Option ARMs Are New Subprime

Continuing our recent series of religio-economic analyses, we shift our attention from the Gospel of Mark to the Gospel of Matthew. In the fifth chapter of Matthew, which details the Sermon on the Mount, the writer observes that rain falls on both “the righteous and the unrighteous.”

“The rain [also] falls on the rich and the poor,” as we observed in the January 8, 2007 edition of the Rude Awakening, “Bonus Envy.” But the story does not end there. Many of the rich are pretty good at siphoning rain away from the poor, or at drilling horizontal water wells under the poor’s property. That’s just the way of the world.

But if it is any comfort to the poor of the earth, acid rain also falls on the rich and poor alike. Of course, the rich possess better defenses against acid rain than the poor. But these defenses are not always foolproof.

Sometimes the acid rain of economic adversity burns a hole right through these defenses and erodes some or all of the wealth that the rich have amassed for themselves. The housing bust, for example, has victimized nearly every home-owning individual in the country, even those individuals who own homes in the Hamptons – the posh summertime playground of Manhattan’s rich (or formerly rich) Wall Streeters.


High-end homes everywhere are taking a beating. As home prices slide, many high-end homeowners – like so many of their subprime counterparts – find themselves hopelessly upside down in their mortgages.

Once the value of a home falls well below the size of the mortgage against it, the homeowner loses the incentive to continue making payments. The calculus is approximately the same, no matter whether the mortgage be $100,000 or $1,000,000.

That said, the truly rich would not go into foreclosure, no matter how disadvantageous that mortgage math might become. The truly rich possess other assets that could be liquidated to satisfy their mortgages.

But many, many of the theoretically rich individuals of the late great housing bubble were never really very rich at all. They were simply “credit-worthy.” They earned enough money to qualify for a monster mortgage. As long as nothing changed, paying the mortgage was doable. But if anything changed – anything at all – paying the mortgage was absolutely non-doable.

Something changed.

Lots of big-ticket employees lost their jobs; home prices tanked and credit disappeared. When you add all this up, you get lots of pain and suffering, even in “rich” households. And you also get an alarming rise in delinquencies and foreclosures within the “prime” and “near-prime” loan categories. Big-ticket mortgages are the new sub-prime. For three straight months, option adjustable-rate mortgages (“option-ARMs”) – a preferred product of many formerly rich homeowners – have generated proportionally more delinquencies and foreclosures than subprime mortgages.

“Wells Fargo ‘acquired’ $115 billion of these things (i.e., Option- ARMs) when it bought Wachovia,” blogger Karl Denninger observes. “[Wells] claims they’re worth $93 billion. Oh really? A bunch of loans that were mostly at or near 100% loan-to-value (that is, near zero equity) when originally written, in markets where prices have declined by half? Oh, and in May, [Wells] said 51% of the balances out [on these loans] were being paid only on the minimum due. That is, [these loans] were still negatively amortizing even as house prices fell! Talk about double-screwed!”

In other words, the housing-bust-cum-credit-crisis might not be over just yet.

The Daily Reckoning