type: timeline_event
In 2006, option adjustable-rate mortgages (option ARMs) reached 42 percent of all ARM loan volume in non-subprime, non-agency securitizations, up from 32 percent in 2005 and just 12 percent in 2004. Leading issuers included Washington Mutual, IndyMac, Countrywide, Wachovia, BankUnited Financial, Downey Savings, FirstFed Financial, and Guaranty Financial Group. These toxic mortgage products allowed borrowers to make artificially low minimum monthly payments for up to five years, with the difference between the minimum payment and actual interest being added to the loan balance, creating negative amortization.
Washington Mutual had been a traditionally prudent lender but underwent a dramatic transformation from 2003 to 2006, shifting its originations from 64 percent low-risk fixed-rate mortgages to just 25 percent, while high-risk loans jumped from 19 percent to 55 percent of originations. IndyMac pushed aggressively for loan growth, increasing volume by approximately 50 percent in 2006 even as overall industry volume fell slightly. Less than 10 percent of the dollar volume in a $354 million pool of residential mortgages that IndyMac packaged into securities in 2006 involved full documentation loans—the rest were low- or no-documentation "stated income" loans. Lenders pursued these risky products because investors were willing to pay premium prices for the higher yields.
The payment shock built into option ARMs was catastrophic. With more than 65 percent of borrowers electing minimum monthly payments (reaching 85 percent for 2006 and 2007 vintages), loans that hit negative amortization caps—where the balance grew to 110-125 percent of the original amount—had to be recast much earlier than the five-year term. The potential average payment increase on recast loans was 63 percent, adding $1,053 per month on top of the current average payment of $1,672. When Washington Mutual failed in 2008, it held $52.9 billion in option ARMs out of $118.9 billion in single-family loans, with $3.23 billion of its option ARM portfolio already non-performing. By 2009, all the biggest option ARM players—Washington Mutual, Countrywide, IndyMac, and Wachovia—were out of business or had been sold. The Office of Thrift Supervision, which regulated most of these institutions, took no action to curtail option ARM lending despite clear evidence of unsustainable risk.