There is something to be said about creative marketing and the influence it has had on this credit bubble. Yes, it is one thing to go after the Federal Reserve, Wall Street, greedy speculators, or unscrupulous lenders since we tend to associate a sense of responsibility with them in creating this credit bubble. […]
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There is something to be said about creative marketing and the influence it has had on this credit bubble. Yes, it is one thing to go after the Federal Reserve, Wall Street, greedy speculators, or unscrupulous lenders since we tend to associate a sense of responsibility with them in creating this credit bubble. Yet not much has been examined about those that played on the psychological strings of the public and enticed them with dreams of golden brick roads and endless sunshine. The advertising behind the credit bubble has been amazing in its subtlety and deep in misguided financial advice. Let us take for example a current ad that has a woman talking about a Pay Option ARM mortgage.

The ad plays along this script:

“With my flexible mortgage, I have the option to pay what I can, when I can. I can pay:

[use ridiculously low negative amortization monthly payment here]

[use financially destructive interest only option here]

[use with no emphasis fixed interest rate here]

The next part of the ad shows us a quick clip that subliminally tells us a lot of how people perceive credit. It uses the difference between the negative amortization payment and the fixed payment and calls it, get this, your savings.”

Maybe some of you have seen this ad or some variant of it. Frankly, I’m astonished they are still marketing this stuff given the political negativity surrounding the current housing market. This is one of the few that is currently airing and I’m not sure how much longer it will be going for given the nature of these mortgages. Yet the striking point of the ad is the message that whatever you don’t pay today is the same as you actually saving for tomorrow. This in fact is not only factually incorrect but also financially destructive. Think about what a negative amortization loan does. If you are to elect to pay only the lowest payment option, you are in effect increasing your mortgage balance each month. This in the world of reality and mathematics has the effect of growing your balance, the opposite of saving.

Now keep in mind that many of these Pay Option ARM mortgages were taken on by “financially savvy” folks with good credit that would never be mixed in with those sub-primers. Yet there is just as much of a risk for these to default since practically every loan of this category given out in the past two years in the state is now underwater. The entire state of California is now facing multiple challenges that will put significant pressure on prices for the next few years. So even a 5 or 10 percent down payment is now wiped out. Needless to say all those no money down loans with second mortgages are just waiting to be walked away from; that is if the government doesn’t step in and starts picking them up in the great mortgage swap meet of 2008.

Another stunning message in the ad is the person talking said something to the effect, “this mortgage is great. One month I can pay the full payment and the other month I can pay the minimum. I can decide to pay whatever I like.” Yet another free lunch mentality. I’m sure you know of folks in your immediate circle of friends and confidants that have back breaking credit card debt and yet you hear them say, “but I only pay [insert minimum payment that does nothing to the balance here] a month!” And not only do they say this with a straight face, they are proud of it. Even the wording of the loan is Orwellian. Pay Option? How about I take option D and simply not pay at all. Seems like a lot of folks are electing to use that one. These loans should be called, “pray that housing keeps going up while I make the minimum payment so I can unload the property in this forever Ponzi scheme of housing before my mortgage recasts in 2 years” loans. A little truth in advertising there.

Everyone Makes $250,000

The media for some reason doesn’t like pointing out that American household incomes simply do not support home prices. The implication is the problem is the loans and not that wages simply do not reflect current housing prices. After all, if everyone was making $250,000 prices would be cheap today. Right now the topic du jour of course is the bailout of Bear Stearns. It’s almost as if Bear Stearns held some sort of capitalism kryptonite and if the box where to be open, the world would start trembling. Glad it only took $29 billion to right the entire global economy. I think we got a great deal on that one! Let us once again re-examine the income breakdown of American households:

One of the charges leveled a few years ago when I started posting was ironically a common message that stated, “you’ll be surprised how many households in California make $250,000.” I’m not sure if this figure was given in some late night lending infomercial but the number seemed to stick and was used often. Now that the tide is drifting out to the vast blue Pacific Ocean those people were right, I am surprised how many households make $250,000 in California. Clearly it isn’t enough since those people with Pay Option ARM mortgages only make the minimum payment at a rate of 70 percent. Now I’ll give it to many that there are many households in the coastal regions that are in the six-digit range but this doesn’t go far in high cost areas. Yet there is a difference from a household making $120,000 and a household making $250,000. I think the above statistics put a major cloud on the prospects for higher housing prices.

Now why is this data important? Well let us look at the data for the entire state of California to see what sub-prime mortgages are looking like:

Source: FirstAmerican CoreLogic, LoanPerformance Data via the New York Fed.

If we dig deeper into the data we get these astonishing numbers:

California housing units: 12,214,549

Number of sub-prime: 500,958

Average balance: $325,672

What this means is California alone currently has $163 billion in active sub-prime loans in which, 47.5% were done with low or no documentation. This doesn’t even examine the Pay Option ARM mortgages. What you’ll be happy to hear is most of these loans were originated at the height of the bubble:

And the sub-prime loan of flavor in California was the 2/28 mortgage. Guess how many of those 2/28 loans will be resetting this year? How about 43.2 percent. Does that make this now infamous chart make more sense?

And guess how many folks actually took cash out of their homes on these toxic mortgages? How about 256,630 or over 50 percent of the entire sub-prime California mortgage pool. Don’t you just love the flexibility these mortgages offered like the creative advertising was telling us? Talk about a gigantic mess. As we discussed in a previous article the FHA $300 billion bailout proposal would most likely leave all these loans out on a vine since it is very likely that for the most part, these are underwater or very close to it given the date of origination and market conditions. That $29 billion to Bear Stearns doesn’t seem so large when the amount of California sub-prime loans is over 5 times as much. A billion here a billion there and soon we’re talking about pulling out the real American Express card. Put it on our tab and we’ll pay it later.

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Related Posts:
■The Abyss is Deep: The Housing Abyss is Deep: 4 Major Reasons Why Housing in Southern California is Nowhere Near a Bottom.
■True American Idol: Subprime Mortgage Lenders Send off a Blast Heard Around the World.
■When will my home cost me an ARM and a leg?
■Dr. Housing Bubble Celebrates Monumental 100th Post! Top 10 Housing Articles.
■Foreclosures jump statewide by 40% in California in just one quarter! Welcome to California’s Gold!

Via [DrHousingBubble]

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This entry was posted on Tuesday, April 8th, 2008 at 5:07 am and is filed under Real-estate news. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.