Get Ready for the Second Wave

First the subprimes, now the option ARMs...

[John Hussman's weekly market comment, November 9, 2009:]

The problem is that these Option ARM and Alt-A structures were specifically designed as “teasers” – allowing loans to be made without documentation of creditworthiness, in return for post-reset interest terms that were generally higher than a documented lender would have paid... Similarly, Option ARM mortgages typically have very permissive payment schedules prior to the reset date, which have allowed homeowners to essentially live in these houses (at least temporarily) with fairly discretionary payments. The data suggest that most of these borrowers have allowed their mortgages to “negatively amortize,” allowing the loan balances to grow larger even as property values have depreciated. Once again, the resets on these are problematic for borrowers with questionable credit- worthiness, who bought the homes largely in anticipation of price appreciation. For these borrowers, the transition from discretionary payments to more demanding terms is unlikely to be smooth.