Mercury Rising 鳯女

Politics, life, and other things that matter

Understanding the mortgage mess

Posted by Charles II on April 30, 2007

The mess in mortgages is not, basically, a money issue. With modest amounts of money and some serious federal pressure on mortgage holders to abstain from foreclosure and negotiate reasonable terms, it could be fixed. What is characteristic of panics is that unforeseen events lead people to liquidate assets at fire sale prices and cut costs with reckless disregard for future consequences.

The man who pioneered innovation in mortgages has now supplied us with a road map for why there could be a panic in the mortgage market. Via Tanta at Calculated Risk, this is what he said at (raise your irony shields) the Michael Milken conference:

The vast majority of these loans, all of these theoretically, problem loans, are in securities, which have been tranched and then tranched and then re-tranched . . . [in] mortgage securities and then some tranch is put in CDOs. … it became evident that there are a whole host of unforeseen technical problems if you try to restructure or do large amounts of restructuring within the security, some of which, we had never even heard of or thought about.

One of the accountants … raised his hand and said, well you can’t do that. If you restructure that many loans, you’re going to taint the Q election and FAS 140 and what he was basically saying in English for the rest of [us] poor fools, was that there is a presumption when you – when a bank sells loans, into a securitization that it sold the loans . . . And what he was saying is wait a minute, if you guys can restructure all these loans without going back to bondholder, you obviously have control and you’ve just tainted 140 and Q election.

…Well, wait a minute; we have to restructure the loans. The worst thing you can think of is freezing the pool and not being able to do what we need to do … you’ve just basically told us we now have a problem that we don’t quite exactly know how we’re going to fix …

Now, this could become the basis of a panic.  A bank has 100 mortgages, 80 of which are prime mortgages at, say 5%, 10 of which are non-standard terms but considered otherwise prime loans called Alt-A (at say 6%), and 10 subprime loans, which carry high interest rates (say, 10%). The average rate is 5.6%. 

These are then bundled and turned into a security paying 6%, which is sold to a pension fund. That is, the bank sacrifices 0.4% interest in order to get the loans off of its books. If one of the mortgages defaults, then either the bank or the purchaser of the bundled security or a mortgage insuror eats the cost.

But now suppose that the original bundler bundles the security with other securities to create a new security. He could create one with all prime mortgages, one with mostly subprime mortgages, and one with a mix of Alt-A and subprime mortgages. He could then sell the riskier ones to investors willing to accept risk in exchange for higher returns, and sell the lower-paying ones to people who need guaranteed income.

All well and good until it starts to unravel. When a substantial number of mortgages default, who eats the cost?  What Ranieri is saying is that there is no simple way to re-negotiate the mortgages and sort out who pays. It gets stalled in court, in Congress, in the regulatory agencies as the different financial interests fight it out.

This is the stuff of panics.

12 Responses to “Understanding the mortgage mess”

  1. whig said

    All according to plan, I gather now. The Republicans have achieved their mission of scamming all the money out of the system they can, and when they turn over power they want to leave us with nothing.

  2. whig said

    What are we prepared to give them to walk away?

  3. whig said

    I think if we give an inch, they will take it and blame us for the economic depression they caused.

  4. whig said

    They’ve done it before, you know.

  5. Charles said

    I think they want the Depression to start on the Democratic president’s watch. Or to have the Democratic president fail to clean up their Depression.

    They’ve never gotten over Roosevelt.

    Nor Teddy nor Eleanor, for that matter.

  6. whig said

    I think we should declare Renaissance.

  7. whig said

    Major investment in arts, culture, humanities.

  8. whig said

    Just thinking ahead, because right now it’s hard to be creatively focused in a positive way while the Republicans aren’t out of office yet.

  9. whig said

    Also, by financing artistic endeavor we will have more artists, just as by financing soldiering endeavors we have had more soldiers.

  10. Charles said

    Burma Shave.

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