bostonbubble.com

[john p]

Admin:

That article you posted today has me thinking:

http://www.gloucestertimes.com/pubiz/local_story_225093932?keyword=topstory

This rate hike is targeting more the over $417k loans with adjustable rates and then those under.

My problem is that although the borrowers assumed the risk, the lenders could stand to gain if they can get the borrowers to resign for more. They gain by getting a higher mortgage rate. My questions for all are will the profits from the higher rate coming from the percentage of those who can jump the hurdle with the higher rate cover the cost of those who can't? If the profits outweigh the losses, what do the lenders care?

My problem is that it is almost like the punishment doesn't meet the crime here. Are lenders obligated to readjust based on any fundamentals or can they just pick a rate? For instance, it is in their best interest to overstate the risk to themselves and screw the borrower. Does the borrower have any options typically, meaning can they refinance, or would you guess that there are penalties that make it not possible?

Typically, interest rates track the 10 year yield; I'm seeing a separation now. The Federal Reserve has not raised rates in a long time, why are mortgage rates going up so sharply? I have a feeling that this correction is being played way too strategic in order to favor the banks. The banks are attacking the rich folks that overextended first, because who cares about them, and then everyone else. It's kind of like the whole credit card teaser rates, they start you off low and then put their hooks into you.

If the Federal Reserve isn't changing the rate, and is cool right now, what basis do banks have at readjusting at such high rates? What is it, risky or not? If it is as risky as the bank that wants to readjust from 4.5% to 10% says it is, why isn't the FED doing anything? If the risk is overstated, why can the banks hike rates so much?

I know lots of you folks are buyers and see the fundamentals in your favor but see these sellers stuck upside down on a see-saw, but sticking and slowly rolling downward like honey and see this adjustable rate mortgage readjustment as just enough heat to turn the honey into water and send the prices down, however, if banks are allowed to behave this way, we are all in deep trouble one way or another.

Lastly, if you want to know if a guy is going the bathroom at the beach, watch him slowly walk out to about 8 inches above his stomach, with his body posture facing outward and his eyes staring sideways. After 45 seconds or so when he reaches down and then moves quickly about 10 yards to the spot he was standing in, you know he just took a leak. Watching the banks right now gives me the same impression. This overadjustment needs to be watched very carefully....

[admin]

[admin]

[john p]

Awesome, thanks, it helps me understand the relationship better.

Ok, to answer your question, what should the FED do different?

My answer is that his reaction to the forces of inflation is nothing. This in my mind has to do with the future value of money. If the yield flattens and the future value of the dollar is not at risk, what basis does a bank have to forecast that their future value of the borrower's dollars will be so much less? Does that lender get to employ his own judgment on what the future value of the dollar will be or is there some sort of basis that they need to follow. If "risk" is the issue, the lender is no smarter than the borrower. They lent the money at the low rate so they too must have had the same forecast as the borrower. To say that the borrower was irresponsible also implicates the lender because they were both on the same wavelength. If the lender is allowed to punish the borrower by adjusting them to a significantly higher rate, it is not fair in my mind.

My idea is this:

If a borrower got a rate of say 4.5% when the prevailing rate was 5.5%, my solution is that however much lower the rate was relative to the prevailing rate at the time, the lender can increase in a refinance beyond the current prevailing rate; so say today the rate is $6.75, maybe they have to pay 7.75%. A second option would be that they are given the prevailing rate but have to pay 4 or 5 times the premium in interest they normally would have gotten and that amount gets added to their principle payment. I think this is a more fair solution. In addition, the FED should amp up the lending standards to purify the practice. The folks at the FED are pretty smart and they must have known all along what was going on.

I appreciate the "moral hazard" concept that you offered a while back, but I think that people are turning a blind eye to the pistol whipping that lenders are giving borrowers that got adjustable rates; the lender and the borrower needed to have the same forecast at the time they did business. If a lender doesn't give out money with a good faith belief that the rate has a chance at maintaining it's course, they should never be allowed to dangle it out there, because it doesn't take a genius to understand that it would create a credit and asset bubble.

[admin]

Maybe I'm misunderstanding something here, which is entirely possible given that I have only ever thought about using a fixed rate loan for myself... Here is my impression of how things worked for adjustable rate mortgages (and this could be wrong):

• Loan rates adjust according to a formula that is spelled out in the mortgage that you sign as opposed to just adjusting to what the lender feels like charging.
  
• The rate is typically fixed for an introductory period and won't begin adjusting for some amount of time, possibly a few years.
  
• The reason that a lot of loans are going to see a huge adjustment in rates is that they were taken out when interest rates were at or near the very trough. They are adjusting from an extremely low rate to what is normal now if you were to take out a new loan. Had they been adjusting all along, there wouldn't be this huge spike now - the spike is mainly a function of all the little adjustments that accumulated during the introductory period.
  

The first point is probably the most important one, with regard to the potential issue that you raised. I think that adjustments to existing loans are based on a function of some more general variable (perhaps the 10 year yield or some index).

- admin

[john p]

I would never do an adjustable rate mortgage so I don't know how they work very well. When all the politicians are trying to make us feel bad for the families that got cold cocked by a rate adjustment, what do you think happened? I get your point about it creeping up all along so that people should have had a fair warning, but how does the adjustment get so far apart from the prevailing rate? If the functions that you are referring to as part of the contract of the loan have been distorted by foreign influence i.e. that emerging credit to developing nations stuff, then wouldn't the Government's role be to step in and mediate and negotiate on the behalf of these borrowers. It gives a more capitalistic approach to this problem which I prefer. I mean I could see Barney Frank saying, hey guys you and I both knew that this was tied to that because of this and if these things did that that would have triggered the risk factor. These folks should not have to absorb what happened here entirely, the formula you used to gauge all this got skewed because you banks are doing everything possible to find money to fuel these emerging markets. For you to take it out on Mr and Mrs Red White and Blue is unacceptable. Let's step back and be reasonable and find a better metric to measure the risk you folks really have here.

[JCK]

Most ARMs are based on an index plus a margin. You've got it right; there's a fixed introductory period (1-10 years typically depending on the loan), and then index (e.g., 10 year treasury or LIBOR index) plus a margin. There are also caps on (1) how much it can adjust in any one year and (2) the total adjustment from the fixed rate.

[john p]

thanks JCK:

http://www.moneycafe.com/library/libor.htm

Because this index is based in England, do you think the devaluation of the dollar is affecting the adjustable rate functions?

[john p]

http://www.rgemonitor.com/blog/setser/209241

I'm starting to think if you've got a variable rate, you're helping to pay the world's speeding ticket.

[admin]

[admin]

Oh, wait a second - something else just occurred to me. Most (all?) of the "innovative" loans that became popular during the boom are only available in adjustable rate flavors. Negative amortization, stated income, low/no down payment, etc. may only have been available with adjustable rates. Getting a fixed rate loan may have required a significant down payment, proof of income, actually paying off the principal from the start, etc. So maybe the major factor leading to adjustable rate loans when it made no sense was that these people really couldn't have bought otherwise. It isn't just the smaller difference between a 30 year fixed and vanilla ARM as I was thinking before.

- admin

[john p]

I get that, unfortunately, the price of the house was higher than historical norms because of increased affordability that the lower rate afforded.

I am not advocating letting the "followers" off the hook, I am making sure that the punishment meets the crime. I think that they might be piling on right now.

http://www.msnbc.msn.com/id/20246355/

I mean these guy's toes are still tapping.

http://beginnersinvest.about.com/od/banking/a/aa071105a.htm

Are these adjustments more pronounced because of "Eurodollars"? Is that fair? The LIBOR rate is advertised as a very even keeled number. If you factor in the weak dollar it changes the intent of it being the port in the storm and the honest broker. (In my opinion).

I think that the banking industry can take a little extra from these folks because people will think; hey they gambled they get what they deserve. If they pull this stuff now on them, how will this affect pensions, COLA's and things like that? I don't want to socialize banking, I just want to make sure that if indices change, the fundamentals associated with them need to adjust as well and we need to know who has the power to adjust or define these indices.

[john p]

http://www.tscl.org/newcontent/102701.asp

This is a very good read:

http://www.shadowstats.com/cgi-bin/sgs/article/id=340

I remember working on a project where the smoke evacuation system failed the performance specification. Because it was a design build project the "executives" were more concerned about changing the performance criteria of the test than increase the performance of the actual system.

I think our society needs to see what ingredients are in each index, who controls them, and who benefits them as changes are being proposed.

[john p]

http://www.shadowstats.com/cgi-bin/sgs/article/id=343

This is an excellent read.

[john p]

http://www.cbo.gov/ftpdoc.cfm?index=8253&type=0#figure2