I think that the reference to a “second wave” of defaults is a bit misleading to the extent that there are numerous and distinct waves heading our way. The option-ARM wave is its own animal, and absent mass modifications it is going to hit and it will hurt.
The Alt-A/Prime loans will generate numerous waves, categorized by the loan terms. There are loans that upon reset will immediately become unaffordable and will go into default – that’s one wave. As FSD addresses above, we have already seen ’04/’05 vintage 3/1 ARMS reset with negligible impact on payments and thus minimal defaults. It should be noted that many 3/1 and 5/1 loans in SoCal do not go to P&I on the reset but have a longer (often 10 yr) IO period, which keeps payments lower.
However, it seems likely that the loan indices (LIBOR et al.) will eventually rise and thus cause payments to rise. This will likely take several years to play out. Due a rise in the indices (and possibly coupled with income reduction due to a weak economy) will we see another, later wave of defaults due again to inability to service the loan. So there will be successive waves generated by inability.
There is also an entirely separate category of potential defaults where ability is not an issue. These are the “business decision” waves that will be generated by borrowers with ability who decide to ruthlessly default because they are hundreds of thousands of dollars upside down and they can rent or buy a similar home for 1/2 of their present monthly outlay. The bigger the spread between servicing the current property and servicing a rental/new property, the more likely the ruthless default.
As to “bailouts”, I will restate the obvious which is that the recent housing bill is only the beginning.
