Friday, November 6, 2009

Wells Fargo (WFC) Kicks the Can by Transofrming Option ARM Mortgages into Interest Only

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If you are not familiar with what an option ARM mortgage is, read this piece [Aug 13, 2008: Option ARMs- Who Thought Up these Time Bombs?]].  I too was unfamiliar with it, despite following markets closely, until I read a BusinessWeek article in October 2006.  Interest only mortgages? Yep I knew about those.  Alt A mortgages? Yep.  [March 19, 2008: Alt A Mortgages Beginning to Break Down]  But option ARMs?  Wow - eye opening.  In summary these loans are the type where your mortgage payment not only does not cover the interest (as with an interest only mortgage) but does not even cover all the principal.  So each month your principal goes UP - this is the bestt kind of loan for day trading homes (as was all the rage in 05-07)... you put the least amount of money down, and hence your leverage is the highest.  Once I read that article, it all began making sense to me... how people on $40K of income were buying $560K houses in California.  And then I got very worried... but the bubble would not burst for 5-6 quarters after that reading.

As you should know by now our financial oligarchs are doing everything in their power to deny what sits on their balance sheet; much like the bank zombies did for a decade+ in Japan.  Our government and central bank is complicit - we have changed accounting rules, we've changed rules for marking losses on commercial loans, we've.... well I won't rehash it.  The reality is there is much bad out there that is swept under the rug in typical "kick the can" process... out of sight, out of mind.  If we just change the accounting, all our problems go away. 

Another technique of "make believe" is not foreclosing on homes; I've read stories (many) where people have been sitting in homes well over a year without making a payment and not being foreclosed on.  Because the banks only want to admit to X many losses a quarter or else they might actually look weak.  So we have this shadow inventory of defaulted homes that people are living in 'rent free!' as banks look the other way, waiting for miracle rebound I suppose.  But to come full circle to paragraph one - a very interesting tactic by Wells Fargo in dealing with the most toxic of all mortgages (option ARM) they are "transitioning" people into the second most toxic (interest only).  That's step 1.  Step 2 is for Ben Bernanke to unleashes enough paper dollars into the global economy, so as to inflate home prices back to where the home owner could actually sell the house in 5-10 years.  Or if that does not work, it will allow Wells to admit the loss in some far off year...

Obviously either of these loans are of the worst variety as they allow people with no "skin in the game" to transform from renters to "owners" but only on paper.  [Jul 6, 2009: WSJ - No Money Down or Negative Equity Top Source of Foreclosures]  And people with no skin in the game are most apt to simply walk away...   while this conversion might forestall the eventuality, I doubt it will change it for most.   But ... anything to keep the mirage going for now.  [Dec 8, 2008: More than Half of Homeowners with Modified Loans are Back in Trouble]    Heck even the Wall Street Journal now uses "kick the can".

Via WSJ
  • Wells Fargo & Co.'s strategy for modifying troubled Pick-A-Pay mortgages looks like a game of kick-the-can-down-the-road.
  • The fourth-largest U.S. bank by assets holds about $107 billion in debt tied to option adjustable-rate mortgages, a relic of the U.S. housing boom that allowed borrowers to make small monthly payments in return for increasing their mortgage balance. Many such borrowers now own homes worth far less than they owe in mortgage debt, and most can't afford a full monthly payment that pays down the loan's principal.
  • To solve that conundrum, Wells Fargo is taking a gamble: The San Francisco company is issuing thousands of interest-only loans that will defer borrowers' balances for as long as six to 10 years.  Wells Fargo is wagering that an eventual rise in housing prices in the worst-hit regions of the U.S. and a rise in consumer income, will eventually cover the bank's underwater Pick-A-Pay debt.
Considering many of these people are not 3, 5, 7% underwater but 25-40%... that's quite a wager.  Especially if we ever return to a normal market with mortgage rates around 6% and no free handouts for people to buy homes.  That will drive prices down yet again.  But again, it goes back to not admitting losses...
  • The move to shift Pick-A-Pay borrowers into interest-only loans helps Wells Fargo avoid hefty write-downs on Pick-A-Pay mortgages that would likely result from foreclosures. But the strategy will leave Wells Fargo holding billions of dollars in mortgage debt tied to distressed properties in battered markets, especially California and Florida.
  • Pick-A-Pay loans accounted for 10.8% of Wells Fargo's average total loans in the third quarter.
  • Wells Fargo has written $2 billion off Pick-A-Pay balances for borrowers, or nearly $46,000 per modified loan. 
Note: Wells Fargo did not actually do option ARM loans themselves, but inherited these when they got a sweetheart deal to take over the 4th largest bank Wachovia, under duress in 2008.  For which Wells got handed a massive amount of tax breaks by Hank Paulson that was snuck into "TARP" at the last minute -even the folks in Congress were outraged... once they bothered to read the bill a few weeks later.  [Nov 13, 2008: Washington Post - A Quiet Windfall for US Banks]

Wachovia, on the other hand, was "Pick a Pay" central.
  • Wells Fargo risks tethering itself to what former Wall Street executive David Shulman calls "wasting assets," since borrowers facing years of negative home equity likely have little incentive to maintain or improve their homes.
So if Wells Fargo is being "good hearted" why not put these people in a fixed 30 year mortgage rather than interest only?  Aha - devil in the details.  Because these borrowers used option ARMs for a reason - they could not truly afford their home with a conventional mortgage.  And they still cannot.  Wells Fargo is writing down the principal by an amount that can get these borrowers qualified for "interest only" (i.e. the bare minimum) - and we'll just kick the can for another half decade+.  Frankly, it's a disaster for the borrower to stay in these mortgages over the long run... they are just renting as not one iota of principal is being paid.

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