Wednesday, June 5, 2019

Housing: Part 351 - The downfall of "Pick-A-Pay" loans

Here is a great article on the history of Golden West Financial Corporation and the development and downfall of option ARMs. (Pick-A-Pay or option ARM refers to mortgages where the borrower can choose their monthly payment for some period of time - sometimes at a rate that doesn't even cover the interest, so that the principal amount grows rather than declines.) An excerpt:

Five months after the Times’s “pariah” story ran, the paper’s Floyd Norris wrote a column about Golden West’s loans. The business columnist had entirely missed the original piece on the Sandlers, he says, and knew little about their bank’s history. Like other option ARMs, Norris wrote, Pick-a-Pay loans were racking up big losses. But when reading Wells Fargo’s first-quarter earnings report, he noticed that less than one-third of 1 percent of Golden West’s loans were expected to recast before the end of 2012, meaning that borrowers wouldn’t see large payment increases for many years. “That struck me as an amazing number,” he says. “How the hell could that be?”

It was the ten-year option at work. Over the next few days, Norris researched the terms of Pick-a-Pay loans, and concluded that the loans’ ten-year option and high loan-to-value cap were remarkably generous, and an attempt to do right by borrowers. Yet in a catastrophic market decline, those terms stripped the bank of leverage. Homeowners could pay less than interest-only in the hope that the market would recover, restoring their equity. If prices stayed depressed, however, they didn’t have much to lose, as their payments “could well be less than the cost of a comparable rental,” Norris wrote.

“I understand it makes some people feel better to know that they have identified someone who acted outrageously,” Norris says. “But sometimes it’s more interesting when nobody acted particularly outrageously and things blew up anyway.”

5 comments:

  1. Great article. Floyd Norris is right, sometimes there are no villains... well, unless you ponder a central bank that suffocates an economy due to a squeamish hysteria regarding inflation and rising real wages....

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  2. Might be useful to add a quick definition of pick-a-pay at the beginning?

    I had to look up the term. Thanks!

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