Policy

ARMs: The unexpected benefits

By Michael Maiello     
June 11, 2015

From: Magazine

Illustration by Chance Bone.

During his term as chairman of the Federal Reserve, Alan Greenspan suggested in 2004 that Americans who had stuck with fixed-rate mortgages were overpaying for their homes. Citing a Fed study, he said that many Americans could have saved tens of thousands of dollars with adjustable-rate mortgages (ARMs), and he encouraged financial-service providers to make ARMs more readily available. The banks did what they were set loose to do, with some lenders adding ultra-low teaser rates to their loans, and the housing boom marched onward until it didn’t. In the aftermath of the crash, Greenspan took much criticism for his earlier comments.

But now, in the slow recovery following the 2007–10 financial crisis, there is some supporting evidence in favor of ARMs. Researchers looking at the financial conditions of households through the Great Recession and into the recovery argue that ARMs are saving homeowners money, and helping them reduce overall debt, improve credit ratings, and make purchases of big-ticket durable goods such as cars. 

ARMs, the argument runs, are an effective transmitter of the Fed’s postcrisis low-interest-rate policies.

The researchers behind this claim—Benjamin J. Keys of the Harris School of Public Policy at the University of Chicago, Tomasz Piskorski from the Columbia Business School, Chicago Booth’s Amit Seru, and Vincent Yao of Fannie Mae—find that in the areas where homeowners saved money by reducing mortgage payments, unemployment fell faster and economic growth was more robust. They write that the benefits were apparent when average payments dropped by as little as $150 a month.

As would be expected during a time of consumer deleveraging, households applied more than 70 percent of their mortgage savings to reducing outstanding credit-card debt. Not only did the lower payments reduce mortgage defaults, but credit-card delinquencies fell. 

“These choices had significant impact on foreclosures, house prices and employment in regions that were more exposed to interest rate declines,” the researchers conclude.

The findings imply that wholesale renegotiations of existing mortgages might have been good for the postcrisis economy. Unfortunately, the securitization of mortgage debts made those debts more difficult to renegotiate. In many cases, the original lender was not in the picture, and single loans had multiple owners.

However, homeowners with ARMs have been able to make lower monthly payments without renegotiating their mortgages, because their monthly payments have fallen along with interest rates.

“By reducing the mortgage rates of ARM borrowers, low interest rate policies may achieve similar effects to mortgage modification programs for these borrowers more quickly (at least in the near term),” the researchers write.

Homeowners with fixed-rate mortgages could always attempt to refinance them, but that requires initiative that may stymie many homeowners, particularly in present times when banks have been reluctant to lend and are now demanding extensive documentation to support the financial health of borrowers. In October 2014, even former Federal Reserve Chairman Ben Bernanke, with a net worth in excess of $1 million, reported that he could not arrange to refinance the mortgage on his Washington, DC, home. By contrast, the researchers note, ARM rates reset automatically, without action required on the part of the borrower and with no additional obligations to check credit or re-underwrite risk on behalf of the lender.

As so much of the stimulus is being used to pay off consumer debts—effectively moving payments from one financial-sector lender to another—should the government in a future crisis tackle consumer debt directly? The researchers suggest more study is needed on that point. Lessening debt burdens in general seems to be effective stimulus indeed.

Work cited

Benjamin J. Keys, Tomasz Piskorski, Amit Seru, and Vincent Yao, “Mortgage Rates, Household Balance Sheets, and the Real Economy,” Working paper, September 2014.

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