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How long before the next mortgage meltdown?

I wish Francis C were still around to explain this. I can’t match that, so let me toss it out and let y’all chime in. It sounds like a complete disaster in the making.

This piece linked by Drudge caught my eye. It’s about people saying the Fed needs to start bumping up interest rates real soon.

To prevent inflation from taking off, the Federal Reserve will need to start boosting interest rates quickly and aggressively once the economy is back on firmer footing, Fed officials warned Tuesday.

“I expect that when it comes time to tighten monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity” to when the Fed was slashing rates to battle the recession and the financial crisis, said Richard Fisher, president of the Federal Reserve Bank of Dallas.

Although Fisher has a reputation for being one of the Fed’s toughest inflation fighters, it marked the second such warning by a central bank official in recent days. Fed member Kevin Warsh on Friday said the central bank will need to move swiftly when the time comes to raise rates.

At the same time I’ve seen several talking heads on TV saying that there’s a hidden disaster with ARMs that will arise sooner or later. Here’s a sample I found googling a little.

Two other hybrid mortgages are about to become as well known as subprime mortgages: Alt-A (alternative A-paper) and Option ARM. Alt-A mortgages are considered less risky than subprime mortgages and are credit-score driven. They require less documentation (such as proof of income) than prime loans but have higher interest rates. Option ARM mortgages allow buyers to receive a lower interest rate, often called a “teaser rate,” which can be as low as 1 percent. The homeowner pays off only the interest for 3, 5, 7, even 10 years. However, when that rate adjusts, it can be devastatingly high. These loans were heavily marketed to upper-tier home buyers over the last several years. Now, that bubble is about to burst. With the adjustment of those loans’ rates fast approaching and default rates already abnormally high, many who feared the worst are about to see those fears come to pass.

The next wave of foreclosures is coming, mainly due to the growing number of defaulting homeowners with Alt-A and Option ARMs. Where subprime mortgages represented about a trillion dollars in loans, Alt-A and Option ARMs represent well over that amount. More than half of these loans are expected to default based on current trends. This isn’t good news for the lending industry or for the homeowners who failed to recognize the repercussions of their teaser rate loans.

The ARM crisis is ongoing, and the second half of the mortgage collapse seems inevitable. Some in the industry are saying that it may take up to 5 years to completely rid the system of these “bad” loans. However, if the buyers and sellers of these adjustable rate mortgages have learned anything, it’s that the combination of greed and ignorance can have exponentially devastating effects.

If there is a huge backload of ARMs ready to crash because we have 10% or whatever unemployed with no sign that will be getting better for at least a year, it doesn’t take a genius to realize that a big jump in interest rates will exacerbate that problem significantly. Ouch. This economy could be in much worse shape by next year’s elections than it is today.

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