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Alt-A and long term debt



April 01, 2008 – Comments (5)

Some of the headlines are claiming the write-downs and the end of the losses is near.  Anyone that has looked at the graphs around the Alt-A paper knows that simply isn't true.

Mish has been tracking one sample of Alt-A paper from WaMu. It is paper that is less than a year old and already has a quarter behind 60 days or more.  Half the deliquent loans are in foreclosure and already the bank owns 4.4% of the properties.

Alt-A isn't making the headlines that it ought to, and these things have huge reset rates over the next two years.

Mish makes a claim that the data on the one he is following shows evidence of people just walking away.  In a way, I view that as positive.  It means that some of the problem is being dealt with now rather than one or two years from now when their mortgage resets.

A few posts back I linked to a piece on how the actual contract on these Alt-A mortgages are linked to a set of bank rates and Citibank was trying to scam customers into signing customers into longer term contracts at over 6% when currently the contracts specify 4-5%, the prime of a few places plus 2-3%.  If this hit the headlines big time people with these kinds of mortgages trying to save their homes might try and get locked in now and save themselves a heck of a lot of grief. 

But, I suspect if enough people get locked in long term at these lower rates the banking system will remain in trouble for years.  I've said it before, America has an insane banking system in that it does not require matching of deposits to debt by length of term.  But then, that is what the securitization of debt is all about, passing on the risk of rate changes from selling long term debt and financing it with short term money. 

And this risk is showing up all over the place, failed auctions so gee, that 30-60 days you intended to hold paper not due until 2049, well, now you either have to hold it, or sell it at a price that gives it a higher effective yield. 

I have a friend that has a wide range of investments and in January I was warning him to make sure he wasn't holding any long term debt, or treasuries.  30-year paper even in good business or excellent credit areas can still easily plummet to half price.  The leverage of changing yield is enormous when there is such a long maturity date.  For 20 years there has been someone to step up to the plate and always buy this stuff, but people have finally figured out that it isn't as easy to sell when people start pricing in the risk of not finding a buyer and that they are only getting 3-5% for potentially having their money locked up, well, in some cases, probably until after they're dead.

In Canada the banking system does not take on the risk of 30-year mortgages.  You might call all mortgages in Canada resets because the rate is constantly reset to reflect current rates.  You decide if you want a floating rate, or a term of anywhere from 6 months to 10 years where the rate is fixed.

This is a piece of a puzzle I am just putting together, but historically in Canada you always got 1-2% more on bank deposit rates by locking in for 5 years over say 1 year.  The spread between locking in 1 year and 5 years seems to have disappeared in the last few years.  It might be a quarter percent these days.  I recently read a paper by Canada Mortgage and Housing, and it said Canada's banking system was far more secure around mortgages because of the vertical integration, ours tend to hold the debt, but somewhere in another section, it mentioned how Canada had started to securitize mortgage debt in the past few years.  I am betting that's where the spread of interest rates between 1 and 5 years went. 

I am grateful the US bubble has burst and investors are more wary of the paper they buy because it means that Canada will have less consequences to deal with from this insane practice.

5 Comments – Post Your Own

#1) On April 01, 2008 at 9:08 AM, dwot (28.84) wrote:

My reading today...

I love Big Picture's post today on Paulson's regulations.

Bank fog clearing, yeah sure. You've proven yourselves so honorable, we can believe you this time.

I think I already linked to this one on private equity via Financial Armaggadon, but it is worth linking to again, this time with Yves' assessment

This one I haven't read this one of Yves yet, but title, Were risk models and bank regulation destine to fail, has me thinking, don't me started on this one, especially the opening paragraph:

"Avinash D. Persaud gave a speech to the Committee of European Securities Regulators (posted at Willem Buiter's blog) that argues that banks' risk models and regulation based on market based pricing were bound to fail. That's a very bold claim, yet Persaud appears to have the goods"

A bold claim?  All you needed to avoid this mess was a grain of common sense and I swear, an infant has more in its baby finger then these so called experts, or legalized conmen.  I got serious about investing in 2006, but over perhaps up to two years prior my physiotherapist was talking about these crazy subprime mortgages that the US was issuing.  He has had most of his money out of the market since 2005.  Anyway, I didn't know all the details, but I was shocked by what he was saying about the terms of the mortgage and the no money down.  I worked in banking through a home loss period and I have been of the opinion that anything less than 10% down should be outlawed forever.  I didn't know anything about the securitization process or all the other garbage like actually having the ability to repay the loan...  I completely disagree that it is a bold statement to say that they were "bound to fail," each new detail I have learned in this journey has me constantly stunned with, "they did what?! You've got to be kidding."

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#2) On April 01, 2008 at 9:23 AM, dwot (28.84) wrote:

Can this make me laugh, or what, financial stocks up in pre-market?  Bottom fishers unite, there are only so many falling guillotines to catch...

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#3) On April 01, 2008 at 9:40 AM, dwot (28.84) wrote:

My stomach is twisting...  I feel ill...

"In other words, changes in the money supply are no longer governed by changes in the monetary base."

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#4) On April 01, 2008 at 9:51 AM, Gemini846 (34.11) wrote:

I feel your pain. I started stabbing out at small cap banks this morning but there are too many. I ran out of tickers to rate and still have half a page :(

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#5) On April 01, 2008 at 2:30 PM, dwot (28.84) wrote:

In my blog I mentioned Citigroup scamming customers trying to get them to lock in long.  Mish has a post that explains very well that some of these arms will reset lower.  This will be a loss for the banks, but that's the legal contract.

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