"Option ARM" Loans Existed In The 1990s!

What? I thought those were a new product of the 2000 decade to help people buy bigger and better - or in some cases, any home at all - as prices escalated rapidly?

Well, yes.

But here's the ugly little truth - "Option ARMs" did indeed exist in the 1990s. They just weren't called that, and weren't offered to home buyers.

They were offered to businesses.

This afternoon, after the markets closed, I was outside working on my lawn sprinkler system. It got damaged pretty badly by the hurricanes over the last few years, and really needs a new pump and, while I'm out there doing it, I may as well make it state-of-the-art with electronic controls and all (after all, that my thing - I'm an electronics and Internet geek 'ya see)

Anyway, while I'm wielding the Sawzall and cutting out all the old and crusty pipe so I can fit the new stuff, it suddenly hit me like a ton of bricks.

In fact, I nearly cut off one of my fingers the revelation came so hard and fast.

In the 1990s we had this company called Lucent. You might remember them. Here's a chart:


Now back then you will note that their stock was trading at $60 a share (split-adjusted for today, of course).

On November 30th, the last day they traded on the NYSE (they have since merged with Alcatel), they sold for $2.55.

What happened?

Simply put, Lucent wrote "Pay Option ARMs" on their hardware.

Lucent was one of the big "success stories" in the Tech Bubble. But they weren't a company selling some euphemistic service or with some crazy business plan that made no sense. Indeed, they were in one of the "safest" spaces of the market - so everyone thought.

Lucent manufactured telecommunications equipment. Once part of Bell Labs, the inventors of the telephone, they were spun off as an independent company. Lucent was the "hardware part" of the old AT&T Bell Labs, and was one of a handful of companies that made network equipment that all the Internet companies - including my firm - needed to operate.

Well, companies of course needed all these routers, switches, and other equipment. Lucent stood ready to provide it. But many of these new firms didn't have a lot of money to spend on hardware up-front.

So Lucent came up with an innovative plan - they sold you the gear on a long-term capital lease, and allowed you to pay only the interest on the lease, or in some cases, even less than the actual interest! The deal was that when your cash flow improved, and you became profitable, you could pay off the principal on the lease and/or just buy the gear outright.

Doesn't this sound suspiciously similar to what's going on right now? It should. It's exactly the same deal that has been offered to all these homeowners - pay less than the interest cost and/or the fully amortized cost of the hardware now, and when your economic situation improves, which we're sure it will in a few years - you'll have less debt, you'll have a better job, whatever - you can pay off the principle or roll it over into some other form of financing.

What happened to Lucent?

Winstar happened, among others. Winstar was the firm that acquired my company, MCSNet. A couple of years later Winstar ran out of money. See, they couldn't make the payments - oh, they had lots of customers, and lots of cash flow, but they were spending more than they made.

That sounds suspiciously like the homeowners that bought these "Option ARM" loans too, doesn't it?

What happened? Well, Winstar, along with other companies, went under! Lucent was forced to recognize billions of dollars in losses from these deals that stopped performing. To be sure, it wasn't just Winstar (ICG was another bankruptcy of the time) - but Winstar held an incredible amount of Lucent equipment - and thus, debt.

There are lessons here for the Mortgage space.

We've seen this game before - negative amortization, "interest only", all that.

This "feature" in financing really isn't new, and we already know how this story ends!

What's really ugly is that when Lucent blew up it took less than six months to fall from $50 a share to under $5. And, just like the lenders in the ALT-A space today, the first downstroke in their stock price was about 25%, the stock recovered for a few months to within 10% of its previous high, held that with considerable volatility for a few months, and then fell completely out of bed as it became clear that their loans were non-performing and never would be paid off!

Now explain something to me folks -

With anywhere from 30 to 50% of all loans originated in the last year in the "ALT-A" space being these "Option ARM" loans, and with the fact that we know how this story will end, because one of the biggest equipment manufacturers of telecommunications equipment in the world was nearly bankrupted by doing this very same sort of financing, why is it that nobody in the financial media is talking about these mortgage companies doing the VERY SAME THING that nearly bankrupted one of the ICONS of American Industry?