From Volume 4, Issue Number 26 of EIR Online, Published June 28, 2005

U.S. Economic/Financial News

Housing Follies: Less-Than-Interest-Only Mortgages; Sales of Unbuilt Homes

The "trillion-dollar bet" in the title of a USA Today article June 21 refers to the fact that $1 trillion in adjustable-rate mortgages (ARMs), interest-only mortgages, and a still queerer sort of mortgage which doesn't even require the borrower to pay the interest at first—$1 trillion worth of all these funny mortgages will require full monthly payments for the first time in 2007. Will the lenders be able to afford these much greater payments? This $1 trillion constitutes 12% of all U.S. mortgages.

Over the next two years, the increase in monthly payments due to these "balloon" mortgages will cost U.S. homeowners an estimated $40 billion, equivalent to a 40-cent-per-gallon gas-price increase.

It turns out that financiers are using computer models to design new kinds of funny mortgages, just as they use them to design new derivatives. The latest freak mortgage (but is it really the latest?), is called an "optioned ARM." It resembles the interest-only mortgage: The lender is able to pay only interest, no principal, during the initial period of usually 5-15 years. But in this case, he needn't even pay the full interest! If his actual rate is, say 5.9%, he can make interest-only payments at a much-lower rate, for example, 1.9%, during the initial period. So, with this kind of mortgage, the debt can actually grow from month to month, even while the lender continues to pay. And imagine how his payments will jump, once the "initial period" ends, and he has to amortize the now-increased debt, while also paying triple the rate of interest every month!

These mortgages were unknown before 2003, but now constitute 40% of all mortgages given to creditworthy borrowers buying homes costing over $360,000.

USA Today reports that the number of homes for sale before construction is completed rose to 88,000 this April, the highest number ever on record, from 60,000 one year ago, and 40,000 five years ago. Many unbuilt homes for sale are used for "flipping," where a speculator puts down a deposit and then resells the home at completion, or even before. Many major builders try to prohibit "flipping," but some look the other way, as can be seen from Internet sites such as "" One analyst who sees that all this amounts to a huge housing bubble is James Grant, editor of Grant's Interest Rate Observer, who says, "It shows that we are where we've never been before."

FDIC Exposes Greenspan's Lies on Housing Bubble

The FDIC has issued a study of the housing bubble, refuting the Greenspan argument that it is "localized," as reported in the Wall Street Journal June 20. At the request of the Journal, the Federal Deposit Insurance Corp (FDIC) prepared a report on housing prices in the U.S., which concluded that the super-heated housing markets in 22 major metropolitan centers "now make up such a large share of the total U.S. market that a sharp fall in their values could stall or slow national economic growth. Greenspan argued that there is no "national housing bubble," only "froth" in a few local markets.

The 22 major markets now make up 35% of the value of national residential real estate—they were only 24% a decade earlier—so that "the distinction between them and the national market could become meaningless." Even worse, the five largest markets (New York, Los Angeles, Boston, Washington, D.C., and San Diego) make up 24% of the total market value. The Journal notes that this is "reminiscent of how a few technology and blue-chip companies drove the bull and bear markets in stocks starting in the late 1990s."

Housing Market 'At Risk,' 'Heated Beyond Sustainability'

The U.S. housing market is "at risk," and "heated beyond sustainability," warned the University of California at Los Angeles Anderson Forecast, according to media reports June 22. The authors say the market is at risk due to the breakneck pace of housing price increases. "There is no reason a house should be worth 40% more today than it was two years ago," says co-author Christopher Thornberg, noting a finding in his paper in the study titled, "Beware the Froth," a reference to a recent remark by Fed chairman Alan Greenspan, dismissing the possibility that there could be a housing bubble. "And this housing market is heated far beyond the point of sustainability," the report adds. It describes a housing market so top-heavy with appreciation and investment that its likely collapse will drag the overall economy down with it—something EIR readers have been forewarned of by Lyndon LaRouche.

FASB To Revise Accounting Rules for Pensions

The Financial Accounting Standards Board (FASB), the body that writes the accounting rules that American businesses are supposed to follow, said in a New York Times article June 23, that they are preparing an overhaul of how companies calculate the financial impact of their pension plans. The article notes that corporations are likely to oppose these revisions, because a new standard could lead to significant changes in how corporate earnings are reported, and how pension funds are invested.

Under current rules, companies are allowed to report that investments in their pension funds have earned money even when they have not; the companies are also allowed to "smooth" pension values, by spreading year-to-year changes over several years. These accounting practices have come under criticism, because they can mask the health of both the company and the pension fund.

Contacted by EIR, an FASB media representative said that the rules have not yet been released, but when asked about the pension smoothing, this person immediately said that yes, this would be changed, in light of the United Airlines pension fiasco.

All rights reserved © 2005 EIRNS