From the LA Times: “Mortgage lender Countrywide Financial Corp. regularly warns customers about the risks of paying less than the interest due on loans offering that option. Now Chief Executive Angelo Mozilo is calling some of them personally.

Mozilo reached out to borrowers as part of a “little experiment” to understand the reasoning behind making only minimum payments on so-called pay-option loans, a practice that boosts the total amount due, the 67-year-old CEO told investors Wednesday in New York. “What we’re finding out is that they’re pretty smart,” Mozilo said. “It’s like voters: Individually they’re sort of idiots, but collectively they seem to make the right decisions.”

The customers Mozilo spoke with were convinced their home values would continue to rise, more than making up for the added costs, he said. Pay-option loans can accumulate interest, or “negatively amortize,” until a cap or a set date is reached and the interest rate automatically rises. Mozilo said he wanted to know why customers were paying only the minimum.

“The answer was, ‘I’m doing it because the rate of negative amortization is less than the increased value in my house each month,’ ” Mozilo said. “The average age of our borrower is about 38 years old. They have never in their adult lives seen values going down. The concept is alien to them.”

Pay-option loans accounted for about 18% of the $220 billion in residential loans Countrywide extended in the first half of the year.”

Needless to say, these folks are going to be introduced to an alien concept real soon now. And yes, individually, they are sort of idiots. However, Angelo, they’re collectively idiots too. A fundamental principle of life is that, if it sounds too good to be true, it probably is. In this case, these folks seem to believe that they can live in a house without ever actually paying for it. That the appreciation will pay the cost and some buyer will magically appear to pay off the accumulated balance of interest payments they have not made. Well in isolated instances, this might work. But collectively it can’t, that is the equivalent of a community getting rich by taking in one another’s laundry. To mix the metaphor someone has to pay for lunch.

NEW YORK (CNNMoney.com) — With real estate markets slowing and mortgage rates well above levels of recent years, times are getting tougher for homeowners - the number of homes entering into some stage of foreclosure is surging, according to a survey released Wednesday.

In August, 115,292 properties entered into foreclosure, according to RealtyTrac, an online marketplace for foreclosure sales. That was 24 percent above the level in July and 53 percent higher than a year earlier.

Jesse Jones, the head of the Reconstruction Finance Corporation in the 1930s, discussed the results of excessive credit growth in his day:

“Strewn all over was the wreckage of the banks which had become entangled in the financing of real estate promotions and had died of exposure to optimism.”

“Consumers’ borrowing is one of the most conspicuous danger points in the secondary phenomena of prosperity, and consumers’ debts are among the most conspicuous weak spots in recession and depression.”

“In other words, we shall readily understand why the load of debt thus light heartedly incurred by people who foresaw nothing but booms should become a serious matter whenever incomes fell, and that construction would then contribute, directly and through the effects on the credit structure of impaired values of real estate, as much to a depression as it had contributed to the preceding booms. Nothing is so likely to produce cumulative depressive processes as such commitments of a vast number of households to an overhead financed to a great extent by commercial banks.”

The classic notion of a carry trade is to borrow to buy securities whose yield is higher than the borrowing cost. In recent years, this has meant borrowing Japanese yen at extremely low rates, courtesy of the BoJ, swapping the yen in to dollars, and then buying bonds, often US treasuries, yielding much more. The idea is that not only will the rate differential pay well, but also the high-rate currency will tend to outperform the low-rate currency.

A synthetic version of this trade is to short yen futures and buy 10-year bond futures. The COT data shows that large speculators (hedge funds) have piled into this trade in recent weeks in huge quantity, to the extent that the commercials, taking the other side of the trade, have record short positions in the bonds and long positions in the yen. This looks like an accident waiting to happen fo the hedgies, because when the commercials’ position gets to an extreme, the trade usually goes their way.

Given the record size here, any accident could have significant knock-on effects. Watch the yen and the bond for sudden moves!

Business Week produces an excellent article, “Nightmare Mortgages”. Of course, the problem is that BW is usually a fade - by the time it hits BW, it is really old news.

Not sure what to make of this. A bottom in the homebuilders? Seems really early for that…