The Doctor is in: Dr. Housing Bubble on Mozillo and the Toxic Option Arm: Still Running its Course as Mozillo Stands Trial for Fraud

01 Sep

As we’ve been saying for some time, Option Arms are just one of the many
crazed loans created in the bubble – but Option Arms have a special distinction because they are actually NEG AM (the principle keeps growing every month) and killing the equity ratios of homeowners.

Thanks again to Dr. Housing Bubble for being on the cutting edge of what needs to be told: the story of the immense fraud underlying all of these ‘magic’ loans of the housing bubble.

Especially, Dr. for your coverage of Dean Baker’s coverage of the real story of the long term national housing price trends.  Something it seems almost no one else is yet willing to talk about: of COURSE we all knew it was a bubble…

Countrywide and Pay Option ARMs on trial – The most toxic mortgage ever invented by mankind is now under trial by the SEC with Countrywide.

You may or may not know that Angelo Mozilo, former president of toxic mortgage superstar Countrywide Financial is fighting against fraud charges brought on by the SEC.  Countrywide based out of Calabasas California was one of the original option ARM specialists.  Option ARMs are absolutely the worst kind of mortgage ever devised and the current trial is merely a tiny glimpse into this shady underworld of mortgage finance.  The fraud charges against Mozilo and others from Countrywide will provide a view of a mortgage product that never had any right to be in the market place.  Keep in mind that billions and billions of dollars of option ARMs are still out there.  Bank of America is now the proud owner of the Countrywide’s option ARM portfolio.  But let us describe a little bit more of what is going on.

Option ARMs are merely one part of the toxic mortgage universe.  As we now know, default rates on even supposedly secure FHA insured loans are now exploding.  If we look at the current monthly rate of foreclosures it would appear that every government program has done very little in stopping the runaway train:

nationwide monthly foreclosures

If these highly expensive programs designed to stop foreclosures did not help, where did the money go?  The problem stems from loans like option ARMs that were made to people that had no intention or even ability to pay them off.  As we have seen with the massive growth in strategic defaults, people have very little attachment to their homes especially in big bubble states.  What should you expect when you had mortgage companies like Countrywide who had absolutely no respect for the long-term sustainability of their clients?  Their main mission was to become one of the largest mortgage originators in the country.  This was to be accomplished at any cost.

In court documents filed only a few days ago, you can see the obvious trend to more and more risky loan products:

countrywide loan portfolio balance

In 2002 nearly 60 percent of Countrywide loan products were conventional loans.  But by 2006 over 45 percent of loans were non-conforming loans and nearly 10 percent were nonprime!  The option ARM which is the most risky mortgage product ever devised was being made to people with low documentation and in many cases with no ability to pay the loan back.  This is like giving a kid the keys to a Lamborghini just because he has the ability to turn on the ignition.  Everyone knew these loans would blow up at some point.  And to claim that no one saw this coming is not correct and even Mozilo knew about the problems way back in 2006:

By September of 2006 Mozilo already knew that 78% of his option ARM borrowers were making only the minimum payment.  The minimum payment on an option ARM is disastrous because the actual balance grows.  That is, the mortgage actually increases and this was happening at a time when housing values were reaching their apex.  So you have a mortgage balances jumping up and home values collapsing.  Keep in mind that roughly 50 percent of all option ARMs found their way into the California housing market.  This was a much targeted mortgage product for extra inflated states.  I recall some of the ads at the time talking about these loans as being for doctors and business leaders who simply didn’t want the hassle of filling out complicated loan docs.  Of course it was the complete opposite.  The low documentation and low teaser payment allowed those with weak incomes to over leverage and purchase incredibly overpriced homes.  A $100,000 income is weak if you are taking on a $1 million loan.

The SEC is arguing in one area that Countrywide knew the inherent problems with Pay Option ARMs but also didn’t disclose to investors that they were also allowing folks to get second mortgages thus crushing equity ratios:

countrywide pay option arms

Incredibly there is nothing illegal about the loan itself.  The trial hinges more on whether Countrywide knew about the risk and didn’t disclose these risks to investors:

“(New York Times) The S.E.C. focuses on how Countrywide’s underwriting procedures deteriorated over time as it responded to market pressures by offering increasingly risky loans, like the “pay option ARMs” that involved numerous instances of misrepresentations by borrowers. As the loans became more problematic, Countrywide edged closer to collapse as problems developed in the financial markets.

This is very much the long view of the company’s prospects, and the S.E.C. essentially argues that the greater risks in Countrywide’s mortgage operation should have been disclosed to investors. In effect, the company should have revealed that the light at the end of the tunnel may well have been a fast-approaching freight train.”

The point of this all is that many of these toxic deals still exist.  Bank of America still has a large amount of these loans when it acquired Countrywide back in July of 2008.  This is what it looked like at the time of the merger:

countrywide portfolio bofa merger

You don’t hear much about this being talked about because banks are looking for ways to dump this waste onto the taxpayer just like every other failed bailed out program above.  For now, they have taken some option ARMs and converted them to interest only loans (default rates are still soaring).  Of course, the core mission of helping homeowners stay in their homes has failed because home prices are much too high.  Dean Baker who has been spot on about the housing bubble for years and had this to say yesterday:

“(CEPR) Virtually the entire economics profession insisted on ignoring the housing bubble as it expanded to ever more dangerous levels. Remarkably, even after the bursting of this bubble wrecked the economy and has given us the worst downturn in 70 years, most economists are still determined to ignore the bubble.

The basic story is very simple. For a hundred years, from 1896 to 1996, nationwide house prices just tracked the overall rate of inflation. This is a very long period in a very big market. If we see a trend like this persist for a hundred years it is reasonable to expect it to continue into the future, unless something big in the fundamentals changes. And, no one has produced any evidence that passes the laugh test that anything in the fundamentals of the housing market has changed.

This means that we should expect house prices to continue to fall, with nationwide prices dropping another 15 to 20 percent to complete the process of deflating the bubble. This price decline is inevitable and in many ways desirable. I don’t know why any of us would be happy if our kids had to pay more to buy their first house.”

Pierce the bubble but have reforms in place to claw-back money from these banks.  What is the point if the loans are merely shifted to the taxpayer?  This trial will be interesting because those pesky option ARMs are still rearing their ugly little heads.


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