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July 18, 2005
An ARM Warning From Across the Pond
First of all, this is not a picture of David Miles, the chief U.K. economist of Morgan Stanley. But there is no picture of him on the Morgan Stanley website, and this is the only pic that popped up when I plugged David Miles Morgan Stanley into Google Images. So it will have to do.
Morgan Stanley's David Miles, who I believe has a tattoo-free visage, has a strong article about mortgages in the March issue of The Economic Journal, a scholarly British publication which in typical academic fashion just reached my desk today.
He first points out that the British are near tops in the world (behind the Norwegians) in the share of outstanding mortgages that have variable rates, at over 60%. I think the U.S. share is more like a quarter, although around one-third of new U.S. loans are ARMs.
Then Miles tries to answer why the Brits are so big on ARMs. (Remember--the key feature of an ARM is that the rate starts low but can go up a lot. This can be a big problem if your income falls and/or you can't borrow more money right when higher rates kick in.)
Miles concludes that Brits grab ARMS because they "tend to attach a great deal of weight to the level of monthly repayments up front." That's a polite way of saying they're short-sighted.
Also, in Britain, more than 4 million households are paying a "standard" rate that's way higher than the best rate available. Often this is out of ignorance or inertia.
Lenders and financial advisers could help people get better loans, but often they don't, Miles says. One problem is that the so-called independent financial advisers get paid by the lenders. This dulls their incentive to fully inform their clients about the risks of ARMs. As Miles observes with what seems to be a touch of dry British wit:
It is not clear that having a detailed discussion about what might happen to interest rates, the scale of uncertainty about those rates and what that might mean for the affordability of mortgages, is something that is going to be high on the agenda of all financial intermediaries.
Miles favors much stronger regulation, which would require advisers to explain to borrowers in detail how they would be affected under different scenarios for changes in interest rates.
This isn't just an academic exercise. Last year Miles--who is also a prof at the University of London's Imperial College--made a major report on the same theme to Her Majesty's Treasury.
It would be interesting to know what Miles thinks of U.S. rules that purport to ensure that borrowers get suitable mortgages.
Because people who get socked in the ARM by rising interest rates are going to be madder than that guy in the picture.
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Anyone who gets socked by ARM's has no one to blame but themselves, but in this age of the "blame everyone else game", I can see a future of congressional inquries into why ARM's weren't better understood and why banks were so lenient with their lending.
As with everything else, an ARM is a wonderful tool when used in the hands of a knowledgable borrower. Unfortunately it has recently been used mainly by people stretching to buy properties they couldn't otherwise afford.
This almost sounds like the credit card industry and their 0% for one year offers. How many people have become snared in those traps, paying many times over for a single purchase in interest alone when all good intentions to have it paid off by the end of the year took a backseat to consumerism?
Posted by: Wes at July 18, 2005 03:49 PM