Subprime Hearings - HOLY CRAP!

Oh boy........

A few snippets from the hearings today that Chris Dodd's Banking Committee is having on Subprime Mortgages:

Sandra Thompson of the FDIC:
"1.2 Trillion in subprime loans; 14% are delinquent as of 4Q06, and certainly higher now." (That'd be 190 BILLION)
"Interest rates to reset; NEXT YEAR 800,000 ARMs will reset UPWARD."
"Interest rates will adjust upward, not downward."

"We are JUST TOUCHING THE TIP OF THE ICEBERG" - Senator Shelby

"Exotic Loans" was said..... and that ARM comment wasn't Subprime-restricted guys and gals...

"There better be concern for risk" - Shelby

"Why would you make a teaser rate loan to someone with no money down? ..... you have a fee-driven machine..... animal instincts got control of the market....." - Joseph Smith, a bank regulator, explaining that the broker and lenders mark all this up and make money, and how they "sausage" the loans to get them to "AAA" debt tranches (oh boy, can you spell F.R.A.U.D.?) Animal instincts?

"A tsunami of foreclosures is on the horizon" - Senator Menendez (Tsunami? How high is the ground you're standing on there Mr. Investor... and Mr. Consumer!)

"We need to make sure borrowers are qualified and can afford the loans they are given" - Senator Menendez (There goes any hope of these guys being able to refi out - BOOM!)

"We could have done more sooner. What we have observed is risk layering in the extreme; in 2006 risk layering really started to compound..that made these loans unviable." - Roger Cole, Fed Reserve

"Making loans that are unsustainable from the date of inception is an unsafe and unsound practice." (answer to Q from Mel Martinez, sorry didn't get the name of the witness)

"What's happened already has to stop" - Chris Dodd at recess.....

"We think we ought to give people a choice between a fixed-rate loan and ARM for which they can qualify" - Samuelson of Countrywide - but let's not forget what the PR out this morning from the company said: "The company believes that there was overcapacity in the mortgage market in 2004, the company said, and does not agree with federal regulators that borrowers should be approved at the "fully indexed rate" that considers the long-term costs of the loan." (Translation: We don't give a damn whether or not you can make the payments after the first one, two or five years; that's your problem, not ours!)

"One in four Latino homeowners is predicted to lose their home in the next four years.... families have been matched to loans they cannot afford...... they had a stated-income ARM that had income listed at thousands over what they actually made.... the broker sold her the one that was the easiest to process and earned him the highest return..... families are getting matched to risky products without regard to their credit risk.... brokers must be held accountable to the borrowers they serve." - Janis Bowdler, NCLR (and this is just a "subprime" problem, right?)

"The subprime mortgage market .... has been fueled by a complete collapse of responsible underwriting principles... blatant fraud and abuse..... exploitative lending practices...... this fraud-infested market has been producing little social benefit...... unprecedented levels of foreclosure and equity theft happening in full view of banking regulators....... the majority of the loans are to existing homeowners who are being convinced to refinance their debt inappropriately.... the opportunity lies with the broker or lender profiting on the deal..... in fact the subprime portion of the market has been steadily rising; scant little evidence of credit repair..... exploding ADJUSTABLE MORTGAGES WITH TEASER RATES UNDERWRITTEN TO THE TEASER RATE; no evidence of borrower repayment ability; hybrid ARMs needs to be banned..... prepayment penalty locks them in if they discover how they've been scammed and try to get out...... the coming foreclosure crisis SHOULD NOT BE A SURPRISE TO ANYONE......" - Irv Ackelsberg (Consumer Attorney)

"If the hybrid ARM borrowers what DTI would be at fully-indexed rate" - (Dodd Q) Answers: 60% of people would not be able to qualify at the fully-indexed rate (Samuels; CFC); approximately 40% would not qualify (another - HSBC?); Some DTI ratios could be as high as 70% (Mr. Dodd again, claiming he has written testimony backing this)

"Borrowers would have paid a lower rate for a 30/Fixed with documentation than on a 2/28 ARM; would qual at 8.75% on 30/F; 2/28 would cost 9.5%" - Dodd on credit-impaired borrowers and real costs.

"Much of these transactions if you look at them make no sense whatsoever if you look at them from the standpoint of the consumer" - Irv Ackelsberg

"The real market demand here is for bond securities on Wall Street" - Irv

"We are a mortgage lender do not hold ourselves out as a fiduciary to the borrower" - Sameuls, CFC (Oh really? So let me see if I have this right - you have no obligation whatsoever to consider whether someone can afford a loan or whether it is an appropriate product - your only obligation is to make as much money as you can, irrespective of whether it screws everyone you deal with or not! Do I have that right Mr. Samuels?)

"I feel like they took advantage of me because I'm 77; they figured 'oh well she's old and will die soon and we'll take over'" - Ms. Haliburton.

"These teaser rates are a critical bridge for our customers" - quoting an advertisement from one of these originators by Mr. Dodd, now showing that these rates are being used to qualify people on fixed income.....

"It makes the loan affordable" - Mr. Dodd on the teaser rate's purpose to Samuels; Dodd then nails him with the fact that if she was to refi into a prime loan she'd actually pay MORE, and can't qual, because the teaser rate is the only thing she qualifies for!



Now let's distill all this down a bit.

ALT-A is at least three times the Subprime volume. Let's call it $4 trillion in these "ARM/Option-ARM" loans in the Subprime and ALT-A spaces over the last two years. That's probably conservative - the Credit Suisse report, if you extrapolate, looks like maybe as much as $6-8 trillion.

Let's also be conservative and say that the 14% of Subprime foreclosures from 4Q06 won't go up (horsecrap) and that the ALT-A default rate will be much lower; we'll assign a BLENDED default rate of 10%.

That'd be four hundred billion dollars worth of defaults over the next 12 months alone, and the worst part of the ALT-A hard resets won't come until 2008 and 2009!

This is going to be "contained"?

Horseshit.

Second, let's look at Samuels' line of crap about the loan to Ms. Haliburton. A 77 year old woman is going to take a "Prime" loan? On what basis? She's going to mortgage her house for.....what? And if she can't qualify except on a teaser rate now, can she later? That's a big fat NO, even if her credit record improves in a year or two! Why? Because her DTI will actually go UP - she's on a fixed income and the indexed P&I rate on the PRIME loan will always be higher than the teaser rate on the 2/28!

Finally, what may be the most important piece of information out of the hearings:

40-60% (depending on the lender) of all borrowers would not be able to qualify for their mortgage if they were forced to qual on the fully-indexed rate for the product they were offered.

Go back and read this again folks. Then read it again. And again. Let it sink in.

Half of the customers of these firms over the last two years could not afford the house they bought because they could not afford the fully indexed rate on a mortgage - whether it be a conventional fixed product or some form of ARM!

Again - approximately one half of all mortgage originations over the last two years should not have happened at all, and if these rules are put in place going forward, one half of all originations will disappear from mortgage broker's offices and mortgage companies.

Now ask yourself - how many of the companies in this space survive if they (1) have to deal with the inevitable regulation, back-charges and lawsuits that will come out of this in the next year or two, and (2) their income stream from new customers is cut by 50% at the same time.

This smells like ENRON and MCI/Worldcom all over again.

Stay tuned - this is gonna get ugly.

Really ugly.

The worst part of it? Its getting little exposure in the media, and is being played as a "Subprime" mess. Its not. This is a generalized mortgage mess, and the worst part of it is still hidden under the surface.