borrowers. These hardworking, credit-worthy borrowers, like generations before them, are unable to get a reasonably priced mortgage on fair terms. Many are in jeopardy of losing their homes as their mortgage payments escalate or balloon notes become payable."
HUD -- in a few years -- will be able to cite the quote above as evidence showing it was aware of the toxic loans available today. But HUD does not regulate lenders. At the federal level, that's a job for other departments, offices and agencies.
Ask yourself: Why is it that only hardworking subprime borrowers are impacted when "mortgage payments escalate or balloon notes become payable"? Why have federal banking regulators allowed -- and continue to allow -- the origination of loans which clearly represent a looming national debacle? If it's true that "Congress recognizes that today's high cost loans negatively impact consumers, communities, and the economy," then why hasn't Congress or the executive branch done something meaningful to resolve the problem?
We now have a large percentage of loans that involve negative amortization and potentially huge payment increases. It's impossible to believe that some portion of these loans -- and perhaps a large portion -- will not result in financial disaster.
This is not a problem that can be ignored by those who own their homes free and clear. This is not something that does not impact those who have financed with dull, boring self-amortizing loans that required something down. In either case, guess what will happen to the value of your home if nearby properties are dumped on the market or foreclosed?
To understand what's going on, consider the joys of so-called "option" or "flexible" ARM loans.
With such mortgages borrowers typically have four payment choices during the first five years of the loan term: pay as if the loan is being amortized over 30 years, pay as if the loan will be paid off in 15 years, pay on an interest-only basis, or make payments based on a "start rate" that initially generates negative amortization.
The term "negative amortization" means that the monthly payment is insufficient to cover the interest cost. The interest not paid is added to the mortgage debt. Thus, if you pay down a mortgage it is "amortized" and if the debt increases you have "negative amortization."
Borrow $500,000 at 6 percent with an option ARM that has a 1.5 percent start rate and the initial payment will be about $1,725 -- a cost that will top $4,000 in the seventh year of the loan. However, given that this is an adjustable-rate product it's possible that interest rates could rise during the loan term, so maybe a $4,000 monthly payment is a low estimate. You have to wonder if payments which are affordable at $1,725 a month will continue to be tolerable at $4,000 -- or more.
If it's true that escalating payments are a national issue, then where were the federal regulators? Did they not understand the real and present dangers of the very loans they were supposed to oversee?
The argument can be made that option ARMs, stated-income loan applications and mortgages amounts above the value represented by the underlying real estate have all lubricated the economy by allowing additional buyers into the marketplace. Since real estate anchors about 20 percent of all economic activity, more buyers and more transactions are positives -- but not at any cost.
There's no doubt that more loan originations are surely good for the nation's lenders, their loan officers and their shareholders -- at least for the most recent quarter. But are not lenders in business for the long-term? Do the big "investors" who buy mortgage packages such as pension funds and insurance companies benefit from loans which are fundamentally more-risky than traditional mortgages?
Did banking regulators not see how the mortgage market has shifted to high-risk loans? And if they did see such a shift, why did they not move quickly and forcefully to protect the public interest?
The new generation of high-risk loans gained popularity at a time when home prices in most markets were rising with astonishing force. What will happen to such loans in less-robust markets is unknown, but federal banking regulators who oversee much of the loan market should be held responsible for the excess risk they have allowed and for the financial failures which are certain to follow.
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