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The Second Half of the Credit Crisis

Written By Brian Hicks

Posted January 24, 2009

Could it be we’ve just entered the second half of the credit crisis?

Just as 2008 was the year of subprime woes, this one will go down as the year of Option ARM resets (or adjustable rate mortgage resets). With billions in Option ARMs resets in 2009 and 2010, this crisis is about to unleash a fury no one’s prepared for.

It won’t be as bad as subprime, of course. It’ll be worse.

That’s because lenders created these ARMs with "teaser" features to borrowers, which included making lower minimal payments for the first few years before the loan reset to a higher payment schedule. And if that weren’t bad enough, there’s another feature called "negative amortization," which means you’re not paying back any principal.

In fact, with negative amortization loans, your loan balance increases over time. Incredulously, every time you make a payment, you owe the bank even more. These are the loans that allow consumers to buy a house they can’t otherwise afford.

As for speculators, they may use negative amortization loans if they believe prices will increase at a fast pace. But with the opposite happening, they’re out of luck.

And the banks will be left holding the bag.

So when your financial advisor tells you the financial crisis is well behind us, you’ll know better.

Housing aside, despite repeated injections of taxpayer money, the financial system continues to teeter on the brink of disaster. And while hope abounds for Obama’s new approach, described as a "fundamental reform of the $700 billion rescue plan," it may still require trillions more dollars, putting added pressure on our unstable economy.

And if you thought we were in bad shape… look no further than across the pond. 

The UK, just like the U.S., consumed more than it could pay for in what’s amounted to one massive liquidity bubble.  The UK economy shrank 1.5% (vs. 1.2% estimates) in Q4, and the government announced it was in recession.

A House of Cards

It was in February 2008 that British consumers owed $2.7 trillion on credit cards… when debt per capita was at a higher level even than for U.S. households… when British household debt stood at 164% of disposable income, as compared to 138% in the U.S… and when research suggested that one in four people were either struggling with debt or felt their debt was unmanageable.

Here in America, we’re still wondering how it is that no one sounded the bell. Will we actually learn from our mistakes? 

As the "sage of Baltimore" H.L. Mencken once said… "… the common people know what they want, and deserve to get it good and hard."

And if you’re looking for someone or something to blame, try the banks, which took on unsustainable levels of debt, and the greedy CEOs, like ex-Merrill Lynch CEO John Thain, who helped take us to the abyss.

Thain, for what it’s worth, is finally out of the picture at wobbly Bank of America, having come to a "mutual agreement" with CEO Ken Lewis. Who will inherit Thain’s $1.2 million office is anyone’s guess.

Of course, he’s just one of the miscreants who helped bring on the financial crisis.  

To learn more about Thain, his predecessor Stanley O’Neal, and more "culprits of the financial crisis," I urge you to take a read of our new report: The Architects of Destruction.

Good Investing,

Ian L. Cooper