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I see market manipulation at work here. The default rate on mortgages is not high enough (or even projected to be high enough) to seriously impact the value of the mortgage-backed securities. Suppose the default rate rose to 10%. The banks could be expected to recoup a good deal of the principal through foreclosure, so the overall lose might be 5%.

If so then, say, a $100 million pool would be worth $95 million. Factor in the loss of future income when the loan is closed out and you might have another 5% or so per year. Because of the panic these instruments are being valued at half or less of their face. This makes no sense. I'm betting there are some clever investors out there hyping the panic and buying things up at bargain prices. Just look at the Citigroup deal. Sounds like a steal to me.

Those worrying about where the world was going to put their accumulated dollars from the continual trade deficits may be finding out. When the smoke clears much of the US financial sector will be under foreign control.

Policies not Politics
---- Daily Landscape

by rdf (robert.feinman@gmail.com) on Sun Dec 16th, 2007 at 06:27:26 PM EST
I guess this bit by Munchau has some bearing on the issue:

"It is a fully fledged solvency crisis that has arisen because two giant and interlinked bubbles burst simultaneously - one in property, one in credit - leaving banks and investors on the brink of bankruptcy, some hanging on by their fingertips."
by Metatone (metatone [a|t] gmail (dot) com) on Sun Dec 16th, 2007 at 06:41:08 PM EST
[ Parent ]
but you are wildly optimistic if you think the losses are going to be only 5-10%. where do you get that "the default rate on mortgages is not high enough (or even projected to be high enough) to seriously impact the value of the mortgage-backed securities"???

In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Sun Dec 16th, 2007 at 06:42:21 PM EST
[ Parent ]

America's property crisis (Oct 4th 2007)

Nationally, people are defaulting on mortgages at a faster pace than at any point in recent decades. According to the Mortgage Bankers Association, some 5% of all mortgages are delinquent and the share rises to almost 15% for "subprime" mortgages--those lent to people with shaky credit histories. In the second quarter of 2007, almost 3% of subprime loans entered foreclosure (the process of default and repossession). RealtyTrac, a company that tracks foreclosures, reckons up to 1.5m households will enter the process this year (see chart), double last year's figure. And with some 2.5m adjustable-rate mortgages resetting to higher rates before the end of 2008, everyone knows there is much worse to come.




Cracks in the façade (Mar 22nd 2007)
A recent report by analysts at Credit Suisse estimates that 80% of subprime loans made in 2006 included low "teaser" rates; almost eight out of ten Alt-A loans were "liar loans", based on little or no documentation; loan-to-value ratios were often over 90% with a second piggy-bank loan routinely thrown in. America's weakest borrowers, in short, were often able to buy a house without handing over a penny.

Lenders got the demand for loans that they wanted--and more fool them. Amid the continuing boom, some 40% of all originations last year were subprime or Alt-A. But as these mortgages were reset to higher rates and borrowers who had lied about their income failed to pay up, the trap was sprung. A new study by Christopher Cagan, an economist at First American CoreLogic, based on his firm's database of most American mortgages, calculates that 60% of all adjustable-rate loans made since 2004 will be reset to payments that will be 25% higher or more. A fifth will see monthly payments soar by 50% or more.



In the long run, we're all dead. John Maynard Keynes
by Jerome a Paris (etg@eurotrib.com) on Mon Dec 17th, 2007 at 04:12:26 AM EST
[ Parent ]
As we discussed last week; it would be prudent for rdf to read the following link to a California mortgage broker's explanation how all the mortgages sold in the last 6 years will effect foreclosure rates, insolvency etc. Link is: http://blogs.marketwatch.com/greenberg/2007/12/straight-talk-on-the-mortgage-mess-from-an-insider/

Besides the greed factor; these bubbles have been created to mask the inherent weakness in western economies for the past 25-30 years, particularly in the US and UK. When you have a system in which the vast majority of the population-60-70%- have not had an increase in their wages for many years, leads to disastrous effects on our societies.

The fact that comments about the current financial/housing crisis throughout the msm and blogosphere ignores the underlying human and economical problems tells me we can not avoid a meltdown which may be different from the great depression but nonetheless, the consequences will be widespread and painful. Anotherwards, 'NO ONE GETS OUT OF THIS WITHOUT PAIN'

by An American in London on Mon Dec 17th, 2007 at 07:19:27 AM EST
[ Parent ]
An American in London:
Besides the greed factor; these bubbles have been created to mask the inherent weakness in western economies for the past 25-30 years, particularly in the US and UK. When you have a system in which the vast majority of the population-60-70%- have not had an increase in their wages for many years, leads to disastrous effects on our societies.

This is THE key point here. It's the single most relevant way to gut-punch the wave of sleazy, self-serving con-artist crap about reform.

There is no lack of money in the system - even if a fair chunk of it is fictitious, there's enough to still have real value.

But beyond the Anglo Disease we have Anglo Disease squared - another textbook example of explosive economic self-immolation, which seems to be the inevitable and predictable outcome of the 'reform' these snake-oiled chuckleheads are touting as a cure-all.  

Constraining upstream cash supply so it stops circulating among the peasants doesn't just bankrupt the peasants - it bankrupts everyone upstream too.

So semi-socialised income distribution, currency stability, long-term investment and regulations that prevent insane lending and even more insane speculation are the only reliable solutions. They may not be as exciting and hungry as a quarter-by-quarter free-for-all, and a tiny minority of not very interesting people will have to give up their private jets.

But by god, they actually work as good solid economic principles, and are somuch less likely to trash the place than anything we've had since WWII.

by ThatBritGuy (thatbritguy (at) googlemail.com) on Mon Dec 17th, 2007 at 11:55:56 AM EST
[ Parent ]
:-)

Apologies to Robert for joining the mob.

You're forgetting the impact of mortgage foreclosures on CBO market and all the various instruments financially engineered (sic) over the last 20 years.  Most of the latter were leveraged meaning the downside is much worse than the money owed for the mortgages.

She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre

by ATinNM on Sun Dec 16th, 2007 at 07:10:57 PM EST
[ Parent ]
"CBO?"  typo I meant CMO - Collateralized mortgage obligation


She believed in nothing; only her skepticism kept her from being an atheist. -- Jean-Paul Sartre
by ATinNM on Sun Dec 16th, 2007 at 08:21:59 PM EST
[ Parent ]
However, the default rate overall is a quite different thing from the default rate in a particular Collateralized Debt Instrument ... since of course the primary means of meeting the demand for these instruments was in granting mortgages that otherwise would not have existed, some of them will contain a far higher concentration of that 10% default rate.

If the instrument is divided into four equal tranches, and you hold the 25% riskiest tranche a 10% default in the pool is a 40% loss for you ... a 20% default in the pool is an 80% loss. A 40% loss in the pool, which is certainly likely to be seen in many of the instruments that have concentrated the systematic risk of a downturn in the housing market, and the riskiest tranche is wiped out, and the second riskiest tranche has 60% of its backing in default ... and the remaining 40% is the absolute worst risk remaining in the pool.

And consider the higher quality tranches now ... someone bought the second best tranche for slightly better returns than the top tranche while still expecting, absent a meltdown in the housing market, low default risk and low pre-payment risk ... indeed, given that this was rated as an investment grade instrument, you were focusing on the pre-payment risk when deciding between the first and second tranche. But now you are, in effect, mostly holding the junk tranches of the mortgages still standing.

The top quality tranche, which is the best sheltered from default risk, was bought by an institution looking for a rock solid, steady stream of income for a number of decades, and all of a sudden is holding an asset with a clear pre-payment risk, when the returns available to pre-payments is lower than when the top quality tranche was originally lost.

Its lost value across the board ... sure, loss of value in the lowest quality tranches, loss in quality in the highest quality tranches, but still, lost value as financial assets.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.

by BruceMcF (agila61 at netscape dot net) on Mon Dec 17th, 2007 at 05:58:42 AM EST
[ Parent ]
Typical senior tranches go to the 82% watermark. At least, that's the attachment point for which base correlation is quoted. So AAA feels the pain at 18% default rate. Hence the freeze: we are almost there.

Pierre
by Pierre on Mon Dec 17th, 2007 at 10:21:43 AM EST
[ Parent ]
... AAA starts to feel sore before it feels real hurt, because the quality of a tranch declines as the original junk tranches are zeroed out.


I've been accused of being a Marxist, yet while Harpo's my favourite, it's Groucho I'm always quoting. Odd, that.
by BruceMcF (agila61 at netscape dot net) on Tue Dec 18th, 2007 at 06:01:19 PM EST
[ Parent ]

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