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As predicted, the Fed began raising interest rates sometime last year in response to the "booming economy" and the fear of inflation. These increases directly affect the rates set for the option ARMS and can lead to much higher minimum payments. Even worse, for over a fifth of the option ARM loans written up in 2004 and 2005, the value of the house covered by the loan is less than the amount due on the mortgage. This means that a great many American homeowners who cashed in on their equity to have cash to spend or who stretched to buy their dream home based on what they could afford with an option ARM will be facing a very nasty surprise.
Indeed, the results of the Bush economy for ordinary Americans built on a policy of encouraging option ARMS along with the rising interest rates are already coming in.
Foreclosures are up: during the second quarter California foreclosures were up by 67%. More ominously, even areas where housing prices are below-market such as San Antonio, foreclosures are increasing. And because so many mortgages are option ARMS and people have only paid the minimum payment, every time they make a payment, rather than paying down their mortgages they are falling deeper in debt.
The real estate industry expects over $400 billion of debt in option ARMS to be reset this year, and another $2 trillion reset to higher rates in 2007. Once these increases hit, many more people will find themselves too strapped to make their monthly payments. Furthermore, where people are losing their homes in foreclosures, a high percentage of the homes are being sold for 70% of their current market value. Thus, many people have found or will find themselves significantly in debt even after losing their homes.
So how did it happen that so many Americans are at risk of losing their homes? It turns out that under Bush's watch financial regulators changed the rules of what was considered acceptable business practice. Government regulations were rewritten to say it was okay for financial lenders to claim as revenue the amount of the highest payment option for the option ARMS even if the homeowner paid the lowest amount. The changes allowed mortgage holders to record huge profits on revenue that might never be realized. James Grant of Grant's Interest Rate Observer wrote that the negative-amortization accounting is "frankly a fraudulent gambit. But what it lacks in morality, it compensates for in ingenuity."
Because these loans were lucrative for the financial industry, mortgage brokers were commissioned to encourage them. And many, many people who would never have been eligible based on their income and credit-risk were given loans guaranteed to turn their dream home into a nightmarish debt trap.
The financial industry isn't too worried about the bad loans, because they've already built into their calculations some hedges to cover for the riskiness of the loans. In fact, they believe the only ones left holding the bag will be the people who were not smart enough to read the fine print on their loans. And who cares about them?
This administration has been very upfront in saying that individuals should be responsible for their own lives and that it is not the job of the government to regulate industry to prevent these types of problems. They've also been very helpful in writing the rules so the financial industry can rake in profits while helping a great many Americans to put their homes at risk through these creative financial gimmicks.
When the Bush administration is long gone, the financial situation for many Americans will be dramatically poorer. Thus proving once again, ordinary Americans do not fare well under Republican administrations.
For more on this subject, see: Nightmare Mortgages, BusinessWeek, September 11, 2006, http://www.businessweek.com/magazine/content/06_37/b4000001.htm
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