Given the very low interest rates in 21-22 and high prices, a certain percentage of folks would have purchased with a convertible mortgage.
Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
Every product in 2008 was completely viable which is why the Federal Reserve bought everything.
Only 7% of the borrowers defaulted by then, there wasnt mass irresponsibility on the people with mortgages as suggested, this alone blew up some institutions because they were leveraged nearly 50x and one month of missed mortgage payments would cause a massive drawdown on their portfolio.
Without leverage, a portfolio where 93% is going to pay a lot in interest over 5-30 years is a good portfolio.
So there is no reason to get uncomfortable or anxious by seeing the words “subprime” “CDOs” or more, as it comes down to whether the accounting is done properly and the leverage is low. Which, I believe is being done. The "big crash" always comes from a different and unexpected (or less expected) angle, where some completely different sector has too much leverage and flimsy accounting.
What are the big speculative candidates for next crash? Contagion from the Chinese real estate market?
[1]https://pivotal.substack.com/p/minsky-moments-in-venture-cap...
In the runup to the 2008 crisis, a commonly heard mantra was "yeah, subprime lending is fucked up, but it's a small fraction of the economy, it can't cause that much damage". Turned out that it could, via the CDO shenanigans.
I would not at all be surprised if someone has already cooked up a similar leveraged dependency from the "real economy" to crypto markets.
But cryptos have never been considered remotely that reliable by the broader financial system. Thus there is probably little to no leverage using cryptos as collateral. Crypto is currently crashing, but it will only take down itself and not 30 to 100 times as much leverage with it.
Given that the Federal Reserve wants unemployment numbers to rise, they're specifically trying to make share capital worth less, and borrowing capabilities cost more, making revenue-poor corporations stop being so optimistic. so I would just expect lower valuations with much lower revenue multiples (or price to equity ratios), for that reason alone.
Slowed growth in China is always a threat because thats a key revenue driver for many large western companies. Then sure, there is the leverage and accountability problem with Chinese real estate, but I don't get the impression that contagion is that big because nobody thinks that is a safe bet and also avoid too much exposure to the domestic chinese lenders involved. The rumors behind Tether just aren't big enough to matter for this, could only be a slight sting to the commercial paper market and a moderate "finally" for the crypto market as a tether implosion would probably increase confidence there after steep selloffs.
Oil/gas volatility is probably going to have some casualties.
The Oil Glut of the 2010s killed off all but the strongest players in this sector. So I doubt it will be a pillar that collapses. If anything, they will probably do very well in the near-term.
Re: Chinese real estate, the contagion mechanism I've heard the most about isn't West->East investment, it's East->West investment that gets pulled to survive a bear market. I have no idea if it's big enough to matter.
The main concern is stagflation due to rising energy prices. It seems like the market is now finally starting to price in the externalities of abating climate change, which results in higher energy prices across the board (which in turn raises prices of everything else, with inflation due to QE piled on top of it).
This means that output roughly stays the same, but there are more dollars competing for it.
Convertible mortgages became popular as an alternative to either fixed or nonconvertible ARMs when rates were high as a way to preserve the option of locking in on a rate drop without going through a refi. Convertibles don't offer a lot when rates are low—if you want to be able to lock in a low rate and rates are already low, you get a fixed.
Between that, changes in qualification rules, and memories of the collapse leading into the Great Recession, ARMs of all types have shrunk to a very small share (<5%, IIRC) of residential mortgages, and newer ARMs tend to have rate caps.
> Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
Probably not because of adjustments on existing mortgages. If there is sustained stagflation, then the fact that people can't pay their fixed-rate mortgages given other necessary expenses may produce a similar collapse, though.
Plenty of other reasons. Others have bad credit or otherwise get significantly lower payments on an ARM compared to fixed.
I guess there are other reasons, but ARMs are definitely not dead. I don't know the numbers or where to get them though.
What are more dead are the "balloon payment" residential mortgages where they may amortize over 30 years but the principal is due in 5 or 10 years.
you can pay off a 15-year mortgage in less than 15 years - the lien will be released, etc whenever the principal is paid. Everything depends on the specifics of your contract of course but it would be extremely unusual to have a mortgage where this is not allowed.
fixed vs ARM purely depends on how the interest rate is determined, that's it. In principle ARM should be a bit lower than a fixed rate financed at the same time - but if the prime rate goes up then your rate goes up too, where with a fixed it's locked-in forever. Fixed will have a higher interest rate because someone has to assume that risk of an increase in the prime rate, where with an ARM that someone is you.
Taking an ARM vs a fixed is a bet on whether rates are going to stay the same or decrease, vs increase. And boy if you thought 2020-2021 rates weren't going to increase at some point in the future, uh... it's not every day you have a once-in-a-century pandemic that nukes the economy and drives demand for money almost to zero.
I'm not quite sure what you're saying about balloon payments either, the balloon payment happens at the end of a balloon mortgage, with the intention that values will have gone up so you can refinance at that point - but of course, what if they don't?
It's also taking a bet on how long you're going to keep the mortgage. When a bank offers a lower rate for a 7 ARM vs 30 fixed, they're assuming that you will keep the mortgage for more than 7 years. If you pay it off fully before then, you win the bet.
A 30year ARM gives you a lot more flexibility then a 15-year anything. I mean, you can pay off the 30 year in 30 years or 15 years or 5.
Regarding the balloon payment-- not sure what you're missing here. Residential mortgages with balloon payments aren't really offered any more because of huge risk of default when the balloon payment is due.
It can be a very good idea for someone who plans to pay off their mortgage early. If all goes well it is no worse than a 15 year mortgage, but when (really, if is unlikely) something bad happens you have more flexibility. Of course if interest rates go up you will get burned, which is why I go with a 30 year fixed rate that I pay off. I could probably afford payments on a 15 year loan, but I'm not willing to risk it.
I talked a number of people out of ARMs in '21 and '22 by explaining 2008 to them (they were 7-8 years old at the time, so do not remember). It is scary how bad most people are at understanding exponential growth and just how much worse 5% is than 3%
It can make sense if you're financially secure enough to take on the risk.
But the long tail is some people being priced out of their home as their payment rises, and it could have been prevented. So 90-95% of mortgages in the US are fixed rate.
Everyone thinks that 5 years out, everything will be rosy. The metalworker saving 0.6% on a 5/1 ARM vs a fixed 30yr is using the same mental gymnastics that J. Poindexter on Goldman's bond desk is, that central banks are omniscient, omnipotent, and will always magic away the risk inherent in our decisions.
It didn't matter whether an ARM was better or worse in the long run, it mattered that the ARM could get the house and the fixed rate could not.
But yes, subprime loans were carved up and repacked in a way to make them look like AAA bonds. The banks that created these bonds knew that the loans in the bonds were crap; they knowingly lied to investors about it. The ratings agencies stamped all the bonds without any due diligence. Other banks piled on more derivative products on top of those bonds, essentially gambling on whether those bonds would go bad.
There was a slime-trail of fraud, laziness, and greed all the way back the original loan itself.
Subprime was a very small cause of the GFC but it was the tipping point that brought the house down.
There was also record high amounts paid back in 2020. I'd like to know if they adjust for that or just more fear-mongering by big banks, admitedly I'm too cheap to read further to find out.
[0]: https://www.ezhomesearch.com/blog/second-home-mortgage-rates....
The 'certain percentage' actually went over 50% of new mortgages, excluding refinancing.
>Assuming the standard 5-1 and the fact that rates are rising very fast, should we expect a repeat of 2008 in 2026-2027?
You would think so but no. We should expect it in 2022 primarily harming the large cities.
In contrast, if your arm resets from 3% to 7% it's like a 50% increase in mortgage payments. That sucks, but manageable given that your salary likely inflated along with your payment.
Which, anecdotally, has not been true for myself or any of my colleagues (barring the ol' job switch raise). Wage stagnation is an extremely common problem in many countries and industries. Those that have gotten or negotiated for raises aren't getting raises that account for the record-setting inflation (at least in my country, which is seeing the highest rates of inflation in 30+ years)
Can I reside in a world where my salary doubles if my mortgage rate doubles? It sounds very nice.
It's not that your $100K salary should go to $200K if your mortgage goes from 3% to 6%, but rather that your $100K salary should go to $106K instead of just $103K if your mortgage goes from 3% to 6%.
Similarly, if your mortgage fell from 3% to 2%, you'd be pretty close to even if next year's salary went to $102K and likely in bad shape if it instead went to $67K.