The Market Ticker

There's an interesting article that I ran across this evening dealing with California Real Estate at Inside Bay Area. In it a borrower laments about "discrimination" when it comes to home ownership under the "new, tighter guidelines" for mortgage lending.

Let's break this story down a bit - because it deserves investigation.

This lady wants to buy a $500,000 house.

Under traditional guidelines, you can reasonably buy a home that is no more than three times as expensive as your annual income. So, to buy that $500,000 house, you need an income of $166,000 a year (gross, before taxes.)

And that is stretching your repayment abilities to the breaking point - expert advice has long been that you should not exceed 2.5 times your annual gross income.

What does Ms. Pena do for a living?

She works for a janitorial service.

Anyone care to bet whether or not she has a $166,000 a year income, say much less $200,000?

Do we really need to look any further than this for the root of the mortgage and housing problem?

Ms. Pena, prior to just a week or so ago, was getting approved for her mortgage! Ms. Pena was actually about to get the keys when her loan was withdrawn just days before the deal closed.

I am still in awe of the absolute depth of stupidity in this part of the lending marketplace.

This doesn't rival the 1990 Tech Bubble - it radically surpasses it!

We're not talking about people here who are a "bit" under the qualifying income for a safe loan on that amount of money - we're talking about people who have no prayer in hell of being able to make these payments once a "Teaser" or "negative amortization" loan runs out of steam.

What's worse is that there is no way for these people to refinance, because no matter what was to happen to property prices in the future, the same principle would be due (plus the negative amort) AND their income isn't going to rise THAT much to be able to meet the payment load!

So what were these people going to do? During a radically up market I guess you could buy a $500,000 house using one of these "Option ARM" loans, live in it for a year, sell it for $600,000 (remember, prices were going up 20% a year or more in some markets), pocket $50,000 (remember, there are COSTS involved in buying and selling, plus you have insurance, utilities, etc) and then do it again on another house. If you did this enough times and didn't spend the $50,000 (ha!) I suppose EVENTUALLY you could put down enough to drop the payments where you could afford them - but what you'd be buying at that point might be a shack!

This is the sort of insanity that we have had occur in the real estate market. And while there are some people running around screaming about how we need government intervention to "save" these poor people, let me point the finger where it REALLY belongs - directly at the Realtors and Mortgage Brokers.

There is no possible defense to putting someone in a house that costs more than three times their income, unless they can pay down the principle to that ratio using fully-seasoned cash at closing - that is, not some other form of loan, but cold, hard money!

NONE!

I've done more investigation on this around the country, and this is not limited to California. Indeed, it is happening everywhere.

Indeed, look at "Bankrate.com"; there are the two basic ratios that have been the foundation of mortgage lending forever - 28% "Front End" ratio (that is, your P&I payment, fully amortized, on your mortgage is no more than 28% of your gross income) and your "Back End" ratio (total debt to gross income of no more than 36%)

Lest you think that radically violating these standards is somehow "confined", let me point out a few links readily available on the web that say otherwise:

• Morgan Stanley (yes, the big investment bank) - look at the "Max DTI %" line (ratios of 50-55% are considered acceptable!) - this document has a date of 2/2007 on it!
• Reunion Mortgage (revision date of 3/15 - two days ago - yet still has 50% DTI numbers!)
• Lexington Lending (revision date of 12/1/2006) - 42% DTI permitted.
• Oregon Mortgage (no revision date; claims that DTI ratios over 55% may be approvable!)

It took me less than 15 minutes to find these references using nothing more than a Google Search for "loan to income ratio alt-a". Go check it out for yourself - don't take my word for it.

Every one of the links above is for an ALT-A product list - not Subprime - they all have qualifying FICO scores of well over the 620 level that is considered "Subprime."

These standards of sound underwriting of loans have been radically violated industry-wide for the last five years and this is where the root of the problem lies. This nonsense has resulted in radically pumped up property values as people have been able to "qualify" to own homes that they have no prayer of being able to actually afford.

What's even scarier is that I have anecdotal evidence that even the GSE loans (that is, "Conforming" loans sold off to Freddie and Fannie) have had "Back End" ratios as high as fifty percent in some cases.

If this is true then it is time for Congress to step in and put a stop to it; while they cannot (reasonably) police the private mortgage market, they sure as hell can (and must) step in when GSE firms, which have their obligations guaranteed (at least in theory) by government backing, are abusing industry standards.

No loan with a 50% DTI ratio is reasonable. In fact, it can be reasonably argued that any such loan is by defintion predatory. With the "Option ARM" and other "resettable" mortgages being a part of this mix it is entirely possible to get "after reset" DTI ratios as high as 75 - or even in excess of 100% - ratios that insure the borrower will not be able to make the payments! Yet these loans are being offered today - not just historically before "credit tightening" has occurred. I cannot imagine what was considered "acceptable" before the "tighter" revisions were made earlier in the month!

Anyone who thinks that we're going to get a "soft landing" in the housing market, or that the current damage is going to be confined to "Subprime" borrowers needs to have their heads examined.

This is going to hit the entire mortgage marketplace from Prime on down, and with the prevalence of these products, consisting of up to half of all loans written in 2006, we had better be prepared for an absolute financial tsunami!

I am not normally an alarmist when it comes to financial matters, but the deeper I dig into this the worse it smells - and no, folks, the bankers have not fixed the problems since the meltdown first became apparent.

What? I thought those were a new product of the 2000 decade to help people buy bigger and better - or in some cases, any home at all - as prices escalated rapidly?

Well, yes.

But here's the ugly little truth - "Option ARMs" did indeed exist in the 1990s. They just weren't called that, and weren't offered to home buyers.

They were offered to businesses.

This afternoon, after the markets closed, I was outside working on my lawn sprinkler system. It got damaged pretty badly by the hurricanes over the last few years, and really needs a new pump and, while I'm out there doing it, I may as well make it state-of-the-art with electronic controls and all (after all, that my thing - I'm an electronics and Internet geek 'ya see)

Anyway, while I'm wielding the Sawzall and cutting out all the old and crusty pipe so I can fit the new stuff, it suddenly hit me like a ton of bricks.

In fact, I nearly cut off one of my fingers the revelation came so hard and fast.

In the 1990s we had this company called Lucent. You might remember them. Here's a chart:


Now back then you will note that their stock was trading at $60 a share (split-adjusted for today, of course).

On November 30th, the last day they traded on the NYSE (they have since merged with Alcatel), they sold for $2.55.

What happened?

Simply put, Lucent wrote "Pay Option ARMs" on their hardware.

Lucent was one of the big "success stories" in the Tech Bubble. But they weren't a company selling some euphemistic service or with some crazy business plan that made no sense. Indeed, they were in one of the "safest" spaces of the market - so everyone thought.

Lucent manufactured telecommunications equipment. Once part of Bell Labs, the inventors of the telephone, they were spun off as an independent company. Lucent was the "hardware part" of the old AT&T Bell Labs, and was one of a handful of companies that made network equipment that all the Internet companies - including my firm - needed to operate.

Well, companies of course needed all these routers, switches, and other equipment. Lucent stood ready to provide it. But many of these new firms didn't have a lot of money to spend on hardware up-front.

So Lucent came up with an innovative plan - they sold you the gear on a long-term capital lease, and allowed you to pay only the interest on the lease, or in some cases, even less than the actual interest! The deal was that when your cash flow improved, and you became profitable, you could pay off the principal on the lease and/or just buy the gear outright.

Doesn't this sound suspiciously similar to what's going on right now? It should. It's exactly the same deal that has been offered to all these homeowners - pay less than the interest cost and/or the fully amortized cost of the hardware now, and when your economic situation improves, which we're sure it will in a few years - you'll have less debt, you'll have a better job, whatever - you can pay off the principle or roll it over into some other form of financing.

What happened to Lucent?

Winstar happened, among others. Winstar was the firm that acquired my company, MCSNet. A couple of years later Winstar ran out of money. See, they couldn't make the payments - oh, they had lots of customers, and lots of cash flow, but they were spending more than they made.

That sounds suspiciously like the homeowners that bought these "Option ARM" loans too, doesn't it?

What happened? Well, Winstar, along with other companies, went under! Lucent was forced to recognize billions of dollars in losses from these deals that stopped performing. To be sure, it wasn't just Winstar (ICG was another bankruptcy of the time) - but Winstar held an incredible amount of Lucent equipment - and thus, debt.

There are lessons here for the Mortgage space.

We've seen this game before - negative amortization, "interest only", all that.

This "feature" in financing really isn't new, and we already know how this story ends!

What's really ugly is that when Lucent blew up it took less than six months to fall from $50 a share to under $5. And, just like the lenders in the ALT-A space today, the first downstroke in their stock price was about 25%, the stock recovered for a few months to within 10% of its previous high, held that with considerable volatility for a few months, and then fell completely out of bed as it became clear that their loans were non-performing and never would be paid off!

Now explain something to me folks -

With anywhere from 30 to 50% of all loans originated in the last year in the "ALT-A" space being these "Option ARM" loans, and with the fact that we know how this story will end, because one of the biggest equipment manufacturers of telecommunications equipment in the world was nearly bankrupted by doing this very same sort of financing, why is it that nobody in the financial media is talking about these mortgage companies doing the VERY SAME THING that nearly bankrupted one of the ICONS of American Industry?

What's an "Option ARM"?

Its a loan that is also known as a "negative amortization loan". That is, you have "options" as a borrower. You can:

• Pay the full principle and interest every month (what conventional mortgage folks do)
• Pay only the interest due and ignore the principle
• Pay LESS than the full interest amount, based on a lower rate (usually a "teaser" rate) and allow the rest of the interest to be put back into the principle.

This is a popular product for people who can't qualify for mortgages with the full P&I payment. Why? Well, it cuts the P&I - often by half or even more over a fully-amortized product.

The problem is that these loans typically all reset interest rates in either 1 or 2 years, and what's worse, when the negative amortization reaches a limit - typically 110% of the original line - they "hard reset" - that is, you get both an interest rate reset AND you must make a full P&I payment from that point forward.

This event basically always causes your payment to double if you were paying the "minimum option", and it can cause it to TRIPLE in certain cases, especially if you go all the way to the wall and interest rates have risen since you took the loan!

Many people who took these loans did so expecting to refinance out before the "bomb" went off.

But this is kinda like taking a box of dynamite for someone and being given $1,000, lighting a long fuse sticking out of the box, then driving around in your car looking back in the mirror every few minutes to see how much fuse is left.

All the time you're betting that SOMEONE will want that box of dynamite at a price that lets you keep some of that $1,000 - before the fuse runs out.

And oh, by the way, its waterproof fuse and wrapped in kevlar - you can't put it out nor can you cut it short.

What happens to you as the fuse gets shorter? The bids get higher. When you've got an hour's worth of fuse left, the guys tell you "I'll take that box of dynamite for $500 from you". You say "naw, I want more." Then there's 15 minutes left, and its "I'll take it for $250". Naw.....

Then you get down to 5 minutes of fuse left and the only guy who will take the box wants you to pay him $5,000. You don't have it. At three minutes, its $10,000. You don't have that either. With one minute to go, that box suddenly will cost you $100,000 to get rid of.... which of course, you don't have.

You end up sitting in the car saying "f%%% me!" as you watch the fuse disappear inside.....

Just in the last couple of months these loans have started to hit the hard caps and reset. This is totally under reported right now and it is not limited to the "subprime" market. Indeed, most "Option ARM" loans are written for people with VERY GOOD credit!

Virtually EVERY lender has a significant portion of their loan portfolio in these "Option ARM" products. Some are as high as 30%, but there are very, very few lenders with insignificant (below 5%) exposure to this "bomb."

What happens if you can't refinance because your loan-to-value is too high? You're screwed. You either make the payments or your house goes into foreclosure.

This is what I was alluding to yesterday.... and why this "subprime" thing is being grossly misreported.

This is NOT limited to "poor credit risks".

Disclosure: I'm short or hold PUTs on several companies in this sector.

The comments on my last "Wall Street Manipulation" post have certainly come in fast and furious.

Some of them, from the Mortgage Brokers (so they say; all anonymous) are particularly amusing, and demand a response.

Let's look at how we got here guys.

Home values have appreciated at rates that dramatically exceed individual's growth in salaries.

Of course home value expansion significantly beyond the rate of inflation must eventually cause people to be unable to afford houses. The "why" on this isn't particularly difficult to figure out, but for those who were educated in Government Schools, let me lay it out for you.

Let's say that your salary goes up 3% a year. If home prices go up 6% a year, then you might think this is a great thing if you own a home.

But if you don't own a home, then it sucks, because as the price creeps up faster than your salary you find that your payment gets bigger and bigger, while your salary goes up less quickly. And what's much worse is that as your salary goes up your tax bracket does too, and this takes a bigger bite as well!

In many of the home markets values are more than quadrupled in the last ten years.

Salaries, of course, have not grown at that sort of rate - they've grown in the 3% range annually.

So what has the mortgage and homebuilding industry done with this?

Rather than hold down prices for new homes and take a "reasonable" profit, they've done what any good capitalist would do when faced with too much money chasing too few goods - they've raised prices and pocketed the money.

But there's a problem here.

In order to do that mortgage lenders have had to violate principles of good loan underwriting that have existed for more than 50 years!

That is, in order to "find a butt for the seat", they've had to change the rules.

After the 2000 tech bubble explosion this was made quite easy by near-zero money cost from the Fed. This meant that with virtually any interest rate you made money, since the (short term at least) interest rates were close to zero. This, by the way, is the same game that is being played out right now with the Yen "carry trade" - Yen are basically free to borrow, so you can borrow them there and then use the money to buy interest-earning things here - heh, "Free money" shout the traders.

Uh huh. All the way up until you realize that you sold a mortgage that has a 30 year horizon at an interest rate below where it will remain for the entire 30 years!

To control that risk, banks, which used to hold mortgages on their own, started "securitizing" these loans and putting in tricky features to control that risk.

That has allowed the banks to get away with this. See, banks have FEDERAL guidelines they must maintain in terms of loan safety. Why? Because the FDIC has to bail out banks that fail! Remember the S&L crisis? That was caused by S&Ls making risky loans that couldn't be repaid. Banks know all about this stuff, and they're very cognizant (since there was a blowup in their sector among the thrifts) of what happens when you do that.

So to keep their feet out of the frying pan, they figured out a trick - they shoved off the mortgages to the general debt market! Adding to this the mortgage folks figured out that they could take a "bucket" of mortgages, sift them into baskets that were categorized by loan-to-value and FICO score, assign those a risk premium and then sell them in the market as "tranches" of debt - essentially, converting the mortgage to a bond. By doing this the bank is (mostly) insulated from the risk that you won't repay the loan, because once any recourse written into the contract has lapsed, the risk passes to someone else - the bondholder.

And from there we got Option ARMs, 2/28 ARMs, 95% CLTVs and other tricks. We also got a "relaxing" of one of the most important lending guidelines, and one that used to be nearly inviolate just 10 years ago - the 32% mortgage debt to income, and 36% total debt service to income ratios.

This has allowed people to keep buying homes.

But unfortunately, what it has also done is made those home loans unaffordable in the "out years" - more than a year or two after origination.

Why? Because the concept that these loans would last "just a couple of years" and then people would "clean up their credit and/or improve their income and refinance into a conventional 30 year fixed" was a farce - and an act of fraud.

The mortgage bankers and real estate agents know the truth, even if they were educated in government schools. You can't shove 10lbs of crap in a 5lb bag. It doesn't fit. By artificially holding down the payments for a couple of years all you've done is shift the pain to the later years, with a totally unrealistic view of where that borrower's income will be in those years.

What every one of the folks that has sold a house or loan with other than a fixed-term conventional loan - other than a 15 or 30 year, or at the outside, a 5/1 ARM - has done is screw the buyer. Every time. They've made money by bending the buyer over the table and taking turns, because the entire basis of that borrower being able to either refinance out or pay off the loan depends on the continued asset inflation of the house - a pattern that they KNOW must, at some point, end.

This charade worked through the early years of '00 because home values rose fast enough that even with negative-amort or interest-only loans, or "fancy" CLTV ratios, the house appreciated in value enough that if you got in trouble you could roll it over and do a quick sale to some OTHER sucker, who would then repeat the process and do it all over again!

But eventually all such charades must come to an end.

Now, the end is here.

Home values are actually going down in many markets, especially Florida and California. The economy in places like Michigan is in the TANK, particularly around the Detroit area, as automakers fold back their operations and people's real income goes down.

Just last night PMI, one of the big "mortgage insurance" companies, released a report saying that "92% of their portfolio was to people with FICO scores of 620 and above", in a bald-faced attempt to reassure people that their exposure to subprime was "small".

The nasty truth is that this little ditty said exactly nothing about their real risk of default, because a FICO score of 620 has a roughly 1 in 10 chance of default, a FICO of 700 has a roughly 1 in 100 risk, and a FICO score of 800 has a roughly 1 in 1200 risk. That is more than a 100:1 ratio of risk, and yet PMI's press release and presentation said NOTHING about WHERE in the range of 620 to 800+ their distribution lay!

Reassurance? Baloney! If anything that ditty was the best argument for shorting PMI I've seen in the last month!

Here is reality folks - until home values regress to the mean growth rates, this problem will not and cannot end.

What needs to be done? A few things, most notably:

1. The policy of qualifying borrowers at "teaser" rates and under "minimum" payments for Option ARMs must end. These borowers must be qualfiied under the fully amortized and expanded P&I payment and, if they cannot qualify under those rules, their applications must be denied!
2. LTV and CLTV numbers over 80% must come with a PMI requirement on the entire loan balance, irrespective of whether that 80% ratio is violated by a first, second, or HELOC, and when the violation occurs. No exceptions! This will force the PMI companies to properly quote the actual risk associated with default and cover it.
3. Debt to income ratios must be restored to historical underwriting guidelines (36% maximum debt service to income) at the time of loan origination. If you can't qualify under these rules, you can't afford the house!
4. No recourse securitization must end. There is no way to curtail fraud if you can pass the buck to someone else and stick them with the lack of a seat when the music stops. As a result the law must change so that if the foundation of a given loan's claims is proven false, recourse extends all the way back to the originator! This will stop the "liar loans" dead in their tracks (stated income inflation), it will stop the CLTV scam with "silent" seconds and unseasoned down payments, and it will stop appraisal inflation - all three of which are major components of the problems in the industry today.

These changes will come with a cost. They would have removed 30-40% of the last half of 2006's origination traffic if they had been in place then. That sounds nasty but the truth is that until the asset price inflation is corrected, there is no fix for this problem, and the only way to solve asset price inflation is to increase supply and decrease demand!

If you're in the real estate business, whether as a Realtor, Mortgage Banker/Broker or otherwise, you've contributed to this stupidity - you are going to have to take some of the pain. And pain it will be - perhaps extreme pain for those of you in overheated markets.

But without these structural changes and the pain that comes from them, we face the stark reality that even PRIME loans written in the last few years are not safe.

Update: Consumer sentiment numbers are now out, and they are down below expectations. What's potentially really bad is that the worst deterioration is among people with high incomes - the folks who spend money and keep the economy going. People are figuring it out guys.... the chickens are home and they're starting to squawk!

Disclosure: I'm either short or hold PUTs on several stocks in this sector at present. My money is where my mouth is.

What a wild ride the last week or so in the markets.

Up 100, down 100. Up 200, down 200. 300 point swings in a day.

This is all blamed on the "Subprime" mortgage market. And that, my friends, is a lie.

Quick education here - "Subprime" loans are made to people who have spotty credit. If you made a few late payments on your credit cards, have a lot of debt on them and little assets, or simply have next to nothing on your credit report, you're "Subprime." These folks have over representation in the minorities and the working poor, but this isn't really about race.

Its about credit quality, and with risk comes higher potential rewards.

But here's the 900lb gorilla in the room. Its what is called "Alt-A" mortgages, and you know what they are. They're advertised on the radio every day. "Quicken Loans, a rate around 5%" (as just one example.) You listen to the radio, you've heard 'em. And at the end is the disclaimer (APR 7.5%) - buried in the quick speak.

The underlying problem here is that starting with the 00/01 crash in the tech stocks the Fed got very aggressive in cutting rates - down to levels that had never been seen before. 1% Fed Funds. Unheard of. This created an explosion of liquidity, because bankers could borrow money short-term for 1%, lend it to you at 4 or 5%, and make an incredible amount of money.

And lend it they did - but they didn't take any long-term bets at that price. Why not? Because the Fed Funds rate is an overnight deal - it can change any time.

So what mortgage bankers do is write your loan, hold the loan for a short period of time, package up those loans into what are called "tranches" and sell them on the marketplace. Hedge funds and big investment banks - Goldman, Morgan Stanley, Merrill Lynch - they're the buyers. This is how the mortgage originators manage THEIR risk - that of a big hike in interest rates that puts their investment underwater.

Now here's the problem.

The ALT-A market is in fact more risky than the Subprime! Why? Because the percentage of these loans is huge compared to the Subprime. Countrywide Mortgage, widely thought of as a "prime" mortgage lender, in fact did nearly half of their business in these "Alt-A" products last year. They push these products hard because they're very, very profitable - when things work out.

What's worse is that these products have been pushed as "debt consolidation" loans. "Pay off those high-priced credit cards" scream the ads. Yeah, right, and risk your house!

But now we've got a problem. House prices are stagnant or actually declining in many places in this country. And these "Option ARMs" have a bomb built into them - they capitalize the unpaid interest back into the loan, raising its principle value. When the interest rate resets, and this is just starting to happen, the effective rate (when computed on the original loan balance) of many of these loans will reach 12%!

TWELVE percent guys. Interest rates last seen when Jimmy Carter was President.

You remember those days, don't you? I sure do. The market - and the economy - were in the TANK! Why? Because borrowing money was insanely expensive and inflation was high too.

Now here's the REALLY bad news. All of these mortgage companies book profits when you carry back "option interest" as additional principle! How's that, you ask?

Well, its actually quite legal, even if tricky. See, your balance went up, and they expect you'll pay it. Since you originally borrowed $X, but now owe $Y in principle, they book that as "free money" - profit - on the deal.

This of course assumes you actually pay it back! If you don't.......

There is no good news here folks. In fact, its all bad news.

And what do the "Talking Heads" say on CNBC and the other "news" outlets? The same thing they said as the Tech Crash was about to get underway, but the first companies were just starting to get in trouble.

"Its contained."
"There is no underlying problem."
"This is just a short-term correction (in the housing market)."
"We are 'untroubled' by our exposure to subprime."

Yeah. Anyone remember 1999?

Here's the deal folks.

All those folks who took out HELOCs (home equity lines of credit) did not cut up their credit cards. They just paid them off using the HELOC, but kept spending. This was ok when your house value went up faster than the interest that you imputed back into the loan using those "option loans".

But now the price appreciation in the house has gone to zero, and that imputed principle is actually additional debt!

In many places these loans are actually underwater right now. That is, you owe more on your house, all up, than its worth. And some of those states are "zero recourse" - that is, you can walk off and hand the mortgage company the keys, and while they will trash your credit rating they can't sue you.

People know this, and they're exploiting it. How? Well that's cute too. Many folks, facing a crushing blow of debt via an impending reset they KNOW is coming, are doing the following:

Let's say you have a $750,000 house. You took a first mortgage as a "2/1 10%" ARM, which is a common ALT-A product. Its cheap because the interest rate is only locked for two years, then it floats at LIBOR (a commonly used interest rate benchmark) plus some percentage. You then took an "option interest" loan for the rest (down payment, what's that?) or even better, you borrowed the downstroke somewhere, then paid it back using a "silent second" - a Home Equity line (HELOC) that had an "option interest" feature.

Well, now the chickens are coming home. Your house has actually depreciated in value by 10% because, well, nobody's buying right now. So you have a $750,000 house with a $750,000 mortgage but the house is only worth $675,000! What's worse is that the interest rate is about to reset 2% up from your "teaser rate", and you know you can't make the payments three months from now.

So you shop for a $500,000 house (remember, its a down market!) You qual for that mortgage (your FICO score is still quite good, as you haven't blown a payment yet) on the basis of selling the OTHER house. You get the loan on THAT house, but its an ALT-A product too; you simply lie about your income, and since its a no-DOC loan and your FICO is in the 650 range, it goes right through.

You move in, then default on the original $750,000 loan!

This is happening all over California, and the bank is left holding the bag!

Note that NONE of this is happening in the Subprime space - its all in ALT-A!

And virtually ALL of the lenders are exposed to the ALT-A mess.

This hasn't gotten any press at all, but it will in the coming months. Mark my words. The resets from 2005's "peak of the bubble" are just starting on these loans - close to 20 percent of all mortgages out there are ALT-A products right now, and 50% of those written in the last two years! Essentially ALL Home Equity lines fall into this category!

Now sure, not all of the HELOCs are going to default. But historically, less than 1% of all mortgages ever go into default. Right now we have the highest rate of defaults in history, and we haven't even started with the ALT-A products yet.

This is the story that hasn't been covered folks.

Come back here in six months - I'll remind you right here - when the true pain begins. This fall and especially this coming winter, its going to be a big story, and the REAL risk to the economy is going to come from this angle, with no real way for the Fed - or anyone else - to bail it out.

Mark my words.

What can you do about it? Be careful. If you're invested, you need to be paying attention. If your time horizon is 20 years or more, then none of this matters much to you, because this, like all other business cycles, will work its way out.

But if you're within 5 years of retirement I'd be thinking about a very strong bias towards fixed income. There is a serious risk of a 20% to 30% decline in the market - similar to what happened in 2000-2003 - and once it starts it will accelerate in a huge hurry. When the losses begin to be realized you're going to have a lot of people who will suddenly get religion, and the selloff is likely to be extreme and protracted.

Now of course I could be completely full of it.

But I don't think so.

Statistics supporting the above:

1. Conbined "loan to value" on ALT-A purchases in 2006 was 88% on average, with 55% of buyers taking out a second at the same time as the purchase.
2. Low or no-documentation (stated income) loans were 81% of total originations.
3. Interest only and option ARMs were 62% of purchase originations in 2006.
4. 1-year hybrid ARMs were 28% of ALT-A originations in 2006 (these loans reset in just one year!)
5. Investors and second home buyers were 22% of ALT-A purchase originations in the last year.
6. Approximately 40% of purchases in 2006 involved second mortgages taken at the same time as the purchase. This is important because these "piggybacks" are how you get around loan-to-value restrictions! While the industry has tried to say that this is primarily a subprime thing, THAT IS A LIE - 55% of ALT-As had piggypacks in 2006!
7. TWENTY FOUR PERCENT OF ALL NEW ALT-A ORIGINATIONS WERE INTEREST ONLY OR NEGATIVE AMORTIZATION IN 2006!