» The Sub-Prime Second Wave? II Blog for Trading Success: Ray Barros

Published in December 19th, 2008

By all reports, there is a second-wave interest crunch to hit the US - perhaps as early as next year. If you Google ‘Alt-A’ (Alternative Paper A), Option Arms and Interest Only, you’ll find a ton of information. But before I get into tonight’s piece, let’s deal with what those acronyms mean:

1) Alt-A: A classification of mortgages where the risk profile falls between prime and subprime. The borrowers behind these mortgages will typically have clean credit histories, but the mortgage itself will generally have some issues that increase its risk profile. These issues include higher loan-to-value and debt-to-income ratios or inadequate documentation of the borrower’s income. Investopedia

2) Option ‘ARM’: An adjustable rate mortgage (ARM) is a mortgage loan where the interest rate on the note is periodically adjusted based on a variety of indices. Wikipedia

3) Interest only: An interest-only loan is a loan in which for a set term the borrower pays only the interest on the principal balance, with the principal balance unchanged. At the end of the interest-only term the borrower may enter an interest-only mortgage, pay the principal, or (with some lenders) convert the loan to a principal and interest payment (or amortized) loan at his/her option. Wikipedia

The problem with the loans is their interest rates will either be reset higher or the loan is to fall due and refinance is required. Both events are likely to occur from end 2008 to 2012.

A piece by Scott Pelley for CBS 60 minutes argues that the resets will lead to a second wave sub-prime leading to at least a 50% failure. Pelley’s piece stated that there were 1 trillion Alt-A mortgages and 500-600 billion Option Arms. So we are looking at around 750 billion failures.

BUT, Prof. Samuel Bornstein who conducted a survey for the National Association of the Self-Employed (NASE) argues that the problem is much larger. In the press release of November 21, 2008, he stated that 3.7 million small and medium size business owners own Alt-A and other mortgages; 1.27 are already in technical default by missing one to three mortgage payments. He said that the rest will lead to massive failures.

So next year the US economy will face a second wave tsunami. Can the US government do anything to forestall the crisis? Stay tuned.

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8 users responded in " The Sub-Prime Second Wave? II "

Ana-IDkit said, in December 19th, 2008 at 7:55 pm

Ray

Here is the The Mortgage Meltdown video with reference to your post.

Scott Pelley reports on the mortgage crisis that’s far from over, with a second wave of expected defaults on the way that could deepen the bottom of the U.S. recession.

December 14, 2008
http://www.cbsnews.com/video/watch/?id=4668112n&tag=topHome;topStory

Monica said, in December 19th, 2008 at 8:54 pm

I am amazed that with Japan’s example of living through the lost decade (zero interest rate) and Bernake’s specialty of the Great Depression, that the Fed and the Treasury should know better and apply different remedies. Surely, easing monetary policy to zero is not the answer? Isn’t that the definition of insanity? Doing the same thing and expect different outcomes?

Or are the bureaucrats and politicians ’subtly’ telling us that there isn’t anything else they could do … and that globally that “this is a recession we all have to have? (a la Paul Keating when he was the Treasurer)

Ana-IDkit said, in December 20th, 2008 at 9:43 am

More…gloom and doom from:

Quote:
The President-elect hinted again that the current malaise of the economy could last longer than most people expect. He specifically mentioned ‘years, not months’.

He noted that he places the utmost importance in the economic recovery but declined to give details about the price tag of an economic stimulus plan that his administration is working on.

STUMBLED ON THIS SET OF VIDEOS - CNBC INDIA:

http://www.in.com/videos/watchsearch.php?search_data=ray+barros&x=22&y=19

Cross ref http://awanginvest.com/?p=1019#comment-7446

Ana-IDkit said, in December 21st, 2008 at 9:20 am

Ray

Here is one support from a Darwinian point of view….let us see.

Quote
On Friday, the auto bailout was announced: General Motors and Chrysler will get up to $17.4 billion in short-term loans from the U.S. in return for deep concessions, as the Bush administration cited danger to the national economy. Treasury Secretary Hank Paulson reversed himself, asking for the second half of the TARP fund, some $350 billion. Many observers are asking: who gets bailed out next — and where does it end?

Strategists told CNBC the bailout is going to make things worse; but one airline CEO sees a healthy Darwinian market process.

ray said, in December 21st, 2008 at 9:39 am

Hi Monica

From what has been reported the US seem to believe that the Japanese remedy failed because the Japanese failed to throw enough resources into the breach.

Well you certainly cannot blame the FED of doing that.

As fas as a recession is concerned, we have that. The only question will the FED action cause it to turn into a deflation.

ray said, in December 21st, 2008 at 9:45 am

Hi Ana

Thanks for your contributions.

The sad thing about the US car bailout is some sources are saying the funds are insufficient to help beyond the first quarter. It’s said that all Bush wanted to do was to pass this hot potato to Obama.

Bill said, in December 22nd, 2008 at 1:43 pm

Ray

The whole situation reminds me of those cartoon moments when Wile E Coyote runs off a cliff and hangs in mid-air in time to realize he is about to plummet. Both the Fed and Government are scrambling like mad to prevent a disastrous asset deflation. Like Wile E, it is too late. The bubble has burst and now the asset deflation MUST run its course until the process of de-leveraging has completed. All the Fed and Government will achieve is to re-arrange the risk, shifting the burden to the tax-payer and to prolong the agony. Surely the best course of action (from my highly inexperienced point of view) is to accelerate the de-leveraging process so that it finishes in minimum time. After that, we can get back to the process of pumping that bubble back up.

ray said, in December 22nd, 2008 at 3:59 pm

Hi Bill

Well put. All the government has to do is let the failures happen. In time the system will right itself.

Before I am deluged with e-mail accusing me of being hearltess etc, bear this in mind.

This started off as a ‘normal’ recession. The efforts of Bernanke and Co to save the world from crisis now finds us at the brink of an inflation/deflation multi-decade event.

It’s not a question of saving 100k jobs now but rather a choice of saving 100k jobs now or 10000k jobs farther down the track.

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