July 1, 2008 – 12:27 pm

You never believe what they say on Wall Street, but what they do and what Wachovia did shows that what they said was all wrong. Wachovia eliminated minimum payment option ARMs and waived all prepayment penalties associated with these loans:

Effective immediately, the bank is discontinuing the minimum-payment option on all new loans. The minimum option allowed a borrower to make payments lower than the interest due on the loan. By not covering the total interest due, the borrower’s monthly payments and loan balance can increase over time.

Wachovia became a pick-a-payment leader through its acquisition of Golden West Financial Corp at the height of the housing bubble. The $24 billion deal was jeered immediately by Wall Street analysts and has been a major reason for the ousting of former CEO Ken Thompson:

The loans have become a source of misery for the bank: In the first quarter, Wachovia set aside $2.8 billion to cover expected loan losses, including $1.1 billion for the pick-a-payment portfolio, where losses rose to $240 million, from $1 million a year earlier.

The larger issue is that by suspending the Option ARMS the bank is admitting what the rest of us seemed to know in 2006, that the deal made no sense. But the rusting of Golden West will leave tsunami-sized ripples in the credit crunch:

THIS IS HUGE, not only for Wachovia but for every bank or investor who owns Pay Option ARMs or securities derived from them.

One of the big problems for banks with these loans on their books is that they are allowed to book as revenue the FULLY INDEXED payment amount of Index + Margin each month for each borrower. This can be as much or more as twice the minimum allowed payment. This is because in theory is they will get it back if they repo and sell the home or the borrower sells it or refi’s. But, now with the gross amount of negative equity out there, most borrowers can’t sell or refi and the banks are only recovering 50% though foreclosure.

This maybe why if you compare a stock chart of the banks I mentioned above, they are performing much worse than banks that never touched the Pay Option ARM.

And this may be why the bank is so desperate and deceitful in its advertising:

Just a month ago they were running TV commercials with families dancing around their kitchen promoting this loan programs and its ‘low payment options’. I said for months that this was an attempt to make the street think that their Pay Option ARMs were ‘different’ from everybody else’s. It was an obvious attempt at deception.

The worst is not nearly over, there is surely more pain to come in the housing and credit markets as the ripples spread out about the global economy.


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