(click on image for clearer view)It is amazing to me how I keep reading, over and over again, about the 'subprime' problem. Starting a couple of years ago, and back then, justifiably so, the term stuck.
Not only were people with low credit scores given fixed rate loans, as time went on, the guidelines and terms got better and better for the subprime borrowers. Soon it was 100% financing, then 102 and 103% financing, then no doc/stated income, meaning they could claim whatever income they wanted, with little worry the LO or lender would check. Yes, even those loans were 100% financing.
Next, the 'smart' people that run Wall street were so hungry for more loans to securitize, they began to offer adjustable rate, 100% loans. These loans could start out with a small rate, then reset to a larger rate. More often than not, these resets are proving to be more than these people could afford.
As could be predicted, it was the loans given to people with a proven track record of not paying bills on time that blew up first. But how big a percentage of overall loans over the last few years was this 'subprime' group?
By 2005, subprime loans had become 20% of all mortgage originations. In 2006, subprime loans became 24% of loans originated. It was in 2006 most of the subprime companies began to realize major problems, mostly with their buyback agreements. A clause in most of the agreements would force the originating lender to buy back the loan if it went into default. By 2007, subprime originations had fallen as a percentage of total loans to less than 10%.
The rise in adjustable rate loans has been more dramatic, and more encompassing, than the subprime arena. Washington Mutual became famous within lending circles for its Option ARM programs long before awareness of a 'subprime' problem. Countrywide followed suit, and took it to the next level with its "Fast and Easy' program. Fast and Easy became known as 'fast and sleazy', mainly because they were not verifying incomes, even though they had the borrower sign a piece of paper allowing Countrywide to pull past tax records to verify income.
Countrywide then sold these unverified loans to FNMA and FHLMC as prime loans. These loans are now defaulting at a rate greater than subprime. The fate of FNMA and FHLMC are in great peril because of the 'prime' loans Countrywide sold them, that now look to be 'not so prime'.
I still read in newspapers only about the 'subprime' problem. I still hear on CNBC, FOX and CNN about the 'subprime' problem. The majority of loans now defaulting were not subprime at the time of origination. They were 'prime'. The one thing they all have in common is they were, and are, adjustable rate loans.
The reason for most of the defaults is this simple fact - at the time of origination, the borrowers could afford the initial rate. Whether they bought for speculation or not, almost every borrower anticipated that when they took the loan the value of their property would go up. If they could not afford the reset, conventional wisdom was they would be able to refinance, get another low initial rate, and get a little extra cash, because, of course, the property would be worth more.
Because of this thinking, the idea if someone could actually afford the new, higher rate at reset was rarely factored in when considering ability to repay the loan.
Well, for the last 18 months, property values have not gone up. In fact, nationwide, property values have decreased more than 20% since January 2007. As each month goes by, a new phenomena rises in frequency, that of "Jingle Mail". Jingle Mail is the term assigned to homeowners who are walking away from houses because they are upside down in their mortgages, implying they are mailing their keys to the bank. Their reasoning is "why pay 25% more for my house than it is now worth, plus interest, when the same house across the street I can rent for 1/3 the monthly payment?"
This type of action from homeowners, unfortunately, is just starting.
Consider this; Mish at Global Economic Trend Analysis has been tracking one 2007 MBS bond issue from Wamu.
* The original pool size adding up all the tranches is $519.159M.
* 92.6% of the entire bond was rated AAA by both Moodys and S&P.
* 22.89% of the whole pool is in foreclosure or REO status after 1 year.
* 31.17% of the pool is 60 days delinquent or worse
* The top 5 tranches constitute $476.069M out of an original pool size of 519.159M. In other words, 91.7% of this entire mess is still rated AAA.
Folks, these are not subprime loans. They are prime and Alt-A. These were given to people with good credit scores. What's worse, is this entire MBS issue is heading for a complete rating downgrade.
These are all adjustable rate loans.
This is one of thousands of derivatives not yet downgraded. This particular MBS is actually better off than many others that have yet to be downgraded. Most of the MBS yet to be downgraded consist of 'prime' loans.
Because these loans are considered 'prime', the market, the ratings agencies, the banks have all been reluctant to mark these down. Many investment programs such as IRA funds, pension funds, retirement funds, both public and private, hold derivatives just like this one. All of these investment programs, plus many more, can only buy AAA rated investments. As these MBS issues lose their AAA rating, these investment programs must sell them.
This is one HUGE problem. Once they lose the AAA rating, they are not worth anywhere near what was originally paid for them. Everybody who has money in any mutual fund, IRA account, retirement fund, money market account etc. which bought any mortgage backed paper (which almost all of them have some) is going to lose money. Guaranteed. How much you will lose depends on how many derivatives your fund purchased. Do you know how to find these in your fund? It would be wise to find out, today.
A big part of the problem is how the media reports this. they continue to call it a 'subprime' problem. This creates the perception that less than credit worthy borrowers were given loans, and of course, the lowlifes are now defaulting.
By the end of this mortgage mess, many more 'prime' loans will default than subprime. Most resets for adjustable rate prime loans originated in 2005, 2006 and 2007 are still in front of us. Most of the loans originated in those years are adjustable rate. They will reset at a ratio based on what the prime rate is at the time of reset. The Fed has just sent a message to Wall Street that rate cuts are over, and rate hikes are likely.
The only way for people to realize this a huge problem is to stop labeling it a 'subprime' problem and call it what it is, an 'adjustable rate' problem.
Not only were people with low credit scores given fixed rate loans, as time went on, the guidelines and terms got better and better for the subprime borrowers. Soon it was 100% financing, then 102 and 103% financing, then no doc/stated income, meaning they could claim whatever income they wanted, with little worry the LO or lender would check. Yes, even those loans were 100% financing.
Next, the 'smart' people that run Wall street were so hungry for more loans to securitize, they began to offer adjustable rate, 100% loans. These loans could start out with a small rate, then reset to a larger rate. More often than not, these resets are proving to be more than these people could afford.
As could be predicted, it was the loans given to people with a proven track record of not paying bills on time that blew up first. But how big a percentage of overall loans over the last few years was this 'subprime' group?
By 2005, subprime loans had become 20% of all mortgage originations. In 2006, subprime loans became 24% of loans originated. It was in 2006 most of the subprime companies began to realize major problems, mostly with their buyback agreements. A clause in most of the agreements would force the originating lender to buy back the loan if it went into default. By 2007, subprime originations had fallen as a percentage of total loans to less than 10%.
The rise in adjustable rate loans has been more dramatic, and more encompassing, than the subprime arena. Washington Mutual became famous within lending circles for its Option ARM programs long before awareness of a 'subprime' problem. Countrywide followed suit, and took it to the next level with its "Fast and Easy' program. Fast and Easy became known as 'fast and sleazy', mainly because they were not verifying incomes, even though they had the borrower sign a piece of paper allowing Countrywide to pull past tax records to verify income.
Countrywide then sold these unverified loans to FNMA and FHLMC as prime loans. These loans are now defaulting at a rate greater than subprime. The fate of FNMA and FHLMC are in great peril because of the 'prime' loans Countrywide sold them, that now look to be 'not so prime'.
I still read in newspapers only about the 'subprime' problem. I still hear on CNBC, FOX and CNN about the 'subprime' problem. The majority of loans now defaulting were not subprime at the time of origination. They were 'prime'. The one thing they all have in common is they were, and are, adjustable rate loans.
The reason for most of the defaults is this simple fact - at the time of origination, the borrowers could afford the initial rate. Whether they bought for speculation or not, almost every borrower anticipated that when they took the loan the value of their property would go up. If they could not afford the reset, conventional wisdom was they would be able to refinance, get another low initial rate, and get a little extra cash, because, of course, the property would be worth more.
Because of this thinking, the idea if someone could actually afford the new, higher rate at reset was rarely factored in when considering ability to repay the loan.
Well, for the last 18 months, property values have not gone up. In fact, nationwide, property values have decreased more than 20% since January 2007. As each month goes by, a new phenomena rises in frequency, that of "Jingle Mail". Jingle Mail is the term assigned to homeowners who are walking away from houses because they are upside down in their mortgages, implying they are mailing their keys to the bank. Their reasoning is "why pay 25% more for my house than it is now worth, plus interest, when the same house across the street I can rent for 1/3 the monthly payment?"
This type of action from homeowners, unfortunately, is just starting.
Consider this; Mish at Global Economic Trend Analysis has been tracking one 2007 MBS bond issue from Wamu.
* The original pool size adding up all the tranches is $519.159M.
* 92.6% of the entire bond was rated AAA by both Moodys and S&P.
* 22.89% of the whole pool is in foreclosure or REO status after 1 year.
* 31.17% of the pool is 60 days delinquent or worse
* The top 5 tranches constitute $476.069M out of an original pool size of 519.159M. In other words, 91.7% of this entire mess is still rated AAA.
Folks, these are not subprime loans. They are prime and Alt-A. These were given to people with good credit scores. What's worse, is this entire MBS issue is heading for a complete rating downgrade.
These are all adjustable rate loans.
This is one of thousands of derivatives not yet downgraded. This particular MBS is actually better off than many others that have yet to be downgraded. Most of the MBS yet to be downgraded consist of 'prime' loans.
Because these loans are considered 'prime', the market, the ratings agencies, the banks have all been reluctant to mark these down. Many investment programs such as IRA funds, pension funds, retirement funds, both public and private, hold derivatives just like this one. All of these investment programs, plus many more, can only buy AAA rated investments. As these MBS issues lose their AAA rating, these investment programs must sell them.
This is one HUGE problem. Once they lose the AAA rating, they are not worth anywhere near what was originally paid for them. Everybody who has money in any mutual fund, IRA account, retirement fund, money market account etc. which bought any mortgage backed paper (which almost all of them have some) is going to lose money. Guaranteed. How much you will lose depends on how many derivatives your fund purchased. Do you know how to find these in your fund? It would be wise to find out, today.
A big part of the problem is how the media reports this. they continue to call it a 'subprime' problem. This creates the perception that less than credit worthy borrowers were given loans, and of course, the lowlifes are now defaulting.
By the end of this mortgage mess, many more 'prime' loans will default than subprime. Most resets for adjustable rate prime loans originated in 2005, 2006 and 2007 are still in front of us. Most of the loans originated in those years are adjustable rate. They will reset at a ratio based on what the prime rate is at the time of reset. The Fed has just sent a message to Wall Street that rate cuts are over, and rate hikes are likely.
The only way for people to realize this a huge problem is to stop labeling it a 'subprime' problem and call it what it is, an 'adjustable rate' problem.
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