The subprime mortgage debacle has been beaten to death. Everyone and their mom should already have a good handle on what’s been going on. (For you Rip Van Winkle’s out there, check out “Foreclosure Bloodbath,” “Where’s that money, you silly stupid old fool?,” “CDOs: Credit Detonation Obfuscators,” “Grant’s Interest Rate Observations,” and, “Subprime Spoliation.”) There is some evidence, however, that the mortgage trouble is spreading to higher quality loans and the national media hasn’t quite caught on yet.

It has been my belief all along that the problems in subprime aren’t totally due to their credit quality. Lenders have been compensating for credit quality for many, many years with higher interest rates and an array of other precautions. No it’s the types of loans lenders have developed in recent years that are causing the problems. We’re just seeing it in subprime now because it is canary in the coal mine, so to speak.

The real estate bubble led many lenders to let their guard down, in terms of loan products. With permanently rising prices, it seemed, why would anyone default? If they fall behind on their payments they can just sell out at a profit and everyone will be fat and happy. With this mindset, the banks, competing for market share delved into the world of exotic financing giving anyone and everyone all the money they could ever ask for nearly for free (I’m sure those negam loans seemed like free money for flippers at the time). This is old news.

What is new news is it wasn’t just the Subprime guys taking out these loans; there were a hell of a lot of Alt-A and Prime borrowers using these loans, too, and they are now running into the same problems the guys in subprime currently face.

A Bloomberg article yesterday, with the headline, “U.S. Foreclosure Filings Rise 12 Percent in February,” hinted at some of these developing problems. The article quotes a report written last week by Goldman Sachs analyst, Jan Hatzius: “The rise in foreclosures over the past year probably only marks the beginning of the problem… The main reason to expect further deterioration is that house prices are likely to fall significantly in 2007, with further declines possible in subsequent years.”

Schahrzad Berkland, publisher of the California Housing Forecast in San Diego, gets closer to the heart of the matter saying, “People who bought homes in the 1980s and 1990s started refinancing their equity out in the 2000s, so we can’t assume that foreclosures will only affect people who bought their homes in the last couple of years… And a lot of adjustable-rate mortgages were taken out by prime borrowers, so we can’t assume that the more qualified borrowers will be immune to losing their homes.”

But to get the scoop on what’s really going on in Alt-A and Prime you need to ask an insider. Fleck’s contacts have been all over the mortgage meltdown and he relays the latest from a “knowledgeable contact” in yesterday’s rap: “Facts are, subprime loan bulks are fetching a max of 70 cents on the dollar. Two middle-market mortgage banking firms we work with went to bid with $100 mil of Alt-A product they typically get 108-110 for, and the bids came back at 68 and 50, respectively. These are Alt-A loans, much of them option-arm. Not even subprime! The industry is worsening every day.”

It is these option-arms that are the real problem. The markets know this and, according to this insider, are pricing these loans worse than junk. They are a financial avalanche. Just give them some time and they’ll bury you in debt (as they negatively amortize). The sad truth is that there are loads of buried borrowers out there. The subprime guys are just the tip of the iceburg.
LIV

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