Underwater ARMs ?

How bad is the Adustable Rate Mortage (ARM) situation? Stephanie Pomboy via Barron’s Alan Abelson has the straight dope: 

"After modest reflection, any disinterested observer can’t help but find that accompanying table quite alARMing. It’s from a recent MacroMavens report, the handiwork of the incomparable Stephanie Pomboy, whose rants and raves we’ve had the pleasure of occasionally sharing with you. What its blood-curdling numbers depict is that the woes of mortgage lenders are not, as so widely believed, confined to the beleaguered subprime contingent, but are casting a much larger and chillier shadow.

More specifically, the table shows all too clearly that an astounding percentage of adjustable-rate mortgages already are underwater, and it estimates how much equity would be wiped out if home values decline by 5%, 10% and 15% and translates the corresponding losses into dollars.


As Stephanie comments: "Based on the share of ARMs in some state of negative equity at the end of last year and the decline in home prices so far in 2007, a stunning $693 billion in mortgage loans are already in the red. Assuming lenders are able to recover 70% of those assets — which seems optimistic given the massive amount of housing inventory yet to be unwound — that means mortgage lenders are already grappling with $210 billion in outright losses."

And that, she points out, is merely the direct hit. Thanks to what she nicely dubs the "divine miracle of leverage," the total financial exposure to these claims is many multiples of that. To which we say, ugh!

What’s more, Stephanie notes, these horrendous losses are coming at a time when the financial sector is "uniquely unprepared to withstand them." Commercial banks, she points out, have let their loan-loss provisions sink to 20-year lows while increasing their exposure to real estate to record highs. Mortgages, she reckons, account for a tidy 55% of total bank loans — and that doesn’t include the trillion dollars worth of mortgage-backed securities on bank balance sheets.

So much for the myth that banks have cleverly "offloaded" their real estate risk.

Every time I hear the phrase "Well Contained," I am reminded of that amusing scene from "The Princess Bride:"   

[Vizzini has just cut the rope The Dread Pirate Roberts is climbing up]
Inigo Montoya: You keep using that word. I do not think it means what you think it means.

"Well Contained": They keep using that word. I do not think it means what they think it means . . .


Truly Al-ARM-ing
Barron’s Monday, July 9, 2007

Print Friendly, PDF & Email

What's been said:

Discussions found on the web:
  1. Werner Merthens commented on Jul 8

    Good old Alan Abelson
    Ever so eloquent…
    Ever so bearish…
    And usually wrong!

  2. Barry Ritholtz commented on Jul 8

    I notice that you did not address the argument that Stephanie Pomboy raised. Your comments remind me of an old lawyer’s joke:

    When the Facts go against you, argue the Law.

    If the Law is on the opposing party’s side, emphasize the Facts.

    And when the Law and the Facts are against you, call the other lawyer a Schmuck!

  3. UrbanDigs commented on Jul 8

    Hey Inigo Montoya! Isn’t it time that regulation in the lending industry is put in place to protect AGAINST a homebuyer RATIONALIZING A HOME PURCHASE BY TAKING OUT AN ARM LOAN PRODUCT?

    I see it all too often here in NYC real estate.

    Buyer cant find home with their budget –> buyer stretches their max price –> buyer finds home well above their max and falls in love with it –> buyer chooses ARM product to make numbers closer to what could work for them –> buyer rationalized poor decision and spending above their means because of a loan product available to them.

    When will it end? No way the fed will step in and regulate this, it will have to be done in-house and probably will be done ONLY AFTER all those losses are realized.

    Its a shame.

  4. UrbanDigs commented on Jul 8

    PS: He did not say True Love. He said..tooblave..which we all know means to bluff!

    So check his pockets for loose change!

  5. alexd commented on Jul 8

    As I look over my neighbor’s forclosed house (and good riddence the worst neighbors I have ever had!) I am trying to apply what I have seen of their spendthrift lifestyle to the loss of equity situation. The question that comes to my mind is that in terms of spending when does the tipping point occour? For those who are frugal the loss of some hypothetical equity in our house does not make a difference.Of course we are the ones with a 30 year loan. I did have a 5 year loan years ago that ballooned but when I got it I was not thinking of how much more might our house might be worth but rather in which direction interest rates were going. It worked out and now we are sitting on a 30 and we try to make an extra payment a year.

    So I wonder at what point do those stretched out borrowers the ones who live in the bizzaro world of personal finance, curtatil their spending. I suspect that many who have ARMS at this point might also have a lot of consumer debt. Is there a correlation of late ARM payments and delinquent consumer debt?

    for those whogot arms just because that was all they could manage I simply feel sorry for them.

    So has the broad effect on this situation already occoured? Is occouring? Or will occour? Also is there anything close to this happening internationally. London?

    Just trying to figure out how to bet.

  6. Philippe commented on Jul 8


    It could well be that Mr Abelson and Mrs Pomboy are wrong but if they are it is only by a « small margin » of error 3.250 Trillion of USD which represent the increase of the real estate loans since 1985 until now.
    If they are wrong Mr Kash will not be their detractor either, please see at the captioned address.
    Frankly the issue is less the outstanding loans than the accounting treatment among banks where it seems that « no one is equal in rights and accounting obligations when it comes to reflect the state of their respective business »
    In the year 2000 they were creative (creative accounting was the culprit) in the year 2006/2007 they are secretive .
    No more power to the imagination?

  7. Winston Munn commented on Jul 8

    Maybe (probably) I am simply dimwitted, but doesn’t it require a default on the underlying mortgage to produce these losses? Until that default occurs, the value of the loan has been reduced but the actual loss has not occured.

    It seems to me that the effected parties will be those who used the underlying loan as collateral and those who loaned against that collateral.

  8. Idaho_Spud commented on Jul 8

    Winston Munn, yes it does require loan defaults to increase for these losses to be realized. That is what is so alarming about this chart:


    Notice that this uncanny spike in defaults is occurring against the backdrop af a “great” economy with allegedly low unemployment. I wonder how bad it will get if either of those two conditions worsen… I know, I know, the business cycle has been suspended.

  9. Werner Merthens commented on Jul 8

    You are right, I did not address Stephanie Pomboy raised.

    I apologize for calling the other lawyer a schmuck.

    Whatever the situation may be, only the future will tell which position is right.

    I merely meant to point out that the perennial bearish camp is usually wrong, and that the optimists will always triumph in the long run!

  10. blam commented on Jul 8

    The other shoe to drop is likely to be personal consumption expenditures as the death of MEW is realized.

    Bubble deflation has a very nasty momentum component that tends to exaggerate the woes in related bubbles.

    Here’s hoping I am still wrong about goldilocks. Maybe she really is a nice girl and not the trollop I have always taken her for.

  11. Idaho_Spud commented on Jul 8

    @ Winston Munn:

    Interesting article. Did you notice that the bank in question was dabbling in a much less opaque market than CDO/MBS equity tranche stuff?

    They got crushed in a market that sends precise daily signals, as opposed to the murky waters of the mark-to-model stuff that mortgages have become.

    I suspect we would all freak out if the curtain were suddenly pulled away and this stuff were marked to market. Which is probably why certain investment banks are colluding not to sell any – or else trying to create an IPO to unload it. LOL.

  12. S commented on Jul 8

    My name is Inigio Montoya. ARMs killed my father. Prepare to die.

  13. Winston Munn commented on Jul 8

    It appears to me that we sit on the verge of a massive liquidity contraction that could occur virtually overnight as loans are called in while margin calls go out.

  14. D. commented on Jul 8

    I merely meant to point out that the perennial bearish camp is usually wrong, and that the optimists will always triumph in the long run!

    In the long run we ALL DIE!

  15. Philippe commented on Jul 8

    The most important for borrowers is to service the interest payment and arrange a differed repayment schedule for the principal.
    Lenders will not object they have no advantage in inflating the number of houses to be sold.
    Over time the real estates crisis have always recovered with higher prices.

  16. jesus commented on Jul 8

    Anybody who has studied markets, knows that real estate will correct severely before it ever gets better.

    The question really is what impact will this have on the economy. A loss of a trillion in wealth seems like a lot. But then that’s how much we lost by going to war in Iraq. We’ve managed to get through that.

  17. david foster commented on Jul 8

    How exactly is the number “amount of ARMs in negative equity” computer? Say a house is worth $500K and has a $500K outstanding loan balance, for equity of $0. Now the local housing prices slip and the house is worth only $400K, for an equity of negative $100K.

    Would Pomboy’s analysis count this at $100k, which is the amount of the negative equity, or at $500K, which is the amount of the loan which is in a negative equity condition?

  18. REW commented on Jul 8

    Jesus’s comment suggests he hasn’t studied markets, at least not home prices.
    About those very scary numbers in the chart: have home prices ever corrected 15%? When, and how often?
    Seems like a very scary and very unlikely outcome based on history.
    But that doesn’t sell newspapers does it?

  19. you are wrong commented on Jul 8

    Sure, it is still a buyer’s market. but housing around Boston is turning around. thanks to Fed pumping liquidity by defending low short-term interest rate. mortgage rate is still historically low. and that mean your call on housing is wrong.

  20. Dale C. commented on Jul 8


    While it is true that the U.S. economy can handle the $500 billion to $1 trillion dollar lost on ARM mortgages so far, you must see that this $1 trillion is on the front end of a leveraging process that multiplies the initial $1 trillion many times over.

    The ARM’s are packaged into RMBS’s, these are packaged into CDO’s, these are bought by hedge funds leveraged 10 times over, credit default swaps are formed based on the CDO’s and these are formed into synthetic CDO’s, the synthetic CDO’s are bought by hedge funds leveraged 10 times over, the hedge funds are funded by funds of funds leveraged 4 or 5 times…

    The initial $1 trillion at risk ends up becoming a few hundred trillion at risk.

  21. brion commented on Jul 8

    -…optimists will always triumph in the long run!-
    Go long and stay long Werner….You da man!

  22. brion commented on Jul 8

    “A loss of a trillion in wealth seems like a lot. But then that’s how much we lost by going to war in Iraq. We’ve managed to get through that.”

    (somebody has to say it…)
    Jesus, a Trillion here and a Trillion there and pretty soon you’re talking about real money…
    (that phrase began life as a “million” quote, moved on to “billion” and is now headed to “Kajillion”)

  23. ECONOMISTA NON GRATA commented on Jul 8

    you are wrong; You are wrong…! Couldn’t resist… ;-)

    Have you ever hesrd of a “Dead cat bounce….”? You may have some seasonal improvements. However, Boston is just circling the toilet bowl at a slightly higher level for the moment….

    Best regards,


  24. jag commented on Jul 8

    “housing around Boston is turning around”

    Living in Boston I might have agreed a month or so ago but I’ve seen the For Sale signs repopulate the area and seen strange sights such as “Luxury” townhouses (seemingly “soldout” a year ago) now back on the market as “luxury rentals”…..this in a “great” area.

    Might be wrong but my experience has been that when things appear that make NO sense, there’s something BAD going on behind the scenes. I’ve never seen “for rent” signs in my neighborhood area (a nice one) in 20 years. Now they’re routine. If I could short the Boston housing market, I would.

  25. KnotRP commented on Jul 8


    Spending $1T on Iraq, or even $1T on housing, tends to push the economy along, whether the spending results in use capacity or waste.

    It’s when that $1T stops that things get unpleasant.

    Last time I checked, we were still spending on Iraq.
    What’s new is that housing has stopped.

    That’s why the housing market stall is NOT like the continuing war.

  26. anon commented on Jul 8

    I can’t resist either: You are wrong, you are wrong. Only the MAR says things are better. Two more objective data sources show otherwise (Warren, Case-Shiller). Having lived in metro Boston for 30 years, I cannot remember seeing more ‘for sale’ panels up.

  27. MikeW commented on Jul 8

    I saw this in Abelson’s column, which I enjoy weekly, but I didn’t understand it.

    “$693 billion in mortgage loans are already in the red. Assuming lenders are able to recover 70% of those assets … that means mortgage lenders are already grappling with $210 billion in outright losses.”

    Doesn’t the $210B loss figure depend on an assumption that ALL $693B of the “in the red”
    loans will end in foreclosure with 70%
    That may very well happen, but it’s
    pretty bold to assert such a specific
    figure and call it “outright” at this

  28. MikeW commented on Jul 8

    Also: I think it’s much too soon to say
    we’ve managed to “get through” the loss of $1T (or however much it may turn out to be)
    spent on war in Iraq.

    Many people
    attribute at least part of the great
    stagflation of the late ’70’s to the
    defecits resulting from the Vietnam
    War, and that economic affliction didn’t
    peak until half a decade after we helicoptered out of the embassy in Saigon…

  29. Stuart commented on Jul 8

    I’m wondering where the hundreds of billions of dollars of losses already incurred are sitting, let alone forecasting the affects of a 15% further reduction. I certaintly haven’t heard anything approaching nearly a fraction of these losses.

  30. Maverick commented on Jul 8

    Unfortunately, the last rental unit I have is on a MTA from WAMU. I cashed in my equity with a HELOC, but left a 10% “cushion” in case of implosion. I’m now 22% down in value and would have to come up with a large wad of cash in order to sell. Did I mention I live in a hot job market (N.VA)? Of course mortgage companies want a certain LTV for a refi and that doesn’t include “negative equity”. Stephanie is right on the button AND the general trend is for higher rates in the coming years. This won’t be pretty. We maybe looking at five years of problems.

  31. Bob commented on Jul 8

    One poster asked if home prices have ever corrected by 15%?

    In many of the bubble coastal markets, there has already been a correction of that magnitude.

    I live in Tampa. A house that sold in my neighborhood for 535K in November, 2005 was repo’d and recently sold for 400K, resetting home values in my neighborhood to that lower level. I think we have more to go in “bubbly” areas.

    check out home price trends here:


    You can easily find at that website:

    1. Former bubble markets that are undergoing a substantial correction
    2. Midwest markets in the rust belt that are grinding down slowly
    3. Interior sunbelt markets, i.e. Austin, Tx, that have seen rapid appreciation recently.

    I doubt that markets that did not experience the real estate mania will have severe corrections, though if there is a big spike in unemployement, that outlook could easily change.

  32. jack commented on Jul 8

    you think its bad now wait until the truth comes out on fannie mae and all the sub prime loans they bought and sold you aint seen nothin yet

  33. John Mark commented on Jul 9

    You say: “$693 billion in mortgage loans are already in the red. Assuming lenders are able to recover 70% of those assets … that means mortgage lenders are already grappling with $210 billion in outright losses.”

    Why can they only recover 70% of these Assets? If all the homes had 100% financing I could see a 30% loss in a market where prices have gone down 15-20% but not all of those loans are 100% financing. The property that had only a 70% LTV loan that goes bad should be able to be sold even in the worst market at little or no loss. Without knowing the average LTV on these loans I do not see how you can come up with a realistic number on losses.

  34. michael schumacher commented on Jul 9

    Good thread….however some here underestimate the “power” that the current administration has in basically not reporting the reality of the sub-prime mess. I’m not going into detail (as most here already have a great understanding of it and it’s consequences) Here are two examples of people commenting or attempting to influence where they really should STFU. First one is the continued (three times in three months) calling of the bottom by Hank Paulsen, nevermind that the perma-bulls have called a bottom for going on 9 months now….let’s just give them a little re-enforcement from good ‘ole Hank and Ben.

    And the capper (for me) was the CEO of Coca Cola calling the sub-prime Issue (not a problem, mind you, an ISSUE) is completely contained.

    With “experts” like that……..no wonder people ignore actual facts and economic indicators and just say “Have a Coke and a Smile”.

    And don’t get me started about this CDO collusion BS with the banks……are they just going to create the mother of all shell companies to off-load these for the third qtr? How many “chewco’s” will be created over the next few months so that these “issues” do not affect the precious profit margin that HAS to be met so that the show can continue.

    Lastly….did anyone actually see the article that Cramer “wrote” about Bear Stearns wonderfully valued stock price??? Sort of glossed over the exposure they have to it and then actually said the stock was a buy.

    We have truly entered the age of spin, nothing negative is truthful any longer……or at least for the next 16 months or so.


  35. Lintel commented on Jul 9

    “If I could short the Boston housing market, I would.”

    jag, you can short Boston. The CME has a suite of housing futures and options contracts. Boston is one of the MSAs you can trade. These contracts use S&P/Case-Shiller Indexes to settle. You can transact your view. Go to: http://housingrdc.cme.com/index.html

  36. Lintel commented on Jul 9

    “If I could short the Boston housing market, I would.”

    jag, you can short Boston. The CME has a suite of housing futures and options contracts. Boston is one of the MSAs you can trade. These contracts use S&P/Case-Shiller Indexes to settle. You can transact your view. Go to: http://housingrdc.cme.com/index.html

  37. Nurse Bubble commented on Jul 9

    > have home prices ever corrected 15%?

    Of course they have. Not counting the Great Depression, many regional markets have had housing busts. This bubble is HUGE and national though.

    Used home prices corrected 6% in the DC area over the last 12 months, and 7% in San Diego. Other areas corrected more. New home prices have corrected at least 2x more than used home prices. The depreciation will continue for at least 5 years, possibly 10-12 years.

  38. The Big Picture commented on Jul 18

    “Right now things are starting to come unglued”

    That’s a quote from Charles Gradante of hedge-fund consultant Hennessee Group. The only question is how far this thing is going to spread — to other funds, to underwriters and ratings agencies, to investment banks special charges. You know, how *CONTA…

Posted Under