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One of the features of a
credit-driven bubble is an increasing belief in the inevitability of future
price increases of the asset classes that are attracting the greatest share
of the credit. Many recent articles about residential real estate highlight
the trend toward increasingly leveraged mortages - zero down payment,
interest-only, payment-skipping options, mortgages for more than 100% of the
value of the home, negative amortization, and other "creative
options". These mortages make sense both to the borrower and the lender
under the assumption that the price of the home itself can only go up.
Bloomberg today feaures an article
on the US housing market, citing Robert Shiller of Irrational Exuberance
fame. And Bill Bonner's always witty Daily
Reckoning quotes analyst James Grant on the mortgage credit bubble.
Bloomberg gives a profile of a
family who have chosen an interest-only mortage based on the belief that the
home will appriciate fast enough to build up equity.
Firefighter Bruno Gonzalez, his wife and three children
are moving next week into a new, $1.1 million ``mini-mansion,'' as he calls
it, in Pleasanton, California. The mortgage requires them to pay only
interest for the first seven years. Payments on the $880,000 loan will be
$3,300 a month, compared with $5,000 on a conventional 30-year fixed
mortgage.
`Walk Away Millionaires'
Since they won't be paying any principal, they are betting on rising prices
to increase their equity. The value of the family's previous home in Castro Valley, California, soared to $745,000 from $375,000 in just over five years.
"We know in the long run the house will appreciate so much that we're
going to walk away without having to pay the principal down, really,''
Gonzalez said Wednesday in a telephone interview. While the home purchase is
``a stretch'' for the family's $155,000 annual income, Gonzalez said,
"we're going to walk away millionaires.''
Now from Bonner's piece:
"Lenders are coming up with increasingly creative
mortgages aimed at owners whose budgets are stretched thin," the Wall
Street Journal reports. "Lenders such as Countrywide Financial Corp. are
offering mortgages that allow some borrowers to skip up to 10 payments over
the life of the loan. The rise of these oddball mortgages comes at a time
when sky-high home prices are making it tougher for many borrowers to afford their
dream house - or any house...
"Already, some loans that seemed novel just a year or two ago have
become almost mainstream. One example: interest- only mortgages, which allow
borrowers to pay interest and no principal in the early years of the
loan..."
And along comes Washington Mutual to help indebted homeowners, like a
bartender helps alcoholics. The big mortgage lender now offers an
adjustable-rate mortgage with an interest-only feature. "It calls this
mortgage Option- ARM," reports Grant's Interest Rate Observer.
"In just one year," continues Grant's, "the percentage of
WAMU's customers selecting Option-ARMs has leapt to 40% from 5%, according to
Harry Tomlinson, senior vice president for the Northeast region....The
borrower can elect to go interest-only and make no amortization payment.
Tomlinson explains: 'If you have a little bit of financial challenges, you
can always have the option of deferred amortization, but you don't have to.
That's a choice. What I see is a shift in the mortgage product, going from
our product used by one's home...to a product where people can leverage their
home as a financial asset, and that's a big shift.'"
Robert Blumen
Robert Blumen is an independent
software developer based in San Francisco, California
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