Prices in America’s housing market may have slumped, but the pain for a significant subset of homeowners has barely begun... The bank’s [Barclays] Nicholas Strand says that roughly 1.4m households, most of them in California, hold a particularly nasty type of adjustable-rate mortgage called the “option ARM”. Although the overall value of option ARMs is lower than that of subprime loans—some $500 billion, according to Mr Strand, compared with about $1 trillion in subprime loans—their sting is more venomous.
But the real crunch will come when the mortgages “recast”, forcing borrowers to start making full payments. The loans recast after a set period (typically some five years after origination) or when the principal hits a predetermined ceiling. The biggest wave of recasts is due to happen in 2010 and 2011.
An option-ARM product called Pick-a-Pay (a name that gave fair warning it could lead to trouble) accounts for 45% of consumer lending at Wachovia, a large bank. Wachovia stopped originating loans that allow negative amortisation in June, and is setting aside heftier reserves to cope with expected losses.
Given this market's bi-polar behavior and very short time frame I do think there will be a 6 month tradeable bounce approaching in the financial stocks. However, I ultimately expect that in the second half of 2009, they'll get clobbered again by this POA implosion.
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