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Underwater ARMs ?

Posted By Barry Ritholtz On July 8, 2007 @ 6:30 am In Credit,Data Analysis,Real Estate | Comments Disabled

How bad is the Adustable Rate Mortage (ARM) situation? Stephanie Pomboy via Barron’s Alan Abelson [1] has the straight dope: 

"After modest reflection, any disinterested observer can’t help but find that accompanying table quite alARMing. It’s from a recent MacroMavens report, the handiwork of the incomparable Stephanie Pomboy, whose rants and raves we’ve had the pleasure of occasionally sharing with you. What its blood-curdling numbers depict is that the woes of mortgage lenders are not, as so widely believed, confined to the beleaguered subprime contingent, but are casting a much larger and chillier shadow.

More specifically, the table shows all too clearly that an astounding percentage of adjustable-rate mortgages already are underwater, and it estimates how much equity would be wiped out if home values decline by 5%, 10% and 15% and translates the corresponding losses into dollars.

Bahouse_20070706_2 [2]

As Stephanie comments: "Based on the share of ARMs in some state of negative equity at the end of last year and the decline in home prices so far in 2007, a stunning $693 billion in mortgage loans are already in the red. Assuming lenders are able to recover 70% of those assets — which seems optimistic given the massive amount of housing inventory yet to be unwound — that means mortgage lenders are already grappling with $210 billion in outright losses."

And that, she points out, is merely the direct hit. Thanks to what she nicely dubs the "divine miracle of leverage," the total financial exposure to these claims is many multiples of that. To which we say, ugh!

What’s more, Stephanie notes, these horrendous losses are coming at a time when the financial sector is "uniquely unprepared to withstand them." Commercial banks, she points out, have let their loan-loss provisions sink to 20-year lows while increasing their exposure to real estate to record highs. Mortgages, she reckons, account for a tidy 55% of total bank loans — and that doesn’t include the trillion dollars worth of mortgage-backed securities on bank balance sheets.

So much for the myth that banks have cleverly "offloaded" their real estate risk.

Every time I hear the phrase "Well Contained," I am reminded of that amusing scene [3] from "The Princess Bride [4]:"   

[Vizzini has just cut the rope The Dread Pirate Roberts is climbing up]
Inigo Montoya: You keep using that word. I do not think it means what you think it means.

"Well Contained": They keep using that word. I do not think it means what they think it means . . .


Truly Al-ARM-ing [1]
Barron’s Monday, July 9, 2007

Article printed from The Big Picture: http://www.ritholtz.com/blog

URL to article: http://www.ritholtz.com/blog/2007/07/underwater-arms/

URLs in this post:

[1] Barron’s Alan Abelson: http://online.barrons.com/article/SB118368600171458761.html

[2] Image: http://bigpicture.typepad.com/.shared/image.html?/photos/uncategorized/2007/07/07/bahouse_20070706.gif

[3] scene: http://www.imdb.com/title/tt0093779/quotes

[4] The Princess Bride: http://www.amazon.com/exec/obidos/ASIN/B00005LOKQ/thebigpictu09-20

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