There is a tendency in politics to see everything in a small time horizon. The fight in front of you is the one that is most important one there is. The problem with this approach is that it lets the clock run out on issues that you should be able to see coming and address before they become a catastrophe. In the late winter and early spring of 2008 everyone knew there was something very rotten in the housing market. Prices were falling and the number of loans in default or foreclosure was growing every month. This would have been a good time take action to address it, but there was a presidential primary race and a big election coming up, so it went on, basically ignored until the weakness in housing caused the financial system to collapse.

Originally posted at Squarestate.net

The wins that the President and the Democratic Party enjoyed in 2008 were due, in part, to the correct assessment by the public that the Republican Party did were to blame for the crisis and would not really do anything to fix it or prevent it from happening again.

One of the proximate causes of the housing collapse was the increase in payments from ARM loans. This process is called payment shock. It comes along in waves depending of the LIBOR (London Inter Bank Overnight Rate) average. Adjustable Rate Mortgages are most commonly tied to the 6-month LIBOR. When that rate goes up so do the interest rates and payments on ARM’s.

Take a look at this chart, which Amherst Securities created projecting the amount of payment shock in the next few years.

In September of 2008 13 billion of total loan recast. In October another 12 billion recast. This lead, in some cases to payments doubling and in all these cases payments going up significantly. The ability of people to get out of their houses or to refinance them dried up completely and the housing bubble collapsed.

Now take a look at the projection for this September and October. Both moths are projected to have 12 billion plus in loans that will experience this price shock. That is bad, bad news. Not just because there will be more people who suddenly have the cost of their monthly loans going up significantly, but because things are far worse than they were economically in 2008. Back then the unemployment rate was 6.2%, as of today it is 9.7% (with all the usual caveats about U3 vs. U6 rates) that is a more than fifty percent increase in the number of jobless folks (including your diarist).

Another really discouraging thing about this chart is the number of loans that are so-called “Option ARM’s”. These loans have four payment options, a specified minimum payment, an interest only, a fifteen year amortization and a thirty year amortization.

Where they get into the payment shock area is when people are making the minimum payment or interest only payment and the actually interest rate makes them have a negative amortization, meaning they are building up more debt in the loan then they are paying off. After a certain amount of time, this has to adjusted an the payment can skyrocket.

Now we get to the politics of this. In the heat of the mid-term election, battles about the same dollar amount in mortgages are likely to have payment shock as in 2008. The question becomes which political party is to blame when it does? There will be literally millions of households who were just eeking by that are now faced with the reality that even if they have a job, they have no way to afford their house payments. There is no doubt that a good part of the blame will be theirs for taking on such a risky loan, but there is also no doubt that they will turn their anger and frustration outward.

It looks as though there are two main ways this will come down. Either the Democratic Party will have been able to do something about housing and will be able to point to the programs that will help them keep their homes or the Republicans will have managed to keep anything from being done.

If we have programs that allow the “cram-down” of principal on mortgages through bankruptcy, then the enormous pain and loss that these payment shocks will cause can be mitigated. After all, it is the rise in the LIBOR and the negative amortization, which is going to cause the majority of these loans to reset so steeply. If the principal can be lowered, then the cost of the payments will not go up as drastically.

This would be an enormous boost to Democrats at all office levels as the cram-down is going to be completely opposed by the Republicans (in fact, they have defeated it once already) and their buddies in the Banking sector.

The problem is that if Democrats do not address this problem and in a hurry, the anti-incumbent mood in the nation is likely to turn from a bush fire to a firestorm. Anger makes people less likely to think rationally. It will not matter to most of the voters that the Republicans obstructed the very thing that would have helped them. Hell, recent polling shows that most of the public do not even understand how the Republicans have obstructed HCR nor what it means to need 60 votes to end debate.

The anger on the left for the perceived bail out of the banks while failing to bail out the public will spread to the independents (traditionally low information voters) and will be a disaster for the Democratic Party as anger trumps reason and the “throw the bums out” mentality takes over.

The fact that this will actually make things worse will not matter. The reality of what Republicans stand for and how they will govern is fading from the minds of most of the nation and by the time it is clear again, we will be in a world of shit.

There is another reason that Democrats should act on this and act now. The banks are still trading in securities tied to loans. If there is another massive wave of defaults the same problem with valuation that nearly brought the economy down will with us again.

No matter where you come down on the way the banking industry, and the economy at large, was kept from total disaster everyone can agree that we can not afford to go through this again. Since we have failed address the structural problems (regulation of securities and housings vulnerability from risky and unscrupulous loan products) we remain open to another crash and all of the fallout that would create for an economy that has just recently leveled out.

This is what is coming. The question is will we deal with it, knowing it will be hard, knowing that the Republicans will obstruct, knowing that money to lobbyists will fall like a waterfall from Wall Street, or will we keep getting caught up in the fight of the moment and be standing in a hard rain in the fall of this year?

The floor is yours.