Thursday, October 4, 2007

The loans from 06 and 07 are the worst performing in history.

Moody's released a report highlighting the various vintages of subprime mortgages and their default characteristics so far. It shouldn't be a mystery to any of my readers that the worst loans were done right before the bubble popped. The reason being is that these were the last available buyers ("greater fool theory") or the most banged up refinance loan scenarios. The market had scraped the bottom of the barrel to approve people that wouldn't have been able to get a loan but the lenders were letting bad loans fund just to keep the volume up and maintain market share. Lenders who are now out of business which number over 161 according to our friends at the Implode-O-Meter would send daily emails and faxes to brokers advertising how crazy their programs were. It was a game of one upmanship. They then pass the loans to the investment banks like Lehman, Goldman Sachs, etc where they were packaged into billion dollar mortgage pools. The "lenders" didn't really care and the investment banks were just passing off the ultimate lending risk to other banks, hedge funds, and foreign governments. I heard a rumor that China has 300B worth of mortgage paper and a lot of it is subprime. They can't be happy. Maybe that's why they are sending shoddy products over. "You sold us bad loans, here are some badly made toys. Enjoy."

Subprime lending is still functioning albeit at much higher interest rates to compensate for the risk. The difference during the bubble years was .50-1%. Now most subprime investors are demanding 2-3 higher than prime and will only lend up to 85%. The sanity is returning to the market. Two forces in Wall St are fear and greed. The greed will return over the coming months and more products will be available to subprime borrowers but the rates will be much higher than Joe Sixpack is expecting.