Just Above Sunset
Volume 5, Number 10
March 11, 2007

The Other Scare Story

 The world as seen from Just Above Sunset -

"Notes on how things seem from out here in Hollywood..."

The Other Scare Story

The last week of August was scare week. With support for the war in Iraq tanking and the Republicans facing the very real prospect of losing both the House and Senate, it was time to do something. So Secretary of Defense Rumsfeld told us that if we didn't agree with the administration - policy, strategy or tactics - we were simply trying to appease "a new type of fascism," which made us cowards, confused and morally bankrupt, and also stunning ignorant of history (see Insults). And we were told the fascists are coming, again, even if the argument that the current bad guts are actually "fascists" borders on the absurd, if the word means anything other than they are very, very, very bad people (see What's in a Word? for the details of that). The president launched a series of major speeches to raise alarm, with the last scheduled for 19 September at the UN. The idea is that we've lost our sense of how scary everything is, and might vote for someone other than those who think this is one fine war that's keeping us safer and making the world a better place.

The administration is feeling very misunderstood - no one gets it - war and war more is the only alternative. Or we all die. Why do far more than half of all Americans see the Iraq war as pointless and not having much to so with the main problem? They seem to wonder why we have to stay there and fix their internal disputes. What's wrong with these people?

On the left one has the not-that-scared Matthew Yglesias here -

    The idea here is that absent the US military, we would be handing Iraq over to some nefarious - and, admittedly, it would be quite nefarious - coalition of Baathists, Iranians, and al-Qaedists, presumably joined by Dr. Evil and the Cobra Commander. Back in the real world, though, these groups are fighting each other. What's more, the "armed groups with ties to Iran" include the political parties that comprise the Iraqi government. So what is it our troops are accomplishing amidst this frothy mix of bad actors?

It seems you're not supposed to ask questions quite that specific.

On the right there's the not-that-scared and quite frustrated ultra-conservative Stephen Bainbridge, a law professor at UCLA, and a full professor at that, saying this -

    There are many advantages to our political system vis-a-vis the British Parliamentary model, but one advantage of the latter is that you can hold a leader accountable. A Prime Minister who has screwed the pooch as badly as Bush very well could have lost his position as party leader.

    In an ideal world, it would be possible to win the war in Iraq, which Bush is right we need to do, and hold Bush accountable for having made it necessary for us to win the war in the first place.

The current scare story doesn't seem to gaining traction, as they say. The really scary thing in the mix is, of course, that very real prospect of the Republicans losing control of both the House and Senate. If that happens there will be some major explaining to do, at the top. And Professor Bainbridge will get his wish. It will turn surprising British in Washington.

But there's the other scare story going around, the collapse of the housing market. The economy is sustained by consumer spending, and about a third of all money being spent on consuming this and that comes from home equity - from refinancing your home's mortgage at a much lower rate with some very clever financial instruments, particularly the adjustable rate mortgage (ARM), which, according to Business Week, might be the riskiest and most complicated home loan product ever created, and from all the new homes purchased with such tools.

So what's the problem? Why should we be scared?

That's the cover story for the September 11, 2006 issue of Business Week, Nightmare Mortgages, by Mara Der Hovanesian. The subhead is "They promise the American Dream: A home of your own - with ultra-low rates and payments anyone can afford. Now, the trap has sprung."

And the hard copy cover is classic - a big, green python wrapped around a cute little home, crushing it (image here). And the words wrap around the image - "How Toxic Is Your Mortgage? Deceptive loans. Phantom profits. And coming soon: A wave of defaults."

And here's the opening -

    For cash-strapped homeowners, it was a pitch they couldn't refuse: Refinance your mortgage at a bargain rate and cut your payments in half. New home buyers, stretching to afford something in a super-heated market, didn't even need to produce documentation, much less a down payment.

    Those who took the bait are in for a nasty surprise. While many Americans have started to worry about falling home prices, borrowers who jumped into so-called option ARM loans have another, more urgent problem: payments that are about to skyrocket.

    The option adjustable rate mortgage (ARM) might be the riskiest and most complicated home loan product ever created. With its temptingly low minimum payments, the option ARM brought a whole new group of buyers into the housing market, extending the boom longer than it could have otherwise lasted, especially in the hottest markets. Suddenly, almost anyone could afford a home - or so they thought. The option ARM's low payments are only temporary. And the less a borrower chooses to pay now, the more is tacked onto the balance.

    The bill is coming due. Many of the option ARMs taken out in 2004 and 2005 are resetting at much higher payment schedules - often to the astonishment of people who thought the low installments were fixed for at least five years. And because home prices have leveled off, borrowers can't count on rising equity to bail them out. What's more, steep penalties prevent them from refinancing. The most diligent home buyers asked enough questions to know that option ARMs can be fraught with risk. But others, caught up in real estate mania, ignored or failed to appreciate the risk.

This could knock the legs out from under the whole economy - the house of cards tumbles. And it's a big house of cards.

So were these people who got themselves into this mess just stupid?

That depends on your point of view -

    There was plenty more going on behind the scenes they didn't know about, either: that their broker was paid more to sell option ARMs than other mortgages; that their lender is allowed to claim the full monthly payment as revenue on its books even when borrowers choose to pay much less; that the loan's interest rates and up-front fees might not have been set by their bank but rather by a hedge fund; and that they'll soon be confronted with the choice of coughing up higher payments or coughing up their home. The option ARM is "like the neutron bomb," says George McCarthy, a housing economist at New York's Ford Foundation. "It's going to kill all the people but leave the houses standing."

    Because banks don't have to report how many option ARMs they underwrite, few choose to do so. But the best available estimates show that option ARMs have soared in popularity. They accounted for as little as 0.5% of all mortgages written in 2003, but that shot up to at least 12.3% through the first five months of this year, according to FirstAmerican LoanPerformance, an industry tracker. And while they made up at least 40% of mortgages in Salinas, Calif., and 26% in Naples, Fla., they're not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51% of mortgages in West Virginia and 26% in Wyoming were option ARMs. Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it's not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc.

That's a big chunk of the economy.

And there are the stories -

    Gordon Burger is among the first wave of option ARM casualties. The 42-year-old police officer from a suburb of Sacramento, Calif., is stuck in a new mortgage that's making him poorer by the month. Burger, a solid earner with clean credit, has bought and sold several houses in the past. In February he got a flyer from a broker advertising an interest rate of 2.2%. It was an unbeatable opportunity, he thought. If he refinanced the mortgage on his $500,000 home into an option ARM, he could save $14,000 in interest payments over three years. Burger quickly pulled the trigger, switching out of his 5.1% fixed-rate loan. "The payment schedule looked like what we talked about, so I just started signing away," says Burger. He didn't read the fine print.

    After two months Burger noticed that the minimum payment of $1,697 was actually adding $1,000 to his balance every month. "I'm not making any ground on this house; it's a loss every month," he says. He says he was told by his lender, Minneapolis-based Homecoming Financial, a unit of Residential Capital, the nation's fifth-largest mortgage shop, that he'd have to pay more than $10,000 in prepayment penalties to refinance out of the loan. If he's unhappy, he should take it up with his broker, the bank said. "They know they're selling crap, and they're doing it in a way that's very deceiving," he says. "Unfortunately, I got sucked into it." In a written statement, Residential said it couldn't comment on Burger's loan but that "each mortgage is designed to meet the specific financial needs of a consumer."

    ... Most of the pain will be born by ordinary people. And it's already happening. More than a fifth of option ARM loans in 2004 and 2005 are upside down - meaning borrowers' homes are worth less than their debt. If home prices fall 10%, that number would double. "The number of houses for sale is tripling in some markets, so people are not going to get out of their debt," says the Ford Foundation's McCarthy. "A lot are going to walk."

    Jennifer and Eric Hinz of Somerset, Wis., are feeling the squeeze. They refinanced out of a 5.25% fixed-rate, 30-year loan in June, 2005, and into an option ARM with a 1% teaser rate from Indymac Bank. The $1,483 payment for their original mortgage dropped to as low as $747 with the new option ARM. They say they had no idea when they signed up, however, that the low payment adds $600 in deferred interest to their balance every month. Worse, they thought the 1% would last three years, but they're already paying 7.68%. "What reasonable human being would ever knowingly give up a 5.25% fixed-rate for what we're getting now?" says Eric, 36, who works in commercial construction. Refinancing is out because they can't afford the $15,000 or so in fees. "I'm paying more, and the interest is just going up and up and up," says Jennifer, 34, a stay-at-home mom. "I feel like we got totally screwed." They say their mortgage broker has stopped returning their phone calls. Indymac declined to comment on the loan's specifics.

This is a bad business, an essentially unregulated free market. The miraculous "invisible hand" Adam Smith was talking about, unfettered competition, the "hand" that produces the greatest good for the greatest number, is slapping a lot of folks around, and hard.

The political dimension to this, as the election approach, is that the conservatives in control of the government worship this miraculous "invisible hand" Adam Smith was talking about, unfettered competition, the "hand" that produces the greatest good for the greatest number. It is the cornerstone of so much of what we're told is how the world works - deregulate business, help no one with any social programs so they develop personal responsibility, and the nation will thrive.

But what about the angry people?

Duncan Black suggests this -

    If, as I cautiously predict, we're about to hit a massive foreclosure wave which is going to hit people at just about every income level there is a certain party whose name starts with the letter 'D' which might find it beneficial to start branding themselves as Friends of Homeowners with some smart policy proposals to back them up.

    Off the top of my head this could include cracking down on bad lending practices, providing legal assistance to victims of dishonest lending practices, removing impediments to prepayment and refinancing, and, of course, repealing the bankruptcy bill...

Let's see. That's "more regulation." And the second item is another social "do good" program that makes people think of themselves as victims, and thus undermines their charter and so forth. The third in an intervention to make the bankers and loan companies drop rules that are a stop-loss for their operations. The fourth hurts the banking industry, just last year given the opportunity to stop people from walking away from their financial responsibilities just because those people have no money left. That will never fly.

Here's another UCLA professor - Mark Kleiman (Public Policy, not Law) with this comment -

    The coming option ARM train wreck combines consumer fraud with (in this case purely legal) corporate book-cooking. Democrats need to start pounding the table now to take full political advantage of the disaster as it unfolds. I especially like the idea of legal assistance for victims of mortgage brokers' flim-flam tactics.

    Of course, the Republicans could beat the Democrats to the punch by actually doing something about the problem before it turns into a catastrophe, but it's a safe bet they won't.

No, they won't.

And Kleiman adds this -

    Note that the option ARM crunch has the potential to make the housing-price landing a good deal harder.

    Usually, when house prices go down, sellers pull back; you could describe this as speculative holding or as loss aversion, but either way transaction volume drops because homeowners don't want to sell their places for less than they think them to be worth.

    But people who can't make their suddenly "adjusted" option-ARM payments, and don't have any equity to refinance, may have no alternative to a distress sale except foreclosure, and the banks aren't going to want to sit on piles of houses either. So we might see the sort of "selling climax" that characterizes the end of a stock-market dive.

    The difference is that big institutions don't generally buy individual houses as investments, so it's hard for big pools of speculative money to come in if a selling panic leaves houses under-priced compared to some external standard of value such as the capitalized value of the rent. Being ready to step up and buy in the face of that sort of crisis is an excellent way to get either rich or broke in a hurry.

So the administration wants us to be scared of the "sort of" fascists, and this is going on. One senses this could lead to people to question not just the Iraq business, and the whole idea that wars are good and stability bad, but all of the premises of the guys who have been running things for the last six years. Is their whole theory of government just plain dangerous?

It's almost as if Business Week is changing things up - "So you think that is scary? Try this!" And here the "this" is far more immediate and not abstract at all. It's personal. With our volunteer and relatively small army, and no draft, and no war bonds or special taxes or anything, the war is a bit of an abstraction for many. Losing your house is not an abstraction. And now declaring bankruptcy won't help you at all.

Friday, September 1, Thomas Frank in the New York Times puts what we're told is good for us in historical perspective -

    What we have watched unfold for a few decades, I have argued, is a broad reversion to 19th-century political form, with free-market economics understood as the state of nature, plutocracy as the default social condition, and, enthroned as the nation's necessary vice, an institutionalized corruption surpassing anything we have seen for 80 years. All that is missing is a return to the gold standard and a war to Christianize the Philippines.

We're getting there. Be patient.

In the same issue of the Times Paul Krugman notes the disconnect -

    There are still some pundits out there lecturing people about how great the economy is. But most analysts seem to finally realize that Americans have good reasons to be unhappy with the state of the economy: although GDP growth has been pretty good for the last few years, most workers have seen their wages lag behind inflation and their benefits deteriorate.

    The disconnect between overall economic growth and the growing squeeze on many working Americans will probably play a big role this November, partly because President Bush seems so out of touch: the more he insists that it's a great economy, the angrier voters seem to get.

And what's the data?

E. J. Dionne covers the latest just out from the Census Bureau, and says it's worse for the administration than Katrina, as in this -

    The "good" news is that the poverty rate, the proportion of Americans who are poor, didn't change much between 2004 and 2005, falling in a statistically insignificant way from 12.7 percent to 12.6 percent. The bad news is that the poverty rate, having risen steadily in recent years, is still higher than it was in 2001, when it stood at 11.7 percent.

    Worse is that the proportion of the poor who are very poor has risen. People are considered in deep poverty if they have half or less of the yearly income of those at the poverty line. In 2005 half the poverty line for a family of three was $7,788; for a family of four it was $9,985. (Try living on that.) According to the new report, 43.1 percent of poor people lived in that sort of deep poverty - a record since 1975, when the government started assembling such statistics.

    In the six economic recoveries since the early 1960s, this is the first time the poverty rate was higher in the recovery's fourth year than it was when the recession was at its worst.

    The number of Americans without health insurance rose, too, to 46.6 million in 2005, up from 45.3 million in 2004 and 41.2 million in 2001. The proportion without insurance is up from 14.6 percent in 2001 to 15.9 percent in 2005.

    What about the middle class? Yes, the median income of American households rose by 1.1 percent last year after five years of decline. But most of the growth was in households headed by Americans 65 and over -- who are helped, rightly, by substantial government benefits. In households headed by people under 65, incomes fell yet again.

    The census had some very good news for the well-to-do. The top fifth of American households received 50.4 percent of all income last year, the highest proportion since 1967, when the Census Bureau started following that trend. The biggest gains were concentrated in the top 5 percent.

    "The economy is growing, and someone is getting the growth," said Sharon Parrott, a senior analyst at the liberal Center on Budget and Policy Priorities. "So now we know who it is."

    President Bush and the Republican Congress, take a bow: You took power to make the well-off even better off, and you have succeeded brilliantly.

Let's see - the line is that the well-off have been made much, much better off because they deserve it, and you'll get yours, eventually. And anyway, the richer they are the better it is for everyone. Right. And the war in Iraq really was necessary, even if the reasons we gave you to start up that all were kind of lame.

One senses that there's the real possibility that people just are not as scared as they're told they're supposed to be, and the possibility that the whole governing theory in play for the last six years is looking to many like smoke and mirrors - a trick to get the goodies and screw everyone else.

Could that shift in public opinion be underway?

No way - people hate the girly Democrats, those do-gooders and tree-huggers who think the government should do things for the people. And people know if they have the right attitude and take personal responsibility they too will get incredibly rich one day, and those tax breaks will come in handy.

But then there's this, noting that last month Rasmussen Reports conducted a national tracking poll of fifteen thousand voters, not the usual 1,012 for minimal statistical validity, and came up with odd results -

    The number of Americans calling themselves Republican has fallen to its lowest level in more than two-and-a-half years. Just 31.9% of American adults now say they're affiliated with the GOP. That's down from 37.2% in October 2004 and 34.5% at the beginning of 2006.

    The number of Democrats has grown slightly, from 36.1% at the beginning of the year to 37.3% now. Those who claim to be unaffiliated have increased to 30.8% this month. That's the highest total recorded since Rasmussen Reports began releasing this data in January 2004.

    Add it all together and the Democrats have their biggest net advantage - more than five percentage points - since January 2004. In the first month of 2006, the Democrats' advantage was just 1.6 percentage points. Last month, 32.8% of adults said they were Republicans and 36.8% identified themselves as Democrats.

These figures must be wrong, or maybe people are tired what Rumsfeld only made explicit - tired of being called cowards who are morally corrupt and intellectually deficient, and who don't know their history. And they know they'll lose their homes. And they know the new rules mean they cannot file for bankruptcy for any relief, as that now ruins you forever, not the seven years like before.

The question is just who should be scared here.

[The Other Scare Story]

Last updated Saturday, March 10, 2007, 10:30 pm Pacific Time

All text and photos, unless otherwise noted, Copyright © 2003, 2004, 2005, 2006, 2007 - Alan M. Pavlik