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Why it takes financial crises so long to unwind [ClearOnMoney]
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Why it takes financial crises so long to unwind

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Commentary

Why it takes financial crises so long to unwind

1 Mar 2010 by Jim Fickett

A number of historical studies suggest that things don't return to normal for 5-10 years after a major financial crisis. Why does it take so long?

Freddie Mac made an announcement last week that illustrates one reason – even when a practice is clearly not sustainable, it often continues until there is absolutely no other choice but to stop.

Freddie Mac said,

Freddie Mac Announces That It Will Cease Purchases of Interest Only Mortgages

Freddie Mac (NYSE: FRE) announced today that on or about September 1, 2010, the company will cease purchasing and securitizing interest only mortgages, including Freddie Mac Initial InterestSM fixed-rate and adjustable-rate mortgages. Additional information will be provided to Freddie Mac Seller/Servicers in an upcoming Single-Family Seller/Servicer Guide bulletin.

Interest only mortgages, including Freddie Mac Initial Interest mortgages, provide for interest-only payments for a specified period of time beginning with the first monthly payment after the note date, and principal and interest payments on a fully amortizing basis for the remainder of the mortgage term.

Why now? It's been obvious since about 2006 that interest-only mortgages were not going to work. The answer is buried in the supplement to the quarterly results, published a few days before the above announcement (click for a larger image):

Interest-only mortgages have been performing poorly for quite a while, but once serious delinquencies hit 18% it was impossible to ignore the problem any longer.

Note that while interest-only mortgages were finally recognized to be a disaster, purchases will not stop until September.

And who is loaning Freddie Mac money to cover the losses? Lucky you.