Train Wrecks are Train Wrecks

"What investors don't know about why the home mortgage securities market is in distress could fill volumes. As is often the case, only after fiery markets burn out do we see the risks that buyers ignore and sellers play down."

"Because so many players in this world have an interest in keeping risks under wraps, a complete understanding of the mortgage market's ills may take time. Unlike recent corporate disasters that have occurred at hyperspeed - think Enron and WorldCom - the mortgage securities boom seems to be unwinding in slow motion. But train wrecks are train wrecks, even when they occur at a crawl."

'"The problems are far broader than subprime," said Josh Rosner, a managing director at Graham-Fisher in New York and an expert on mortgage securities. Rosner says he believes that, absent a huge jump in home prices, investors will soon recognize that credit quality problems have also begun to seep into "the upper tranches" of the loan market."

"Wall Street, of course, prefers a more upbeat approach. And by the end of last week, many there were celebrating the fact that the indexes on mortgage securities, which had been in free fall, had stabilized. Big brokerage firms also have tried to persuade investors that mortgage woes would be limited to subprime loans - those given to people with weak credit histories."

"But last Thursday, the annual report from Countrywide Financial, a major lender, told a different story. While it confirmed fears about subprime loans - 19 percent of those in its portfolio were more than 30 days delinquent at the end of last year, up from 15 percent in 2005"

- "Countrywide also indicated that the percentage of prime borrowers encountering difficulties is rising. Delinquencies in the company's prime home equity loan portfolio totaled 2.93 percent, almost double last year's 1.57 percent."

"And consider the disclosure last Thursday of American Home Mortgage Investment, a home mortgage originator and investor that specializes in loans to those with middle-tier, not weak, credit histories. As of year-end, the company said, 8.13 percent of its loans held for sale (not investment) were nonaccruing. During the same period in 2005, that figure was just 0.43 percent."

"Investors get little to no information about how lenders work with troubled borrowers and whether those efforts actually cure the problem - or simply postpone the inevitable. As a result, investors do not know whether the default figures they are seeing reflect reality."

"In 2002, the Office of the Inspector General in the Department of Housing and Urban Development reviewed the department's loss-mitigation program and found some disturbing practices."

"Financial institutions that were surveyed from May 1999 to April 2001 in many cases chose to delay foreclosures even when it was obvious that loan workouts would probably not succeed, the study said. The audit reviewed practices from 1999 to 2001, but the practices remain very much in place today."

"Mortgage servicers "are approving borrowers for loss mitigation when, based on the servicers' expertise and past experience with delinquent borrowers, the workout is unlikely to succeed," the report said. "These actions are delaying the foreclosure process, increasing the cost of foreclosure, and subsidizing borrowers who do not pay their mortgage for extended periods of time."'

"The report noted several examples of borrowers who received workouts under truly kooky circumstances. One borrower explained that he could not pay his mortgage because of gambling losses; he received a workout and later filed for bankruptcy protection."

"Academic studies suggest that within the first two years of a workout, re-defaults can approach 25 percent. But there are no publicly available data to analyze the success rates of loss mitigation. And this is something investors sorely need."

"No one likes to face ugly realities like financially ailing borrowers who are so strapped that nothing can save them. Not the lenders, not the Wall Street firms that sell the securities, not even the holders. But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market."