Wednesday, March 12, 2008

More Irvine

Monday the focus was Mortgage Equity Withdrawal (MEW) - today the topic is mortgages as options. Here is a great paragraph from this post -

Speculators utilized 100% financing and Option ARMs with low teaser rates to minimize the acquisition and holding costs of a particular property. The small amount they were paying was the “call premium” they were providing the lender. If prices went up, the speculator got to keep all the gains from appreciation, and if prices went down, the speculator could simply walk away from the mortgage and only lose the cost of the payments made, particularly when this debt was a non-recourse, purchase-money mortgage. Another method speculators and homeowners alike used was the “put” option refinance. Late in the bubble when prices were near their peak, many homeowners refinanced their properties and took out 100% of the equity in their homes. In the process, they were buying a “put” from the lender: if prices went down (which they did,) they already had the sales proceeds as if they had actually sold the property at the peak; if prices went up, they got to keep those profits as well.
This is an excellent summation of what happened - and what lenders allowed to happen. The system was set-up to allow people to walk away without any real consequences. Buy properties, no money down, pay teaser rates, if investment tanks - owner just walks away, if investment prospers you reap all the rewards. What a system!

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