Second, you evidently did not go to look at the paper I referenced to check how Cagan chose his 8+ million ARM mortgages and exactly what they consisted of.

Third, your argument re option ARMS is incorrect. A post at Calculated Risk shows an IMF chart that arrays mortgage resets by volume by month through 2016. Option ARM resets don’t even register on the chart, and then only in a small amount, until 2009 and kick in in big numbers in 2010 and 2011. By contrast, the Cagan analysis of 8 million mortgages had a table (page 29) that arrayed initial interest rates by year of first reset. Eyeballing it, it is very clear that the loans with initial rates of 6.5% or higher reset in 2006 or 2007. For instance, loans initially at 6.5% to 7% has 52% reset in 2006, 31.2% reset in 2007, and only 2.2% in 2008. From 7% to 7.5% had 60.6% reset in 2006 and 51.4% reset in 2007, and only 1.8% reset in 2008. For every rate initial rate higher that 7.5%, the resets in each year 2008 or later are no higher than 1.9% and in most cases below 1%.

Thus the claim that Berry’s so-called analysis is meaningful is utter baloney. Only a very small proportion of higher initial interest rate ARMs reset in 2008 or 2009, counter to his claim.

Finally, I note that Andrew Leonard at Salon deems Berry’s argument to be irrelevant, since negative equity is proving to be a bigger driver of defaults than resets. And as I noted in the post, subprimes are showing unprecedented default prior to reset.

Several days before closing, I was presented with a LIbor reset benchmark. I looked at the corelation and went ahead.

Of course. The Libor is corrupted, like everything in the financial universe. The warning signals went off.

It’s still okay. The reset bit me in the ass this year but should be better next year, unless I refi when the fixed rates reflect the unstoppable deflation.

I’ve wondered about this myself alot. Given how ignorant many borrowers are I can see them modifying their mortgages into fixed rate loans with rates higher than their floating rate for the foreseeable future.

Even if this “trap” does not exist, there is a fourth element to Keynes’s critique (perhaps the most important part). Saving involves not spending all of one’s income. It thus means insufficient demand for business output, unless it is balanced by other sources of demand, such as fixed investment. Thus, excessive saving corresponds to an unwanted accumulation of inventories, or what classical economists called a general glut[2]. This pile-up of unsold goods and materials encourages businesses to decrease both production and employment. This in turn lowers people’s incomes—and saving, causing a leftward shift in the S line in the diagram (step B). For Keynes, the fall in income did most of the job ending excessive saving and allowing the loanable funds market to attain equilibrium. Instead of interest-rate adjustment solving the problem, a recession does so.

Several articles a while ago showed convincingly that negative equity was the single biggest factor in defaults (’walkaways’), e.g. even bigger than ability to pay (loan reset).

So if lowering rates does not really help all that many people keep their homes, and in a climate of falling prices cannot really stimulate enough people to buy in order to reverse that trend, how stupid does Bernanke look for hollowing out the dollar and kicking responsible savers in the teeth (inflation meaning most savings and/or money market accounts have a negative return)?

Incidentally, Mike Shedlock had a post yesterday about some interest rates that are going to reset lower. If his reporting is accurate, some lenders may be trying to convert borrowers into fixed-rate loans that are higher than the reset rates.

As with Subprime loans though a large part of the defaults have nothing to do with the payment level.

subprime 2/28s from 2005 and 2006 are rolling off now, and that’s contributing to default problems. and a lot of loans are going bad without ever even getting to the reset. but looking forward a huge aspect of resets is not only rate raises but full amortization of pay-option ARMs (OAs). the journal:

The deteriorating performance of option ARMs is evidence that lax underwriting that led to problems in subprime loans is showing up in the prime market, where defaults typically are minimal. Challenges could grow, as from 2009 to 2011, monthly payments on some $229 billion of option ARMs will be adjusted to include market-rate interest and principal, according to Moody’s Economy.com.

It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS.

$230bn, of which 4 in 5 are negatively amortizing. that’s a massive blast of foreclosures coming — and it’s being pushed closer in time as many OAs revert to full amortization early if LTV rises to 110-115%. most of these loans will reset well before their 2009-2011 schedule — and static rates won’t help any of them.

I think you make the same mistake as the authors in picking a sample, they only look at one bond but you reference the entire universe of ARMs between 04-06. That’s a valid set of loans to analyze but you are including a lot of high credit loans along with the bad ones when doing so. I have a couple of fantastic graphs from BoA’s latest research paper I wish I could post. They show ARM reset shock as a function of Libor for only Subprime loans resetting in 2008. At 5.4% 6M Libor ~ 5% of loans would have a rate shock of 1% or less, at 3% 6M L its ~65%, at 2% 6M L its ~ 90%. At 2.5% 6M Libor ~40% of loans will have their rate reset down.

Again I think you hit the nail on the head in pointing out that defaults aren’t being driven by rates. A small fraction of borrowers who would have been hurt by resets are getting relief from lower Libor. Unfortunately those people are a very small fraction of subprime borrowers, not enough to get excited about.