Mortgage Bubble? Investors Want to Know

Warning - Minor registration required at the above link. While much of the discussion in the blogosphere has been about the housing bubble in California and other. This article discusses how the spread of negative amortization mortgages has created a mortgage bubble.

Along with Golden West, publicly traded lenders with big exposure to these products include Countrywide and Washington Mutual and smaller California banks such as Downey, First Fed and Indymac. Golden West has been selling them for 25 years and has a solid track record with them, even in recessions and rising-rate environments. When fully explained to the right customers, such as a Porsche salesman who makes plenty each year but doesn't know how much he'll score from month to month, "it's a terrific borrower loan," says Mr. Sandler. "We have never had a delinquency, much less a foreclosure, due to the structure of the loan."

But some banks are lowering their credit standards, sometimes qualifying borrowers based on their ability to make the minimum nut, not whether they can afford the whole deal. "That is an outrage," Mr. Sandler says.

t gets better: The unpaid interest gets tacked on to the bank's outstanding loan total, allowing the bank to display loan growth, which investors love. "You get earnings and growth. What more can you ask for?" says Keefe, Bruyette & Woods analyst Fred Cannon.

But there could be credit problems down the road. And at some point, it's plausible regulators might fret about the bank's capital.

Last week, Golden West's stock took a hit after it disclosed how much its exposure to option ARMs has increased. The company reported that $160.2 million of its loans was actually unpaid interest tacked on to borrowers' principal - that negative amortization I mentioned. That's a huge leap from last quarter's $90.2 million and $27 million in last year's second quarter."

So with the growth of ARMS, that negative amortization is reported as loan growth by the bank. So the bank instead of showing growth through origination of new loans is actually growing on the back of consumer spending. Consumers are very vunerable to interest increases. Currently banks don't report how much of their loan growth is due to negative amortization of ARMS. Golden West (the bank cited) does and it reveals a scary picture. I wonder what the situation looks like at Countrywide?

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