I've always thought that a great name for a punk band would be Negative Amortization. Amortization sounds bad enough, like something that a sinful priest would do to himself to get right with God, but negative amortization? Serious Dark Arts territory.
I have since learned that negative amortization is not that hard a concept to grasp. For homeowners paying off a mortgage, it means that your monthly payments are not covering the interest due on your principal. This means that your total amount owed to the bank is actually rising each month. Not a good place to be.
Negative amortization is in the news right now because, as interest rates rise, holders of "option ARMs" -- adjustable rate mortgages that entice consumers with very low initial payments -- are falling into negative amortization territory.
A link from a post at EconBrowser to an extremely downbeat post at the Big Picture summarizes some relevant data from an article in the current Barron's. By the end of 2003, only 1 percent of Washington Mutual's option arms "were in negative amortization. 2004, the percentage jumped to 21 percent. 2005, the percentage jumped again to 47 percent."
That's bad enough -- an expanding mushroom cloud of debt that can only bode ill for the overall economy. But here's the kicker. Washington Mutual has been booking this ballooning consumer debt as earnings.
Yes, that's right, in the first quarter of 2005, Washington Mutual booked $25 million of negative amortization as earnings. In the first quarter of 2006 the number was $203 million.
We're talking about debt here that may never be repaid -- foreclosures are already spiking all over the country. But Washington Mutual -- and it can hardly be alone -- is counting this debt as cash in the bank. That's Enron economics, folks, and we all remember what happened to that company.
Update: Reader Chris Doggett offers some very useful additional information on negative amortization and bank behavior.