ARMs for the Rich

The NYT informs us today that, “The Affluent, Too, Couldn’t Resist Adjustable Rates.”

They took out adjustable-rate mortgages at the peak of the housing bubble to buy homes they would otherwise not be able to afford. Or they refinanced existing mortgages to take cash out. And now, two or three years later, the day of reckoning is here.

These are not lower- and middle-income borrowers, but more affluent consumers with annual incomes of $100,000 or more who are increasingly being ensnared in the home mortgage crisis.

People in all income categories “are facing the shock of new payments that can be twice as much as previous ones,” said Susan M. Wachter, professor of business and a real estate specialist at the Wharton School of the University of Pennsylvania.

Nor will falling interest rates help most of these homeowners, as their low initial payments skyrocket and the worth of their homes erodes, said Allen Fishbein, director of housing and credit policy at the Consumer Federation of America.

[…]

Today’s ARMs were “designed to fail, so you have to refinance,” Ms. Wachter said. “It shouldn’t be surprising that values go up and down in this kind of situation. And when you most need to refinance you can’t — the crux of the crunch.”

[…]

Refinancing requires some equity. Even if homeowners put a substantial amount of money down, many have no equity because their homes are worth less than they owe. In real estate parlance, their mortgages are under water.

The instrument has not yet been devised that can measure how little sympathy I have for people who refinanced their homes to pay for vacations or so that they could live above their already considerable means. If they go under and have to start from scratch, too bad.

These people are just as much speculators as those who buy homes in order to “flip” them when the market goes up. They were willing to take their profits; now they’ll have to accept their losses. That’s the nature of gambling.

FILED UNDER: General, ,
James Joyner
About James Joyner
James Joyner is Professor and Department Head of Security Studies at Marine Corps University's Command and Staff College and a nonresident senior fellow at the Scowcroft Center for Strategy and Security at the Atlantic Council. He's a former Army officer and Desert Storm vet. Views expressed here are his own. Follow James on Twitter @DrJJoyner.

Comments

  1. Dave Schuler says:

    Unfortunately, the new role of the Federal Reserve seems to be to underwrite the gambles of speculators.

  2. yetanotherjohn says:

    The ‘secret’ to financial success is to spend less than you earn.

    The corollary is the path to financial ruin is to spend more than you earn.

    It isn’t rocket science. Even an economist can figure this out.

  3. Dave Schuler says:

    Small-time thinking, yaj. The real way to financial success is spending other people’s money.

    Rent-seeking is a pretty darned good way, too.

  4. Alex Knapp says:

    What I’ve never understood about ARM’s is that I can’t possibly conceive of why anyone would think they’re a good idea. You wouldn’t sign a lease where your landlord could arbitrarily raise your rent whenever he felt like it. Why would you let the bank do the same with your mortgage? Any contract that doesn’t allow you to plan at least a year ahead for budgeting purposes is a lousy contract.

  5. floyd says:

    The government cries Crocodile Tears while lending a hand to those who have already taken an ARM, but they still use their Crocodile Teeth to bite the very hand that feeds them by raising real estate taxes high enough to form a new serf class!
    As with the Serfs in the past, this goes against the “Grain” for those who bear there own burdens as well as those of others.

  6. John Burgess says:

    Alex: While ARMs are not for most people in most circumstances, they do make sense for some.

    They’re not an egregiously bad option for people who know they’re not going to be living in the house they are buying when the adjustment comes due. Many federal workers (including military) are assigned to a location for a specified period of time (tour of duty, in other words). If they are certain that they’ll be in the ARM-mortgaged house for only two years and the ARM doesn’t kick in for three, then it’s a good deal.

    If they’re wrong in their predictions, then they can certainly be stuck holding the bag.

    In more stable housing markets and times, many go for the ARM to buy the house they want, then start immediately looking for a fixed-rate mortgage. ARMs are/were generally easier to get then traditional, 30-year fixed-rate mortgages, so getting one to get the house before it went to someone else could make sense.

    There’s assuredly some risk involved. But it needn’t be the same as going on a gambling binge in Atlantic City or Reno.

  7. Michael says:

    You wouldn’t sign a lease where your landlord could arbitrarily raise your rent whenever he felt like it.

    Most rental agreements allow the landlord to raise your rent after a period of time, usually one or two years. It was my understanding that ARMs had similar periods where your rate was static.

    Unfortunately, the new role of the Federal Reserve seems to be to underwrite the gambles of speculators.

    Their role is to try and mitigate the damage those speculators can do to our economy. I think that the stimulus checks being sent out are a poorly though-out and highly political way of doing this, but adjusting interest rates to offset credit tightening in a recession would seem to be exactly what the Fed was designed to do.

    If the gamblers were the only ones who would get burned, I’d say let them get burned. But if some fool sets his house on fire in your neighborhood, you don’t say let it burn, because eventually it’s going to burn the house of someone who wasn’t foolish, quite possibly your own.

  8. mike says:

    I took one b/c I knew that I would be selling NLT 4 years later and financially it made sense (as long as I didn’t blow the money I was saving) I knew the risks just like everyone else. Why people look to the gov’t to bail them out, I don’t understand – oh wait, I do, that’s what our society is evolving toward.

  9. Dave Schuler says:

    Their role is to try and mitigate the damage those speculators can do to our economy

    Actually I was thinking more of the lengthy period in the early part of this century in which interest rates were kept very low. IMO that set the stage for current problems. Although I understand the emergency first aid approach the Fed is using now, I’m skeptical that purely monetary measures will solve the problems that are out there.

  10. Michael says:

    Actually I was thinking more of the lengthy period in the early part of this century in which interest rates were kept very low. IMO that set the stage for current problems.

    No doubt it played some part, but then they were trying to head of a recession after 9/11.

    Although I understand the emergency first aid approach the Fed is using now, I’m skeptical that purely monetary measures will solve the problems that are out there.

    Like all first aid, it’s not meant to solve the problem, it’s to keep the problem from getting worse until it can be solved. You’re absolutely right that money alone won’t fix things, but the things that will fix it are slow to get moving, and their effects take time to ripple through. In this case, the Fed is looking for a tourniquet until it can get a suture kit.

  11. My understanding is that too easy credit created this particular problem. And the government’s response is to keep lowering interest rates and lower capital requirements for Freddie Mac and Fannie Mae to make even more money available with less stringent credit requirements.

    Anybody care to explain this to me?

  12. Michael says:

    My understanding is that too easy credit created this particular problem.

    It wasn’t the ease of obtaining the credit, it was that credit was given to people who couldn’t pay it back, and securities backed by those loans were marked as being good investments when they were not.

    Just like tech startups in the mid-90s, it wasn’t the fact that people were investing so much money into them, it’s the fact that people were investing in startups that weren’t worth investing in.

    By lowering interest rates, and the barrier to Freddie Mac/Fannie Mae mortgages, the Fed is trying to minimize the coming a housing surplus and a credit shortage which will effect the entire economy, not just those involved in the mortgages. The last thing we want in the economy is for people to stop buying the goods we’re producing, that is part of what cause the Great Depression.

  13. Michael, thanks for your thoughtful and considerate response. I understand what you wrote, but still have questions. We can argue semantically about what easy credit means, but I interpret it to mean that credit is too easy to get, i.e., higher and higher levels of risk being acceptable to get money at roughly the same interest rate is effectively the same thing as saying that “securities backed by those loans were marked as being good investments when they were not.” I’m bombarded daily with radio spots of the usual suspects offering loans — even if you’ve missed a few payments. Un-freaking believable. When are the lenders who have, and apparently are still, discounting risk to non-existence going to have to pay the consequences or is the government going to continue to virtually indemnify these excesses forever? The more money the government pumps in, the longer the day of reckoning is postponed and the worse the crisis gets. It’s not like there’s no downside to throwing more and more money at this problem.

    I’m also not sure I agree about your root cause of the depression. I was taught that the primary problems that caused and lengthened the depression were protectionism (Smoot-Hawley) and that there wasn’t any money available period, not that money wasn’t available at 5% instead of 8%.

  14. Michael says:

    The more money the government pumps in, the longer the day of reckoning is postponed and the worse the crisis gets. It’s not like there’s no downside to throwing more and more money at this problem.

    I don’t know how much the government is floating loan holders, I honestly haven’t been keeping up with too much of this because little of it effects me at the moment since I don’t own a home, or any investments backed by mortgages.

    I’m also not sure I agree about your root cause of the depression. I was taught that the primary problems that caused and lengthened the depression were protectionism (Smoot-Hawley) and that there wasn’t any money available period, not that money wasn’t available at 5% instead of 8%.

    I didn’t say it was the root cause, just one of many causes that, long with protectionism and a severe drought, all came together to fuel the depression.

  15. Michael says:

    We can argue semantically about what easy credit means, but I interpret it to mean that credit is too easy to get, i.e., higher and higher levels of risk being acceptable to get money at roughly the same interest rate is effectively the same thing as saying that “securities backed by those loans were marked as being good investments when they were not.”

    Okay, what I meant by “easy credit” is credit that you can obtain at low cost (low interest), which makes expensive purchases more attractive as they can be paid off over time without incurring too much additional expense. A company putting off buying new equipment on high interest credit may be more inclined to purchase now that interest rates are lower, thus injecting cash into the economy now.

    Your definition is what I consider “inappropriate credit”, where people are given more credit than they can afford. If the credit taken out by the business will likely be paid off, then it is a good investment. However, giving large amounts of credit to someone who is not likely to be able to pay it off is a bad investment, even at the high interest rates an ARM resets to.