Journal: Option ARMs Doing Worse than Subprime

The Journal has an interesting little news story this morning on option adjustable-rate mortgages, reporting that these time bombs now have worse foreclosure and delinquency rates than subprime mortgages.

The Audit has been on the lookout for a couple of months for more reporting on option ARMs, which are going to be a big problem for the housing market and financial system over the next couple of years. So even though this is a 460-word news story stuck inside on C2, we’ll take what we can get.

Option ARMs are the egregious “Pick-a-Pay” mortgages—ones that allow borrowers to choose how little to pay on the note in the first few years of the loan. That means in many cases borrowers can choose to pay less than the interest due that month, instead tacking it on to the end of the note—something known as negative amortization.

These gimmicks are the ultimate bubble artifacts. There’s little-to-no reason for them other than to allow people with good credit scores to buy homes they can’t afford, hoping they’ll be able to afford them (or the house will have increased in value enough to refinance or sell for a profit) by the time the Pick-a-Pay period comes to an end.

Here are the numbers:

As of April, 36.9% of Pick-A-Pay loans were at least 60 days past due, while 19% were in foreclosure, according to data from First American CoreLogic, a unit of Santa Ana, Calif.-based First American Corp. In contrast, 33.9% of subprime loans were delinquent, with 14.5% of those loans in foreclosure, the figures show.

It takes one disastrous financial product to be worse than subprime. And it’s only going to get worse. The Journal notes that option ARMs are concentrated in bombed-out markets like California and Florida. So when these notes “reset” into normal ARMs where the principal has to like, you know, actually be paid off, these people are going to walk away in droves. Not only will the house be worth half what it was when the loan was signed, the loan itself will have increased in size during that time. It’s a recipe for destruction.

On the bright side, the Journal tells us that remaining option ARMs are a “much smaller portion of outstanding mortgages than subprime loans.” But it doesn’t quantify that, which it should have. According to this McClatchy story from last month, outstanding option ARMs total $230 billion. But a previous Journal story and Bloomberg have reported that $750 billion of option ARMs were issued from 2004 to 2007. The Journal in a nice piece in January warning on option ARMs reported that $1.9 billion in subprime mortgages and $1.9 billion in prime mortgages were issued in the same time.

I think the discrepancy between the McClatchy $230 billion outstanding number and the Bloomberg/WSJ $750 billion number is that many of the mortgages issued in 2004 and 2005 were refinanced or unloaded as mortgagees sold higher. Many of those, plus more from 2006 and 2007 have been foreclosed on and thus taken out of the pool. I couldn’t find a current number for outstanding subprime and/or prime mortgages. If you know where to find it, drop me a link.

But today’s Journal story notes how big a problem option ARMs are for certain banks. Like Wells Fargo, which swallowed Herb and Marion Sandler’s Golden West Pick-a-Pay factory (via its swallowing of failing Wachovia):

San Francisco-based Wells Fargo holds a mountain of Pick-A-Pays, having acquired $115 billion of the loans in its purchase of teetering Wachovia Corp., which it agreed to buy late last year.

Due to complicated accounting rules, Wells Fargo assigns the loans a value of $93.2 billion, giving it room to absorb future losses on the loans. The bank, however, won’t say whether losses from the loans have risen beyond the firm’s original expectations. Wells Fargo declined to comment Friday.

In a securities filing in May, the company said that borrowers accounting for 51% of its outstanding Pick-A-Pay balances made only the minimum payment as of March 31.

In other words, there’s no way in hell those loans are worth $93.2 billion. That’s just more evidence that we’re living in a period of reality suspension as far as accounting goes.

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at Follow him on Twitter at @ryanchittum.