The Pay Option ARM

By: Doug Noland | Fri, Feb 6, 2004
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UNEDITED!

It was another adventure through treacherous financial markets. For the week, the Dow and S&P 500 added 1%. The Morgan Stanley Consumer index gained 2% and the Morgan Stanley Cyclicals added less than 1%. The Transports were about unchanged, while the Utilities declined 1%. The broader market was volatile, while ending the week with small gains. The small cap Russell 2000 added less than 1%, increasing 2004 gains to 5%. The S&P400 Mid-cap index was up 1%. The NASDAQ100 and Morgan Stanley High tech indices finished slightly positive. The Semiconductors added 1%. The Street.com Internet index gained 1% (up 7% y-t-d), while the NASDAQ Telecom index declined 1% (up 6% y-t-d). The Biotechs added 1%, increasing 2004 gains to 6%. The Broker/Dealers were unchanged (up 6% y-t-d), while the Banks added 1% (up 3% y-t-d). With bullion (also volatile) up 90 cents, the HUI gold index recovered almost 6%.

In the face of solid economic data, the bond market thumbed its nose and shot higher. For the week, 2-year yields dipped 7 basis points to 1.75%, and 5-year yields declined 6 basis points to 3.085%. Ten-year yields dropped 5 basis points to 4.08%, almost returning to "pre-death of considerable period" level. Long-bond yields declined 4 basis points to 4.91%. Benchmark Fannie Mae MBS yields declined 8 basis points. The spread on Fannie's 4 3/8 2013 note narrowed 1 to 32, and the spread on Freddie 4 ½ 2013 note was unchanged at 34. The benchmark 10-year dollar swap spread added 1.0 to 40.5, the widest margin in about three months. The implied yield on December Eurodollars declined 12.5 basis points to 1.925. Corporate spreads generally widened moderately, with volatile conditions apparent in the junk bond market.

Investment grade issuers this week included Citigroup $1 billion, Abbott Labs $500 million, Countrywide $500 million, Wachovia $500 million, United Health $500 million, Merck $350 million, LB-Baden $300 million, Keycorp $250 million, American Axle & Mfg. $250 million, Fifth Third Bank $200 million, Cullen/Frost $100 million, and First Citizens $100 million.

Junk bond funds reported a notable $1.57 billion outflow last week (from AMG). This follows 13 straight weeks of inflows totaling about $4 billion. Junk issuance didn't seem to miss a beat. Sellers included Playtex $500 million, Argosy Gaming $350 million, Ply Gem Industries $225 million, GCI Inc. $230 million, Affinity Group $200 million, Pinnacle Foods $195 million, Ormat Funding $190 million, Inverness Medical $150 million, Dunlop $120 million, and Ameripath $75 million.

Convert issuers included Delta Airlines $325 million, Mesa Air $170 million, American Axle & Manufacturing $130 million and Equinix $75 million.

Foreign dollar debt issuers included Export-Import Bank of Korea $1 billion, Rabobank $500 million, and Woori Bank $400 million.

According to JPMorgan, asset-backed security issuance "picked up towards the end of January, bringing total volume to $37.5 billion," about 10% ahead of January 2003. "Home Equity, Global RMBS (residential MBS) and Student Loans have dominated issuance..."

Freddie Mac posted 30-year fixed mortgage rates rose 4 basis points this week to 5.72% (up 8bsp in two weeks). Fifteen-year fixed mortgage rates rose 6 basis points to 5.03%. One-year adjustable mortgages could be had at 3.61%, up 2 basis points last week and up 5 basis points in two weeks. The Mortgage Bankers Association Purchase Application index declined by less than 2%. Purchase applications were 18% above the year ago level, with dollar volume up almost 39%. Refi applications also declined slightly, with volume down 42% from a year earlier. It is, however, worth noting that the Refi application index has been above 3,000 (historically high level) for three straight weeks for the first time in five months. The average Purchase mortgage was for $205,400, with the average adjustable-rate mortgage at $310,900. The percentage of adjustable-rate mortgages rose slightly to 27.2%, about double the year ago percentage.

Broad Money Supply jumped $34.1 billion to a record $8.95 Trillion, with four-week gains of $116.3 billion. Demand and Checkable Deposits gained $4.0 billion and Savings Deposits added $5.5 billion. Small Denominated Deposits were about unchanged. Retail Money Fund deposits dipped $1.7 billion and Institutional Money Fund deposits declined $2.8 billion. Large Denominated Deposits jumped $9.2 billion and Repurchase Agreements surged $17.4 billion. Eurodollar deposits added $2.1 billion.

Fed Foreign "Custody" holdings of U.S. Debt, Agencies increased $4.4 billion.

Total Bank Credit expanded $13.7 billion for the week of January 28, with 5-week gains of a notable $92.4 billion. Security holdings declined $5.4 billion. Loans & Leases surged $19.1 billion. By category, Commercial and Industrial loans were about unchanged, and Real Estate loans added $0.9 billion. Security loans jumped $12.4 billion and Other loans were up $5.4 billion. Elsewhere, Total Commercial Paper increased $4.3 billion. Non-financial CP increased $0.7 billion, while Financial CP $5 billion.

Currency Watch:

Currencies, along with seemingly everything else, vacillated by the hour. For the week, unrelenting Japanese dollar buying kept this week's dollar decline to a minimum. But the dollar sank about 2% against the Euro, with the dollar index suffering a 1.5% decline. The dollar must hold recent lows or it is likely to abruptly embark on another precarious bear market descent. Emerging debt markets remain unsettled, although most seemed to somewhat stabilize by week's end. The Brazilian bond market gave up more ground this week.

Commodities Watch:

February 3 - Bloomberg (Christian Baumgaertel): "Dollar-based commodity prices on the world market rose 5.8 percent in January from the previous month, led by a 6.8 percent gain in the cost of industrial raw materials, the HWWA economic institute said. From a year earlier, global commodities prices including those for agricultural products, industrial raw materials, as well as metals and energy commodities rose 11.7 percent..."

The CRB index declined about one-half percent, while the Goldman Sachs Commodity index declined better than 1% this week. Pork belly prices jumped 11% this week to a seven-month high.

Global Reflation Watch:

February 4 - Bloomberg (Petter Narvestad): "Knightsbridge Tankers Ltd. and other owners of the largest oil tankers are collecting as much as 50 percent more than break-even on multiyear contracts as spot-market rates surge close to 30-year highs." "Freight rates for dry-bulk cargoes such as iron ore and coal are at a record after rising in January for the ninth month in 12 as an expanding Chinese economy boosts demand for raw materials and port delays tie up ships. The Baltic Dry Index, a measure of the price paid for shipping dry-bulk goods, climbed for a seventh session today to 5,681 points. The index, which gained 17 percent in January, has more than tripled in the past year as demand outpaced growth in the world's bulker fleet. 'We are seeing close to a 100 percent utilization in the dry bulk market,' said Nicolai Hansteen, an analyst at Oslo-based shipbroker Lorentzen & Stemoco... 'It's made rates go through the roof and the situation may last into the second half of this year.'"

February 4 - Bloomberg (Guy Faulconbridge): "Russian consumer prices rose at the fastest pace in a year in January, as prices for services soared after the government allowed increases in the cost of electricity, gas and local services. Russian consumer prices rose 1.8 percent in January from December..."

February 4 - Bloomberg (Seyoon Kim): "South Korean producer prices rose in January at their fastest pace in more than five years because holiday demand bid food prices higher and crude oil costs rose, making fuel, chemicals and other industrial goods more expensive. Producer prices rose 3.8 percent from a year earlier after climbing 3.1 percent in December... Rising food and energy costs may push up prices of everything from restaurant meals to cars and computers, causing consumer-price inflation to accelerate."

February 6 - Bloomberg (Clare Cheung): "Hong Kong's retail sales had their biggest gain in almost a year in December as tourists arrivals surged to a record, and falling unemployment and rising asset prices made people more willing to spend. Sales climbed 6.7 percent from a year earlier..."

February 4 - Bloomberg (Duncan Hooper): "U.K. house prices rose last month at the fastest pace since October 2002, HBOS Plc said, suggesting consumers' willingness to borrow hasn't been dented by November's interest-rate increase. The average cost of a home rose 2.2 percent to 145,610 pounds ($267,405), following a 2 percent gain in December... Annual house-price inflation accelerated for a second month to 16 percent in the quarter ended Jan. 31..."

February 6 - Bloomberg (Sam Fleming): "The number of U.K. shoppers last month rose the most in 2 1/2 years as Britons ramped up spending on home-entertainment systems, mobile phones and home-improvement products, a survey showed. The number of consumers visiting stores in January swelled 5.3 percent from a year ago, the biggest monthly climb since June 2001..."

February 2 - MarketNews: "Excess money and credit supply in the euro area mean the European Central Bank should raise interest rates, according to a group of leading German ECB watchers.... The professors believe that excess liquidity could bring an asset bubble which would then drive up consumer prices. They warn that the inevitable need to correct such a development could prove 'highly costly' as far as jobs and growth are concerned. 'In particular, we see the risk that excess liquidity in the US as well as in the euro area could cause, in a first wave, asset price inflation (on the stock, bond and housing markets) before driving up consumer prices. The inevitable correction of such a development could prove highly costly as far as output and employment are concerned, and thus warrants attention by monetary policy makers. This is why we conclude: 'Too much money is chasing too few goods.'"

Economy Watch:

The January ISM Manufacturing index rose for the eighth straight month to the highest level since December 1983. Prices Paid surged an eye-opening 9.5 points to 75.5, the highest since booming March 2000. The Prices Paid index is up 22.5 points in five months. Production rose almost 2 points to a blistering 71.1. New Orders remain exceptionally strong (although down 2 points) at 71.1, with three consecutive months above 70.

The January ISM Non-manufacturing index jumped a much stronger-than-expected 7.1 points to 65.7, the strongest reading on record (since inception in July 1997). Up 5.4 points to 64.9, New Orders were the second strongest ever.

Factory Orders were up a stronger-than-expected 1.1%, with orders up 8.0% y-o-y. Non-defense Capital Goods orders were up 9.1%, with total Capital Goods orders up 10.5% y-o-y.

December Total Construction Spending was up (slightly less-than-expected) 0.4% to a record annualized $933.2 billion. Total Construction Spending was up 8.0% y-o-y, with Private Residential Spending up 16.2%. Total Private Construction Spending was up 9.4% from December 2002. Expenditures on Office construction were down 4.9% y-o-y, with Commercial Construction up 4.0%. Total Public Construction Spending was up 3.7% y-o-y, led by Commercial up 23.7%, Power up 19.6% and Highway/Street up 10.7%.

December Personal Income was up 0.2% and Personal Spending was up 0.4%. From one year ago, Personal Income is up 3.80%, the strongest y-o-y performance since May 2001. Disposable Income was up 4.7% from December 2002 and up 10.3% over two years. For 2003, Personal Income was up 3.1%, a notable rise from 2002's 2.3%. Up 5.0%, spending posted its strongest gain since 2000. By category, spending on Durable Goods was up 5.1%, Non Durables 6.4%, and Services 4.2%. Spending was up 4.8% during 2002, 4.5% in 2001, and 7.3% during 2000.

Domestic Credit Inflation Watch:

February 4 - American Banker (Damian Paletta): "Domestic lenders are reporting stronger business loan demand, snapping three years of declines, according to a Federal Reserve survey... 'According to domestic respondents, the most important reasons for the strengthening of loan demand over the past three months were increased customer investment in plant and equipment and increased customer needs to finance accounts receivable and inventories,' the Fed said in summing up its latest Senior Loan Officer Opinion Survey... Overall demand for commercial loans increased as many banks made them easier to obtain. In the past three months 18% of domestic banks reported easing their lending standards on commercial and industrial loans for large and middle-market firms; none reported a tightening. The Fed said the net easing was the largest since late 1993... Industry observers said the commercial lending market was finally catching up with the rest of the economy."

February 3 - Bloomberg (Brendan Murray and Simon Kennedy): "The U.S. plans to borrow a net $177 billion from January through March, a record for any quarter and more than the Treasury Department forecast three months ago, to help finance an unprecedented budget deficit. The borrowing will help the U.S. finance a shortfall that the White House today said will swell this fiscal year to $521 billion, the biggest ever in dollar terms."

February 3 - The Asian Wall Street Journal (Phillip Day and Hae Won Choi): "Asian Central banks, among the biggest and most important investors in U.S. securities, are finding other ways to use their vast dollar holdings -- a move that could make it harder for the U.S. to keep financing its fiscal deficit while keeping interest rates low... Asian central banks aren't going to dump their estimated holdings of nearly $1 trillion of U.S. government bonds overnight. But even if they shifted some of their holdings, or just slowed their rate of buying, the results could be felt globally, most notably by the U.S... The percentage of U.S. government debt owned by foreigners rose to 37.3% last year from less than 4.7% in 1965. Foreign central banks hold more than $800 billion in Treasurys -- $1 of every $5 the U.S. government owes. For the U.S. debt market, foreign buying is 'critical - it's probably the biggest driver' of the Treasury market recently, says Michael Ryan, strategist with UBS in New York."

February 3 - Bloomberg (Keith Snider and Will Edwards): "Health-care costs at Thomas Built Buses have jumped between 10 percent and 15 percent each of the past three years. For workers, that means two things: smaller raises and longer hours as the company puts off hiring... U.S. companies' health insurance premiums surged 42 percent in three years to $9,100 for an employee and family last year, according to... Henry J. Kaiser Family Foundation. This year, employers face a further jump of 14 percent... Coming on top of rising liabilities for retirees' health care, such expenses are becoming a drag on hiring, according to companies such as Ford Motor Co. and employers surveyed by the Federal Reserve Board."

February 3 - Bloomberg (Daniel Taub and Rodney Jefferson): "American Financial Realty Trust acquired an office building in Boston occupied by fund management company State Street Corp. for $705 million. The price per square foot was about $675, the highest ever paid in the city, real estate brokers said... Last year's biggest acquisition in Boston, the John Hancock Tower, New England's tallest skyscraper, sold for about $314 a square foot. Chief Executive Nicholas Schorsch said in December the trust had $1 billion to spend on property and was looking at branches that may be left after Bank of America Corp. buys FleetBoston Financial Corp. With the purchase of the building, which opened less than a year ago, American Financial is assured stable revenue worth more than $1 billion over two decades."

February 5 - American Banker (Erick Bergquist): "Home appraisers are usually selected and paid by commissioned loan officers and mortgage brokers, who have an incentive to close as many loans as possible for the highest amount possible. So it is almost inevitable that some appraisers would complain about pressure from originators to overstate property values. But several appraisers interviewed by American Banker said such pressure intensified during the refinancing boom of the last three years. As more consumers sought to take equity out of their homes, the appraisers say, loan officers and mortgage brokers increasingly leaned on them to come through with values high enough to make cash-out refis worthwhile. If the appraisers held their ground, they said, they lost business to others who did not. The perception appears to be held by appraisers nationwide... Of the 500 appraisers October Research Corp. surveyed last year, 55% said they felt pressure to overstate home values..."

January 28 - United Press International: "At the current median price of $560,240 for a Bay Area home, California's housing costs seem to have gone through the roof. At that rate, one would need an annual household income of at least $124,000 to buy an average home, says KPIX-TV, quoting California Budget Project, an advocacy organization for low and middle-income groups. The group says the state's affordable housing crisis is now on an emergency footing. The group says the qualifying income of $124,000 is about $47,000 higher than the average income of an Oakland household, and $32,000 higher than the average income of a San Francisco household. The organization says home prices continue to rise much faster than incomes, keeping many potential buyers in rental housing."

February 6 - Sierra Sun (Truckee, CA - Alisha Wyman): "It's a modest home - one story, 1,400 square feet, located in Tahoe Donner. Six years ago, it sold for $164,000. Today, it's listed for $450,000. The difference between the prices alone is enough to buy a house in most markets... According to the Truckee Affordable Housing Land Use Evaluation Study conducted by Bay Area Economics, a four-member family with an income of $70,800 could afford a home for $234,692. The medium cost for a home in Truckee is $383,000."

Perhaps I am completely out of touch, but $124,000 income to purchase the median-priced $560,000 home (in the San Francisco Bay Area)? Even with the magic elixir of historically low mortgage rates, spending 450% of annual income seems like quite a financial stretch. All the same, we are witnessing extraordinary housing inflation in California (and elsewhere) - in the face of minimal income growth (in contrast to 70's and late-eighties heady income inflation). Clearly, aggressive lenders are playing the instrumental role in this historic Bubble, easing lending terms sufficiently to arm new and move-up buyers for paying ever-increasing prices. There are anecdotes that should have our financial authorities in a cold sweat, but they are instead dusty-dry as they fixate on the miraculous "productivity" and CPI data.

Yet this environment recalls 1998-2000 more with each passing week. Back then, the "stock market; Bubble or not" debate aroused and absorbed. Meanwhile - under the radar screen - truly egregious excess ran completely out of control throughout the Credit system. Junk bond issuance exploded with increasingly suspect Credits taking full advantage. The likes of Enron, Tyco, Global Crossing, Calpine and Cisco borrowed and expanded aggressively; the stock market celebrated. Aggressive vendor financing provided windfall liquidity to scores of uneconomic enterprises, while fueling extraordinary accounting profits for the technology industry. And Wall Street "structured finance" went into overdrive to transform hundreds of billions of risky loans into securities enticing to inebriated Leveraged Speculators and investors alike. The holders of these instruments enjoyed stellar financial profits, for awhile.

Mr. Kudlow provided proof (again) this week that we haven't learned a bloody thing with this comment, "This can't be a Bubble with huge profits." Well, I would strongly argue that profits are today, as they were in '98-2000, both a fundamental Bubble prerequisite and phenomenon. The issue, instead, is the source and sustainability of the finance that is the driving force behind surging business revenues and marketplace liquidity. In this regard, the Greenspan Fed is dead wrong in its expedient assertion that Bubbles are only identifiable after the fact. Those of us that recognized that the late nineties tech boom was being fueled by massive junk bond issuance, reckless lending, accounting chicanery and wild speculation, questioned only the timing of the bust. The Fed's late 1998 bailout of LTCM and aggressive accommodation set the stage for destabilizing blow-off excesses in debt and equity markets.

History again rhymes, as the Fed's late-2002 corporate bond market bailout and accommodation incited blow-off excess for the Great Mortgage Finance Bubble, as well as for asset markets worldwide. And let there be no doubt that runaway lending excess - this time throughout mortgage finance with increasingly suspect Credits, paralleling late- stage tech Bubble developments - is the overriding source of finance driving today's booming corporate profits and speculative markets. It is seductive and especially dangerous, as it fuels self-reinforcing asset inflation and liquidity creation. And in cadence with 1999 and early 2000, reckless lending excess has gone to unimaginable extremes in terms of both quantity and quality. The lending Bubble is, in the end, unsustainable, yet, for now, powerfully self-feeding. And, once again, it all goes mysteriously unrecognized.

The Bottom Line is that the U.S. Mortgage Finance Super Industry is the most powerful financial mechanism orchestrating the greatest financial scheme in history. And, importantly, it is able to adapt to and accommodate evolving conditions, thus ensuring continued sufficient Credit and liquidity to sustain The Bubble.

February 2 - Dow Jones (Julie Haviv): "With volumes of new mortgages and refinancing shrinking, lenders have been putting more efforts into marketing products such as interest-only mortgages to attract consumers... With an interest-only mortgage, the borrower is allowed to pay only interest payments early in the term of the loan, with payment on principal deferred to later years. That means smaller monthly payments for the homeowner in the first years of a mortgage's life. A couple of years ago, there was little demand for interest-only mortgages, but recently, volumes have picked up dramatically. For example, at internet broker Quicken Loans - which last year originated about $12 billion in mortgages - currently about 40% of new loans are interest only, with most of the growth emerging over the past six months, according to its chief economist, Bob Walters. Two years ago, the lender registered zero interest in the loans. Other brokers report a similar pickup. Wells Fargo, one of the U.S.'s leading mortgage lenders, says interest-only mortgages account for one fifth of new loan applications. 'A few years ago, interest-only loans were mostly targeted to the wealthy and sophisticated,' Quicken's Walters said. 'Today they are being offered to a much wider audience that wants to lower their monthly payment.' And the savings are substantial: Interest-only mortgages are typically variable-rate loans that range from 4.25% for a three-year adjustable to 6% for a 10-year... Homeowners can lower their monthly payment by about 20% to 25% by skipping principal payments in the early years of the mortgage...with the mortgage industry facing a drop of one-third in business volumes this year from last year, when the refinancing boom boosted volumes to record levels, there is clearly pressure on brokers. 'There is no doubt that there are lender abuses going on out there because people are currently being offered mortgages that they otherwise may not qualify for,' said Paul Bennett, certified financial planner and president of Private Wealth Advisers in Virginia, said."

So, Wells Fargo - the originator of $470 billion of mortgage loans last year - is seeing 20% Interest-only mortgage applications these days? Wow, things have really taken a decided turn for the worst over the pasts few months. And consistent with so many Exacting Bubble Ironies - the passing of the historic Refi boom did not, as one could have reasonably presumed, usher in the downfall of the Great Mortgage Finance Bubble - anything but. Rather, I would today strongly argue that the recent surge in Interest-only and no-down-payment lending is the lending industry's aggressive response to assure the continued rapid growth of the mortgage business. It is also a major recent development sure to add fuel the National Mortgage Finance and California Housing Bubbles.

After reading Ms. Haviv's informative article (on the recent popularity of Interest-only mortgages), my first thought was, "What about Countrywide Financial?" They are the most innovative and aggressive, while surely determined to expand and grow market share (above their 2003 originations of $435 billion!). Moreover, they have built an enormous lending and servicing infrastructure. They also have an inflated stock price and ballooning balance sheet to sustain. What have they been up to? (They did not return my phone call requesting information on the extent of their Interest-only lending.)

Probing "current rates" at Countrywide's website proved informative. I first put in a Dallas zip code and checked for a $200,000 purchase mortgage. The quick response was rather standard, with 30 and 15-year fixed mortgage rates, along with one and 5-year adjustable mortgages. Things, however, turned more interesting when I input a $500,000 mortgage with a Southern California zip code. Right there, featured prominently along side traditional fixed and adjustable rates, were rates for "Interest Only - 30-year adjustable, Fixed for Five Years." As for monthly payments on a $500,000 loan, a 30-year fixed mortgage at 6.125% calculated a monthly payment of $3,038. An adjustable-rate mortgage fixed for 5 years at 4.875% produced a payment of $2,646. Meanwhile, the Interest-Only mortgage fixed a 5.0% (4.136% APR) for five years produced an enticing payment of only $2,083. Wow, a half million dollar home for $2,000 a month! But it gets "better."

There is also a drop-down menu that provides 10 additional mortgage options including 10 and 15-year fixed mortgages, as well as Interest Only - Fixed for 30-years. Yet there was another mortgage option that caught my eye: "The Pay Option ARM."

From the website: "This program (Pay Option ARM) combines the low interest rate of an adjustable rate mortgage with added flexibility that can keep your monthly payment affordable if interest rates should rise. You can pay down the loan as quickly as you like, but need only pay the interest for the first 10 or 15 years... Initial payment is based on paying off the loan over 30 years with a low introductory interest rate. After the three-month introductory period, you have the option of maintaining your monthly payment even if this falls below the interest due on the outstanding balance. You may always increase your monthly payment to pay off your balance more quickly, or to at least cover the monthly interest due. The interest rate is reviewed and can adjust monthly. The rate is based on the LIBOR rate plus a margin. The minimum payment is reviewed annually and is limited in the amount that it can increase each year. This is a great product for a consumer who only intends to own the property for a short time, who wants the lowest possible monthly payment in the short term, and who prefers affordability and flexibility in the monthly payment. Pay Option ARM loan product features: Low monthly payment gives you greater control in managing your cash flow and financial assets; Pay down your principal balance at your own pace and reduce future monthly payments; Afford a larger home; Greater flexibility in monthly payments when personal income fluctuates; Combines the low initial rate of an Adjustable Rate Mortgage with stability in the monthly payments should interest rates rise."

With a "low introductory rate" of 1.75%, the monthly payment on the $500,000 mortgage is calculated at only $1,786 (less than many (millions?) are paying for rent throughout the Golden State!). And while the "small print" describes a 20% down payment, a pop up appears with the caption, "Worried about your down payment? Would 100% financing help stop the worry? With our 80/20 Loan programs, you might be able to afford that dream home sooner than you think." "Countrywide is now offering 100% home financing with no income documentation. Our 80/20 Stated Program allows qualified borrowers with excellent credit to get an 80% first mortgage and a 20% Home Equity Line of Credit to equal 100% financing on their home... And with the 80/20 Stated Program, qualified borrowers don't even need to provide W-2's, tax returns, or any documentation of income. Simple. Our 80/20 Stated Program features: 100% financing up to $500,000 (80% 1st up to $400,000 and 20% 2nd up to $100,000). No mortgage insurance (PMI) required. Reduced documentation."

So I think I am beginning to understand... It would appear that purchasers are afforded the opportunity to borrow 100% of the $500,000 mortgage, perhaps with a monthly payment of less than $1,800. "What about closing costs," you ask? Interestingly, The Pay Option Arm even comes with negative points, or a $1,250 Credit. And as is illustrated in detail on the "estimated closing costs' worksheet, this Credit reduces out-of-pocket Total Estimated Closing Costs to a mere $1,185. A deal simply too good to refuse, especially in markets with rapidly inflating prices.

Countrywide has other "hot loan options," including the "FlexSaver Arm" featuring "interest only" "flexible monthly play options" - "loan amounts up to $1,000,000" - "loans up to $400,000 with 5% down." "Interest Only Products" with "loan amounts available up to $2,000,000. And, of course, there's the EasyWay Flex mortgage providing 100% financing up to the GSE's $333,700 limit. What ever happened to the GSE's 70% loan-to-value requirements? At Wells Fargo, the Interest Only mortgage option "increases your cash flow - making homeownership more affordable... Redirect your cash flow to supplement your savings or investment funds, maximize contributions to your 401k or other tax-deferred retirement accounts... It's your money to use as you see fit."

Well, it may be the borrowers' "money" to use as they wish, but for the system as a whole these latest mortgage developments are worth pondering for providing the marginal liquidity sustaining financial and economic Bubbles. For now, "Interest Only" may be the elixir - on the margin - for perpetuating the Great Credit Bubble. And let's not forget the evolving "non-profit" Down Payment Assistance Programs. Hundreds of these programs have sprouted up all across the nation, taking "contributions" from home builders and sellers, and "gifting" these funds to buyers for "down payments." The alliance between these groups and the expanding national homebuilders has become a powerful force for sustaining Bubble excess. At Nehemiah (www.getdownpayment.com), one can "click here to view new home communities where you can purchase a home with gift funds from The Nehemiah Program. Participating Nehemiah homebuilders will be happy to help you find the home of your dreams." "Clicking" sends the viewer to a national map. "Clicking" on the state of California provides links to participating homebuilders including Beazer Homes, Centex Homes, Pulte Homes and Heller Development. "Clicking" on Texas provides links to 15 builders, including Beazer, DRHorton, Centex, Lennar, Century, Pulte and Engle. "Clicking" Florida links to twelve builders and Colorado twenty-four.

We have attained the point of providing unlimited funds for zero down-payment, minimal payment mortgages. We should not underestimate the ramifications for this development.

As we approach "G7 Weekend," I will conclude with brief remarks on how truly ridiculous this has all become. Our nation's authorities have cowardly decided that they will not move to correct conspicuous and ballooning imbalances - Not Gonna Do It. Instead, they espouse the view that imbalances must be rectified by more aggressive stimulus and growth from our global trading partners. This is the most dangerously flawed analysis of global finance and economics in history. It is also insulting to our Creditors and the global community at large.

The overriding problem in the world today - and I'm choosing these words carefully - can be traced directly back to the unsound practices of Countrywide, Wells Fargo, Fannie Mae, Freddie Mac, Citigroup, JPMorgan, Bank of America, Goldman Sachs, Merrill Lynch, Morgan Stanley, Lehman, American Express, MBNA, Capital One, and the U.S. financial sector generally. Acute financial and economic fragility is homegrown and will be resolved at home.

Greater inflation and stronger growth in Europe and Japan will in no way change the fact that our financial system is lending recklessly. A stronger Chinese currency will not assuage the speculative impulses of an incredibly powerful and expansive global leveraged speculating community. Heightened Credit growth overseas will not alter the reality that U.S. lending and asset Bubbles now demand unrelenting new Credit/dollar claims inflation. And stronger U.S. exports will not ameliorate the acute risk propagated upon millions of unsuspecting borrowers stretching to afford grossly inflated home prices in California and elsewhere. We're fully in the process of absolutely burying our middle class in mortgage debt. Pressing for continued global Credit excess will surely exacerbate, not mitigate.

It will be interesting to examine the wording of the Group of Seven's statement. Will the Europeans bend? Will the ECB soon buckle and lower rates to support the dollar. Well, I have absolutely no idea. But I do believe it is today important to appreciate that ECB analysis and policy is grounded in the paramount role played by sound money and Credit. Somehow this fundamental framework has been completely discarded by our central bankers and politicians. Is this a case of Irreconcilable Differences between American and European policymakers regarding a critical issue that few understand and that would not likely be contested in public?

Well, in the final analysis, I just don't see how it will be possible to forge a meeting of the minds between the U.S. and Europe with regard to dealing with onerous global imbalances. We've only been biding time, and the markets have taken full advantage. Which leads me to fear that the unavoidable adjustment process will invariably be instigated by tumultuous financial markets. And every time I think through the dynamics of our out-of-control Mortgage Finance Bubble - and see things such as major lenders hawking interest only/no down-payment mortgages to sustain the California Housing Bubble - I instinctively fear for our currency.


 

Doug Noland

Author: Doug Noland

Doug Noland
The Credit Bubble Bulletin
PrudentBear.com

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