Mortgage Bubble? Investors Want to Know Warning - Minor registration required at the above link. While much of the discussion in the blogosphere has been about the housing bubble in California and other. This article discusses how the spread of negative amortization mortgages has created a mortgage bubble.

Along with Golden West, publicly traded lenders with big exposure to these products include Countrywide and Washington Mutual and smaller California banks such as Downey, First Fed and Indymac. Golden West has been selling them for 25 years and has a solid track record with them, even in recessions and rising-rate environments. When fully explained to the right customers, such as a Porsche salesman who makes plenty each year but doesn't know how much he'll score from month to month, "it's a terrific borrower loan," says Mr. Sandler. "We have never had a delinquency, much less a foreclosure, due to the structure of the loan."

But some banks are lowering their credit standards, sometimes qualifying borrowers based on their ability to make the minimum nut, not whether they can afford the whole deal. "That is an outrage," Mr. Sandler says.

t gets better: The unpaid interest gets tacked on to the bank's outstanding loan total, allowing the bank to display loan growth, which investors love. "You get earnings and growth. What more can you ask for?" says Keefe, Bruyette & Woods analyst Fred Cannon.

But there could be credit problems down the road. And at some point, it's plausible regulators might fret about the bank's capital.

Last week, Golden West's stock took a hit after it disclosed how much its exposure to option ARMs has increased. The company reported that $160.2 million of its loans was actually unpaid interest tacked on to borrowers' principal - that negative amortization I mentioned. That's a huge leap from last quarter's $90.2 million and $27 million in last year's second quarter."

So with the growth of ARMS, that negative amortization is reported as loan growth by the bank. So the bank instead of showing growth through origination of new loans is actually growing on the back of consumer spending. Consumers are very vunerable to interest increases. Currently banks don't report how much of their loan growth is due to negative amortization of ARMS. Golden West (the bank cited) does and it reveals a scary picture. I wonder what the situation looks like at Countrywide?

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Regulators Begin to feel uncomfortable Apparently bank regulators have issued new guidance to banks about home equity loans, warning them about homeowners borrow too much against their homes. Of course the impact on these practices is almost non existant.

"It's as easy to get these loans now as it was two months ago," said Michael Menatian, president of Sanborn Mortgage, a mortgage broker in West Hartford, Conn. "If anything, people are offering them even more than before."

Apparently guide lines have only been issued without concrete action. Why?

"We don't want to stifle financial innovation," said Steve Fritts, associate director for risk management policy at the Federal Deposit Insurance Corporation. "We have the most vibrant housing and housing-finance market in the world, and there is a lot of innovation. Normally, we think that if consumers have a lot of choice, that's a good thing."

In many ways this is a good thing as it allows competition for a borrowers business. This means a financial windfall for the consumer by tapping the equity in their home.

Led by the comptroller's office, which oversees nationally chartered banks, federal banking regulators published guidance in May that gave lenders more detailed instructions on how to evaluate the risks in home-equity loans.

The move was a warning shot to lenders. The value of home-equity loans shot up 40 percent in 2004, to $398 billion. Almost all of those loans are at adjustable interest rates, which could rise sharply, and many were extended to people who had just borrowed money to buy a house.

If you have a hybird ARM or an ARM it's time to think about refinance.

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