Thursday, December 6, 2007

Help Me Understand This...

On my way into work this morning, I was listening to a news broadcast. The item was about the proposed freeze on adjustable rate sub-prime mortgages. It contained two statements supporting the freeze by one of the many, many Presidential candidates. One of the statements seemed plausible. The other seemed considerable less so.

The first statement was that something in the neighborhood of $30 billion in mortgages will adjust each month during 2008. This seems plausible.

The second statement was that the adjustments would result in average mortgage payment increases in the magnitude of 30 - 40%. Now, I recognize I'm not a mathematician. But for the average adjustment to be that severe, that would indicate that sizeable number of those loans are "interest only." I understand that in a standard mortgage (believe me, I understand) that much larger portion of the initial payment is interest (as opposed to tax escrow, PMI, or payment on principal). Regardless, it seems that an upward adjustment that even doubled the interest rate shouldn't result in that significant a bump in the payments unless you were paying off an "interest only" mortgage.

Another aspect may be that the characterization applies to all adjustable rate mortgages, even if they aren't "sub-prime." If that's so, the statement is a misdirection. If I'm correct on either of these points, the candidate's statement would appear to be reckless. If I'm wrong, the candidate's characterization may be correct and in the proper context.

Now, at this time I won't discuss the bad economics of a "rate freeze" and how it will act as a binding price ceiling and all that implies. Nor will I discuss the idea of "moral hazard" that arises every time government jumps to provide a bailout. We'll save that for another time.

**UPDATE** This might or might not be a good time to discuss positive vs. normative economic statements again - see my previous post. I'm not sure about the data in the second statement. Consequently I'm reluctant to categorize it as a positive or normative statement. But if it is not accurate, it's a good example of how normative statements can be made to sound positive by using suspect data.

I await your (or even your students') enlightenment.


William Polley said...

My guess is that the big percentage increases they are talking about are in reference to the P&I (principal and interest) only. Even if the servicer holds PMI, taxes, and insurance in escrow, the mortgage documents themselves deal with just P&I.

Another thing to consider is that a lot of these loans could be piggyback loans (80-20 or 90-10, for example) which do not have PMI, and piggyback part of the loan is probably going to jump to an even higher rate than the rest of it.

Yeah, I could see that 30-40% increase in the P&I in such cases is not at all out of the question.

Mike Fladlien said...

in iowa, the Des Moines Register reports that a sizeable amount of iowans support protectionist policies like the ones Hillary proposes...i wager that politicians will say any thing to get elected including interest freezes...