Small business owners, professionals, and corporate employees from generation X forward used the ARMs, and interest only loans to move into more suitable homes. Why not? Home prices were increasing exponentially. It looked like a good investment. And "the man" Greenspan said so.
The advice and loan programs have turned sour and many are now trapped in loans that will soon change dramatically. In the first few years of an Alt-A or subprimes, interest rates are kept low. In fact, some loans allowed substantially reduced "interest only" payments. It was all about getting people in homes to fuel a housing boom. The "affordability" of new homes pushed the market up in general and created artificial wealth. Now the party is over and these Arthur Geeenspan specials are "resetting."
When a nonprime loan "resets," it adds an average of three to six points to the loan payment for Alt-A's and subprimes respectively. It's quite a shock.
"Average Margin" is a specified amount added to the
rate of the mortgage when it "resets" a few years into the loan.
This chart shows the percent of nonprimes resetting in the coming years. In 2009, 630,000 combined nonprime loans will reset to a substantially higher interest, 320,000 in 2010. By 2011, all but 3% the subprimes will have reset. However, starting in 2011, nearly 40% of the Alt-A's, 850,000 in all, are scheduled to reset. Families and individuals in these homes will have a home loan well over the assessed home value and a substantial increase in interest payments. They'll be in a recession economy.
The loss of homes is not the sole manifestation of rampant fiscal mismanagement and systemic corruption. It's a symptom of an economy going in to a steep decline after years of looting by insiders.
Why are we going through all of these gyrations and special programs to prop up a financial system that clearly created this exposure with full knowledge of the substantial risks? Why are we diverting funds to cover bad loans by U.S. banks and bad investments in securities based on those loans by financial interests overseas?
A partial answer is that the U.S. banks that knowingly made these bad loans must be preserved and have their investments preserved. Overseas banks and others who invested in special stock offerings based on this high risk housing bubble must see their investments preserved in some profitable form. (See the next installment of "The Money Party at Work" for a broader explanation.)
We may not know how this crisis will end but it's clear how it started. Despite warnings from some of the most respected housing experts in the public and private sector, the die was cast by failed financial guru and Wall Street promoter Alan Greenspan in 2004 when he offered uncharacteristically clear advice to home buyers.
From Money Party to Citizens: Drop Dead! Feb.1, 2008
In 2004, Greenspan told a credit union association crowd that "the refinancing phenomenon" had been supportive for the economy and that the use of home equity "helped cushion" declining stock prices. Then Greenspan showed his supposed genius with this advice to home buyers and owners:
"American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home." Understanding household debt obligations, Federal Reserve Board, Feb. 23, 2004
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