More than Subprime Resets: The Real Meaning of Two Waves

Regular HW readers likely know that I’ve referenced two looming waves of resets as it relates to the mortgage market, although I haven’t gone into a ton of detail covering what this means just yet. I will now. To start, a picture is worth a thousand words:

I’ve seen others like this over the last few months, but this is the most recent (via IMF and sourced to Credit Suisse, hat tip to an anonymous HW reader).

I’ve seen numerous bloggers reference “two waves” recently, but all are so far incorrectly referring to the ebb and flow in the subprime credit sector and are too focused on the short term — the problem here is unfortunately more widespread than that when you take a broader view of the market. Two words describe the second wave I’ve been referring to: option ARMs. (Trust me, you’ll start hearing about this soon enough in the press.)

To understand what you’re seeing above, you need to keep in mind where most of the option ARM lending took place during the housing boom: markets like California and Florida, markets that are now literally watching their property values nose dive in key regions throughout each state.

For these borrowers, a recapitalization of their option ARM mortgage will likely come at the worst possible time — 2010 and into 2011. Most housing pundits are suggesting that housing prices won’t stablize until early 2009 (even the NAR is predicting a lousy 2008). That suggests any recovery in housing may come far too late for a large swath of borrowers who will suddenly find themselves upside down and seeing their mortgage recast in ways they might even now think impossible. Hope springs eternal, after all, and 2010 seems a long way off.

I’ve often said I’m not inherently bearish when it comes to mortgages — the truth is that I don’t want to be bearish. But I do have to be realistic; and in terms of billions of dollars’ worth of outstanding loan volume, the option ARM reset surge looks to be just as large as the subprime problem we’re now facing as an industry.

Given the likely battered and bruised condition of the market coming out of 2008 and into 2009, it’s looking right now as if 2010 could be a bad case of deja vu, all over again.

Update: It appears the press has caught on, and that Calculated Risk was also on this story on this as well. Both are recommended reads.