Subprime explained

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subprime derivatives

http://www.youtube.com/watch?v=0YNyn1XGyWg&

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1. 26 indicted for subprime fraud

U.S. attorney alleges defendants obtained millions to pay for rent-regulated condominium apartments in Manhattan.
By Zak Sos, CNN assignment editor
July 10 2007: 7:13 PM EDT

NEW YORK (CNN) -- The federal government announced Tuesday a bust in a multi-million dollar subprime mortgage lending scheme and indicted more than two dozen alleged co-conspirators.

Michael J. Garcia, U.S. Attorney for the Southern District of New York, charged 26 people with fraudulently acquiring over 1,000 home mortgages and home equity loans totaling at least $200 million.

http://money.cnn.com/2007/07/10/real_estate/subprime_fraud/index.htm?

NAACP hits subprime lenders with class action suit

http://www.reuters.com/article/topNews/idUKN1140583220070711?rpc=44


S&P finally says subprime is mostly junk

Commentary: New methodology is death knell for the troubled industry
By MarketWatch
Last Update: 12:51 PM ET Jul 10, 2007

WASHINGTON (MarketWatch) -- Standard & Poor's just drove a huge harpoon into the heart of the mortgage credit bubble, and it's going to take a long time to clean up the mess once the beast finally dies.
S&P, one of the three main credit-rating agencies that served as enablers of the subprime-mortgage boom, announced Tuesday that it would lower its ratings on 612 bonds, a small portion of the mortgage-backed securities it had given its seal of approval to. See full story.

http://www.marketwatch.com/news/story/sp-finally-says-subprime-mostly/story.aspx?guid=%7BDFBA4993-031E-4E88-8F56-5B08FD9AA07D%7D&

[A HERETIC I AM]

2. Here is a thread started in GD the other day based on the Marketwatch.com story;

http://www.democraticunderground.com/discuss/duboard.php?az=view_all&address=389x1298452

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3. Thank You A HERETIC I AM

For those of us that missed it....the comments alone are really helpful. We learn from others involved,
their knowledge and advice they share.
I try with my posting and others like yourself sharing information is a real tool to understand what is truly happening in the housing market.

Thanks again friend....:hi:

[A HERETIC I AM]

4. My pleasure. That vid explains how these securities are created very well

and the important thing to remember is that the big problem is the possible change in ratings of the AAA paper.

If you buy BB paper and it's rating changes to BBB or you buy C paper and it goes to CC it isn't really that big of a deal because it is speculative grade in the first place. Upgrades and downgrades in credit quality happen all the time in the bond market but if you buy a mortgage bond in a speculative tranche, you can't really expect an upgrade (or shouldn't, anyway).

In the video, Steve Liesman clearly points out the possible cascading effect of downgrading the AAA paper. If the bond in the highest credit tranche gets downgraded, everything else below it must also adjust downward. Of course, getting 30% returns on a bond is pretty spectacular and that fact still attracts investors.

Just in case the readers aren't clear why some part of a group of sub prime loans can be AAA and other parts can be BBB, this is why it works out that way: Because the likelihood of most homeowners making a predictable number of payments on time is very high. Most new homeowners are going to make timely payments on their mortgages for a specific length of time, generally and the likelihood of them being late or delinquent in say--years 1 thru 3 is very, VERY LOW. So the bonds rated AAA cover the time from year 1 to year 3 (as an example)Years 3 thru 7 see a slightly higher rate of late payments and a slightly higher rate of defaulting. These years are the AA paper and so on. The highest risk is not always years 27 thru 30. It could be years 15 thru 18 because historically, the majority of 30 year home loans are paid off in this time frame because people move, they refinance, etc. Why is this paper rated lower? Because if the loan is paid off early, the bond holder does not receive the expected interest payments. The risk involved that the bond will continue paying regular interest payments and then receiving par at maturity is very high. This is called, understandably so "Pre-payment Risk". The segmenting of a pool of mortgages and issuing bonds on the segments is commonplace. The segments are called a "Tranch" or "Tranche" (The above is for illustration only as I understand these securities and may not reflect an actual tranche structure of a CDO.)

These types of instruments have been around for quite a long time and are not unusual. What is unusual is described in the video briefly - that the ENTIRE pool of mortgages, the the whole CDO is made up of sub-prime loans.

There are many, many CMO bonds you can buy that come from pools made up entirely of loans made to people with perfect credit. They are rated either AAA or "Agency" (because they are put out by the FHLMA or FNMA, for instance and are implicitly guaranteed by the US government) and they pay, understandably so, lower coupon rates than bonds issued from higher risk mortgage pools.

The fact that S&P is downgrading certain tranches and is finally questioning how the bond pools ratings were arrived at to begin with IS A GOOD THING, not a bad thing. Mortgage companies and issuers, me, you, your neighbor and everyone else that needs money to purchase property depends on the confidence of investors, and that they are willing to purchase these securities. And the investors? Are people like me, you, your neighbors and everyone else.