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Wachovia's Option ARM Debacle

Written By Brian Hicks

Posted July 24, 2008





As the ultimate showman of his time, P. T. Barnum sure knew how to draw a crowd.

In fact, as he lined his pockets with their dough time and time again he also became famous for that quip that “there’s a sucker is born every minute.”

But while Barnum profited from this time-tested truism, those words never actually left his lips. The famous phrase was said by one of his competitors—-a banker named David Hannum, which seems fitting given the current state of the lending business.

One of the biggest lending scams, of course, was the Option ARM.

It was pushed by these wolves not only because it was easy to qualify for but also because it’s low initial payments were the ultimate bait. That’s the reason they call them “teaser rates” to begin with.

But while these initially enticing rates were quite marketable to the “monthly payment nation” that bought them, it doesn’t take long before the payments on these loans nearly double.

When that happens, it nearly buries many of the people that got them with no clear understanding of how they worked in the first place.

And to make matters worse, even if these troubled borrowers are able to make the higher payments, they often do so at the “minimum payment” amount, which adds the uncollected interest to their loan balance, driving them deeper and deeper in debt.

Nice trick huh?

But the truth is that is was a little too clever. These loans are blowing up left and right. That’s the next stage of crisis as these loans go bust too in numbers much larger than the estimates.

A big player in these loans was Wachovia. They stumbled into this abyss when they bought Golden West for $2.6 billion in 2006.

Of course I’m just guessing but I’d bet that is one decision Wachovia would like to take back.

Here’s the skinny on Wachovia from The Charlotte Observer.

It is by Rick Rothacker entitled: Wachovia aims to unravel Pick-a-Payment problems

“Amid ballooning loan losses, Wachovia Corp. is taking more steps to unwind its troubled $122 billion Pick-A-Payment mortgage portfolio. But it’s not going to be a quick fix – or a cheap one.

Wachovia last month said it would stop offering a minimum payment option that causes a borrower’s loan balance to increase, essentially eliminating the Pick-A-Payment product. Now it’s taking more steps to refinance existing Pick-A-Pay customers into traditional loans, including reassigning 1,000 employees to contact customers.

In some cases, borrowers will be offered a reduction in their principal owed as part of a refinancing, the bank said. In other cases, troubled borrowers may be encouraged to sell their homes at a loss to avoid foreclosure.

These loans, which give customers monthly payment options, were the core product the Charlotte bank inherited in its 2006 acquisition of California-based Golden West Financial Corp. But the huge plunge in U.S. housing prices, particularly in California and Florida, has sent many of these borrowers spiraling into default.

Meanwhile, the losses emerging in the portfolio are staggering. The bank said it now expects cumulative losses of 12 percent over the lifetime of the portfolio, with most coming in the next three years. In April, the bank had estimated total losses of 7.5 percent.

The bank’s models have it setting aside $8.7 billion in 2008 to cover Pick-A-Payment losses and expected losses, followed by another $5.6 billion in 2009. The bank’s calculations are based on housing declines bottoming out in 2010.

At the end of the second quarter, about 5.8 percent of the Pick-A-Pay loan book was considered nonperforming, compared with less than 1 percent of the bank’s traditional mortgages. Pick-A-Pay loans are plagued by their concentration in dismal housing markets. Borrowers also can elect to pay less than the interest owed, inflating their balances owed. About 65 percent of Pick-A-Pay customers selected this option in May.

With Pick-A-Pay curtailed and the mortgage market remaining sluggish, Wachovia plans to dramatically restructure its mortgage unit. The bank said Tuesday it plans to cut about 4,400 mortgage jobs, about 38 percent of the current mortgage work force of 11,500.

As part of the ongoing reorganization, two top mortgage executives who joined the company from Golden West, Rich Fikani and Tim Wilson, will no longer report to mortgage head David Pope, spokesman Don Vecchiarello said.

The company ‘hasn’t reached a conclusion on what new roles they will have, if any,’ he said.”

Those guys from Golden West must be laughing themselves silly.

I guess there really is a sucker born every minute.