by Calculated Risk on 8/05/2005 12:15:00 PM

Kenneth R. Harney writes that Wall Street has put the brakes on Option ARMs. He believes that an Aug 1st S&P negative report downgrade on option ARMs, combined with a new rgulatory guidance in the Fall will be "sayonara" for Option ARMs.

On Aug. 1, Standard & Poor's blew the whistle on option ARMs. After an intensive study of recent mortgage-backed bonds, it concluded that lenders are allowing credit standards to slip too far. And too many of the borrowers using option ARMs are paying the minimum amounts per month, thereby accumulating potentially toxic levels of debt — especially in markets where home values are likely to soften.

“We wanted to jump in before this got any worse,'' said Standard & Poor's mortgage bond director Michael Stack. By “any worse,'' he meant that if credit standards continued to decline, there would be a rising probability of defaults on option ARMs — something unacceptable to bond investors.

A second development potentially affecting option ARMs is under way at the federal financial regulatory agencies. A task force headed by Deputy Comptroller of the Currency Barbara Grunkemeyer is preparing new underwriting and credit risk guidelines on option ARMs, interest-only mortgages and reduced-documentation loans offered by the nation's lenders. In an interview, Grunkemeyer said the new guidelines could be out “by early fall,'' but there is no specific target date.

She said that financial regulators have “noticed that these products have taken off in the past six months.'' The goal of the guidelines will not be to eliminate any particular loan type, she emphasized, but “to make sure banks are offering (interest-only and option ARMs) in a safe and sound manner and doing so in a way that allows consumers to understand the risks.''

Judging by the negligible impact of the previous "guidance", the S&P report downgrade is probably far more important.

Hat tip to Ben Jones - a all housing, all the time, site. I'm primarily following housing since I think it is the key to the overall economy going forward. Housing has been the driver for jobs, credit growth, the declining savings rate, and probably even a major contributor to the trade deficit. I believe the end of the housing boom will lead to slower growth and will have major implications for the World economy.