Are We Nearing the End of the Subprime Follies?

Posted on March 26, 2008
Filed Under Economy, Mortgage Smarts | Leave a Comment

About a year ago, I started writing about what I saw to be looming problems in the mortgage industry. Check out my related posts on The Real Problem With Subprime Loans and this mortgage come-on in Mortgage Madness – Homebuyers Beware.

Within a few short months, things really started downhill and had tanked pretty well by the end of 2007. You can read more at imploded mortgage lenders where they track all the lenders that have folded since late 2006. So far, were at 246 – and counting.

Are we at the bottom? Probably not, but getting close. There’s certainly more trouble on the horizon. We just won’t know for sure until after it happens because all one can do is guess how many folks will actually default.

Okay, that’s not entirely true. We can probably assume most all of the subprime adjustable rate mortgages waiting to reset to higher rates, will end up in default because as the feeding frenzy was reaching it’s peak, the business being written made less and less fiscal sense.

According to this recent article, we should see ARM resets peak during the next couple months.

Nationwide, 1.5 million subprime adjustable-rate mortgages will reset to higher interest rates this year – with May and June being peak months, said Rick Sharga, a spokesman for Realty Trac, an online marketer of foreclosure properties.

Many of those borrowers are vulnerable to foreclosure either because their monthly payments will become unaffordable when the rate changes, or they already are having trouble making their payments.

Foreclosure filings typically are issued after a borrower has been in default for 90 days. Those borrowers then usually lose their home within three to four months if they can’t work out a deal with the lender or find a way to pay what they owe. Translation: Those whose loans reset in May and June could be in the foreclosure process by September and lose their home by the end of the year or early in 2009, Sharga said.

Not sure I entirely agree with this being the peak. It may be, but based on the most common reset periods of 2 and 3 years, I would give it until Spring of 2009 before saying we’re past the worst. It certainly won’t be over, but having seen the worst, the remainder could be more accurately estimated.

Why is this important? Because this isn’t just about people losing their homes…. Since those mortgages were bundled up into securities and traded on the open market, there’s a lot of mortgage backed paper out there that no one quite knows how to value. That has contributed to the current credit and liquidity problems.

Right now, it’s all being treated as junk, and much probably is. The write-downs have been huge and the impact to large investment banks catastrophic. Note Bear Sterns, who went from being one of the biggest players in subprime, to near-bankruptcy.

Had it not been for JP Morgan, with the backing of the Fed, buying them up at a fire-sale price, Bear would now be history. But as I said earlier, all that paper isn’t junk, and at pennies on the dollar, JP got a killer deal – especially with the Fed taking on the lions share of the subprime risk.

It’s hard to feel sorry for Bear Sterns though. At the heyday, they made a killing with some top traders pulling in 8 to 12 million in salary. But that’s just the top. The folks I do feel for are the other 14,000 or so employees that not only lost their job, but a substantial portion of their retirement that was invested in company 401k’s holding Bear stock.

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