Option ARMs and Commercial Real Estate

A friend recently sent me an article from the WSJ about how option ARM resets this year and next may not be as bad as expected. Two basic reasons for it are (a) interest rates are very low so the resets will not be terribly bad for most and (b) a lot of underwater homeowners have already defaulted on their option ARMs even before the resets so there are not that many left there to default. A third possible reason is loan mods but we all know these are not really happening too often or working when they do (the percentages are small on this having an impact), so I will dismiss that one out of hand.

For the first point, let me note that these ARMs are either resetting to adjustable rate mortgages or eventually will go there and interest rates will not stay this low forever, so this is another kicking the can down the road success story. Moreover, a lot of these loans had homeowners simply paying interest only, so even with rates low the new payments that will include principal will still be higher. But, in any event, the low rates do give some people time to get back on their feet and perhaps refinance if their homes are not underwater, which is a good thing.

The second reason, a lot of defaults have already occurred, I do buy, especially in California where the option ARMs were all the rage.

Does this mean banks are out of the woods? In a word - no. Especially smaller local and regional banks still have a load of commercial loans that are continuing to sour and the pain is not done yet on the commercial side, though I would agree the worst is behind us on residential side. On the commercial side most commercial mortgages are expected to be underwater by the end of this year:

http://bubblemeter.blogspot.com/2010/03/elizabeth-warren-half-of-commercial-re.html

I really think we are in for a world of commercial real estate hurt this year and next. I read a stat earlier this year that the U.S. has significantly more, as in around 50% more, commercial real estate than any other country. For a country where consumers are still over their heads in way too much debt, I do not see commercial real estate rebounding any time soon. Obama can spend as much stimulus as he wants but I do not see many businesses walking out the plank and taking on new leases or real estate any time soon in this economy. This will lead to some massive commercial loan losses this year and next, which is simply the next step in this economy.

Disclosures: None.