Juggling Dynamite

An article in the Washington Post this morning reminds us of a major headwind now coming back to the foreground over the next several months: mortgage resets. Fitch Ratings estimates that 70 percent of the $189 billion in outstanding option ARMs will reset to higher payments by 2011.
Option ARMs, also called pick-a-pay loans, allowed borrowers to choose how much to pay each month. Nearly all the borrowers who took out this type of loan from 2004 to 2007 chose to pay less than the interest due. Sometimes they paid as little as 1 percent interest. But the loans eventually require the borrowers to start paying the principal and full interest rate. This rate reset will cause monthly payments to increase an average of 63% over more than $1,053 a month. This type of cost increase will be effectively impossible to pay for the hundreds of thousands of homeowners who bought too much house at bubble prices. (Not too mention those who are now unemployed).
The most severe problems have surfaced in states with the steepest price drops. About 75 percent of option ARMs financed homes are in California, Florida, Nevada and Arizona, where prices have plunged on average 48 percent from the second quarter of 2006 to the first quarter of this year. Most of the effected people will be unable to refinance into lower rate payments because their houses are now worth much less than the loans.
The overall impact of the Option ARM resets should be less than from Subprime over the past 2 years, but the drag of still increasing housing supply and the negative knock-off effects of more families going under are going to continue to be felt in the economy for at least the next 2 years, maybe longer.
See: Another Wave of Foreclosures Loom

A friend sent me a link to a painful but potentially enlightening New York Times article this week: Software Entrepreneur’s Property Is Sold at Auction. This story is common but too little discussed; and the lessons from it can be helpful to all that will hear.
John McFee, started McAfee Associates in the late 1980s to sell computer antivirus software, and made a fortune of about $100 million by 1994, when he sold off the shares of his company, about two years after it went public. Mr. Mcfee then set about losing his fortune in a classically human string of bad investment choices and reckless spending. Proving once again, that when it comes to losing money 100 million can go just as easily as 100 thousand when deployed with disrespect.
Over the past 15 years, McFee had built several homes in remote locations, pouring in incredible sums for recreational pursuits like movie theatres, flying light-weight planes, plane hangars, guest houses and a fleet of antique cars. The collapse of real estate prices and the stock market the past couple of years wiped out big chunks of his capital, forcing him to sell off assets at a fraction of what he had spent on them. All of this underlines the wise adage that money goes where it is wanted and stays where it is well care for. It also reminds us that dumb buying and spending is not “investing”; the price we pay is our greatest risk; and no matter how much money we have, if we spend more than we make we will run out.
Hopefully Mr. McFee is enlightened by his experience and now wiser for it. Hopefuly others can use Mr. McFee as a inverse mentor and learn from his story without having to make the same mistakes. Remember: spend less, save more; once you sell your business protect your capital; timing is everything; don't lose money…don't lose money…humility and self-discipline above all else.

The Shanghai Index had another massive sell-off this morning, falling by a further 6.7% and making the total loss since August 4th now 23.2%. Chinese analyst Andy Xie was interviewed this morning on Bloomberg Television. He points out that “a lot of people in the stock market have fantasies about China…but the recent recovery is not sustainable.” Watch the interview clip here.
China has enormous longer-term potential but as a still export-led economy, rebalancing the economic model to domestic demand will take at least a few years. Xe sees reason for another 25% correction in Chinese stock prices as the reality of a slow global recovery dampens the recent spate of speculative buying.
The Shanghai's negative price trend suggests the prospects for falling risk appetite in other stock and commodity markets around the world.