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Bernanke ARM OK, Head "Explodes"?

By Anonymous

Bernanke misspoke in the recent TIME magazine interview:

TIME: Do you have a mortgage?

Bernanke: Oh, yes, we refinanced.

TIME: Oh, perfect. When?

Bernanke: About 5%. A couple of months ago.

TIME: Good time.

Bernanke: Yes. We had to do it because we had an adjustable rate mortgage and it exploded, so we had to.

TIME: So, did you get a fixed rate at 5%? I think this might be the most valuable piece of information. (Laughter.)

Bernanke: Thirty years fixed rate at a little over 5%.

Bernanke did have an adjustable rate mortgage, but it did not "explode".

First, Dr. Bernanke is the Fed Chairman and "exploding" ARMs are a very important mortgage issue. So I think this topic is relevant and newsworthy (and Bernanke mentioned it).

Second, "explode" has a very clear meaning when discussing mortgages; it means that the borrower's mortgage payment has increased sharply. An ARM can "explode" for two reasons:

1) The interest rate can reset to a much higher level. This isn't much of a concern right now because the most common indexes like LIBOR are at very low levels and most loans are resetting lower.

2) The loan can recast. From Tanta on resets and recasts:

"Reset" refers to a rate change. "Recast" refers to a payment change. ... "Recast" is really just a shorter word for "reamortize": you take the new interest rate, the current balance, and the remaining term of the loan, and recalculate a new payment that will fully amortize the loan over the remaining term.

Neither applied to Bernanke. From the WSJ: Looking a Little Deeper at Bernanke?s Floating Rate Mortgage

The Fed chairman was in an adjustable rate mortgage with a rate that started at 4.125% in 2004 and adjusted after five years to a rate that would be 2.25 percentage points above one-year Libor, which as of the first reset date in June was a little more than one and a half percent. That suggest his costs wouldn?t be exploding now, as the interview suggested. In fact, they?d be going down.

So Bernanke refinanced into a loan with a higher interest rate and with a larger mortgage payment for the security of a fixed rate. This suggests he thinks fixed mortgage rates have bottomed (otherwise he could have paid less on his mortgage, at a 3.75% interest rate, and then refinanced next year). He did not "have to do it".

Full post as published by Calculated Risk on December 19, 2009 (boomark / email).