Ugly Loans

When I read blog posts or comments complaining about people who should have known better than to sign up for mortgages they couldn’t afford, I’m always of two minds. On the one hand, I’m quite sure that there are a decent number of people who knowingly gambled on the proposition that housing prices would go up forever. I am not inclined to be particularly sympathetic to such people, especially if they had other options. (People who took this gamble because it was their only way to get a roof over their heads are a different story.)

On the other hand, some people who make these complaints seem to me to underestimate just how complicated and ghastly some of the loans written during the last five years were. Those loans made it very, very hard for borrowers to see exactly what they were getting into. And I can’t think of a better way to illustrate this point than to link to this explanation of negative amortization option ARMs by the late Tanta at Calculated Risk.

It’s very long: I pasted it into Word and it clocks in at 15 pages and over 3500 words. But there’s not a lot that’s superfluous: Tanta was a very clear writer and thinker, and I think she explained this about as well as possible. But option ARMs are very complicated. And if you’re tempted to discount the possibility that people could have truly not understood what they were signing up for, I’d encourage you to really try to work through it, the way you might if it were a mortgage you were actually considering taking out.

Tough, isn’t it? I note a couple of points. First, the payments, and for that matter the entire structure of the loan, can change unpredictably. There are no tables of payments with this type of loan; it would be difficult to work out what was going to happen to the payments, and when, unless you not only knew how much you would choose to pay every month, but had a copy of the loan document, a pretty serious calculator, decent math skills, and a fair amount of time on your hands.

Second, it’s hard to imagine a person for whom this would be a good type of loan. You’d need to be strapped for cash for the first few months, but thereafter able to pay considerably more than you would have had you taken out a different sort of mortgage. Maybe this would be a good idea if you knew you’d win the lottery six months from now, or were the sole heir of a millionaire who was at death’s door. Otherwise, this mortgage might have been designed to get people into a lot of trouble very fast. It’s a sort of equity-extracting machine, and it’s ugly.

And yet, strange to say, someone created this type of loan, and others adopted and marketed it. Funny thing, that.

Third, this type of mortgage is just plain hard to understand. I had a hard time wrapping my head around its resets and recasts and so on, and I construe texts for a living. Tanta:

“Has your head exploded yet?

But that’s the real point, isn’t it? If your head just exploded, and you’re the kind of person who usually reads CR, just imagine what the kind of person who doesn’t usually read CR makes of all this during some ten-minute spiel by some loan officer.”

Fourth, about that loan officer: Tanta notes one case she’s heard of in which a loan officer just did not understand this kind of loan, and misrepresented it to her clients. Given how complicated this type of loan is, this cannot be an isolated case. But besides simple misunderstandings, there’s also active obfuscation. Here’s a story on how Wachovia instructed its employees to sell their option ARMs (also via CR; bear in mind that this is a negative amortization loan, in which the amount you owe can go up):

“So if I’m paying that minimum payment, I’m not actually putting a dent in my principal though right? My principal and interest they’re just going to keep climbing up right?” the borrower asks in the video tape. “It’s optional,” the broker in the video replied.

“What kind of answer is that?” said Brown [a housing advocate, ed.] after watching the video. “The answer would really be ‘Yes.’ That’s the right answer, that to me would be the true clear straightforward truthful simple answer.”

Now: one might think that people who take out mortgages should not rely on what their loan officer or mortgage broker says. They should read the documents for themselves, and if they don’t understand what they read, they shouldn’t take out the mortgage. I am tempted to agree with this. I have taken out a number of mortgages, and I always do read all the documents. My various loan officers have always reacted to this quaint habit of mine with astonishment, the way they might respond if I arrived at their office in a coach and four accompanied by liveried footmen. Some of them indulge my archaic eccentricities with good humor. Others, however, start conspicuously looking at their watches and tapping their fingers as I settle in with the Flood Plain Report, and make it very clear that they do not regard watching me wade through the details of the arbitration provisions as a productive use of their time. It takes a thick skin to keep reading despite that.

Besides, a lot of people find it hard to understand long, dry, complicated legal documents. We might wish this weren’t true, but it is. Their only options are to trust someone to summarize a mortgage accurately, or not to take out a mortgage at all. And if the summaries they get are wrong, whether because the loan officers themselves do not understand the mortgages they are selling or because of outright deception, then those people are screwed.

There are quite a few of these loans out there: “According to UBS, gross issuance of securitized OA pools was $18.5 billion in 2004, $128 billion in 2005, and $175 billion in 2006.” In the various debates about who is at fault for what, it’s worth bearing in mind that some of the people whose mortgages are in trouble took out loans like these, loans that should never have been marketed outside very special circumstances, and that no normal human being should ever have to understand.

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