As if there wasn’t enough bad news floating around about the housing market, BusinessWeek had another article on it.

The option adjustable rate mortgage (ARM) might be the riskiest and most
complicated home loan product ever created. With its temptingly low
minimum payments, the option ARM brought a whole new group of buyers into
the housing market, extending the boom longer than it could have otherwise
lasted, especially in the hottest markets. Suddenly, almost anyone could
afford a home – or so they thought. The option ARM’s low payments are only
temporary. And the less a borrower chooses to pay now, the more is tacked
onto the balance.

The bill is coming due. Many of the option ARMs taken out in 2004 and
2005 are resetting at much higher payment schedules – often to the
astonishment of people who thought the low installments were fixed for at
least five years. And because home prices have leveled off, borrowers
can’t count on rising equity to bail them out. What’s more, steep
penalties prevent them from refinancing. The most diligent home buyers
asked enough questions to know that option ARMs can be fraught with risk.
But others, caught up in real estate mania, ignored or failed to
appreciate the risk.

There was plenty more going on behind the scenes they didn’t know about,
either: that their broker was paid more to sell option ARMs than other
mortgages; that their lender is allowed to claim the full monthly payment
as revenue on its books even when borrowers choose to pay much less; that
the loan’s interest rates and up-front fees might not have been set by
their bank but rather by a hedge fund; and that they’ll soon be confronted
with the choice of coughing up higher payments or coughing up their home.
The option ARM is ‘like the neutron bomb,’ says George McCarthy, a housing
economist at New York’s Ford Foundation. ‘It’s going to kill all the
people but leave the houses standing.’

What are we missing? We squint. We look around. We scratch our heads. And
then, we look under the cushions and behind the chairs. How can a consumer
economy keep consuming when the consumers have no more money? Or, is there
a source of revenue we have overlooked?

“With soaring stock portfolios now ancient history and leaping house
prices about to be,” writes Gary Shilling, “no other sources, such as
inheritance or pension fund withdrawals, are likely to fill the gap
between robust consumer spending and weak income growth. Consumer
retrenchment and the saving spree I’ve been expecting may finally be about
to commence. And the effects on consumer behavior, especially on borrowing
and discretionary spending, will be broad and deep.”

Shilling expects house prices to drop by at least 20%, which will cause a
“major recession.”