Good question, poway. I always assumed that mortgages were only backed by the house. If that is the case, then if the owner of the house defaults on the loan, the only recourse for the holder of the loan is to foreclose and sell the house. However, in today’s market, the house is likely to sell for much less than the balance left on the loan.
It looks like the big winners here are going to be the CEOs of the companies like FED and others mentioned in the Business Week article. Because FED can book the full payment amount even when the borrower is only making the minimum payment, these option ARMs are a way for CEOs to boost short-term earnings at the expense of the long-term health of the company. This allows CEOs to cash out their stock options in the short-term leaving long-term holders of the stock holding the bag when they borrowers eventually default and the foreclosed house is worth only a fraction of the balance left on the loan.
I believe these option ARMs have enabled the housing bubble to inflate to several times the size it would have otherwise have been. Which means we’re going to see that much bigger of a pop in the near future.
