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November 30, 2007

Subprime: No Farewell to ARMs

You had to know that Feds' leaked proposed plan for bailing out soon-be-reset-smacked homeowners wasn't going to be smooth sailing -- and that's not a bad thing:

Industry executives, market participants and several analysts said implementing any plan would be complicated and riddled with technical and political problems, including possibly encouraging otherwise stable borrowers to miss payments. “If you are a borrower in the group that gets left behind by this scheme, you have a set of perverse incentives to default in order to get the break. It has moral hazard written all over it,” said Don Brownstein, chief executive of Structured Portfolio Management, a hedge fund.

Several mortgage experts also said categorising borrowers would be difficult, given that their financial information might never have been collected before. Also, a large percentage of adjustable rate subprime loans have already been sold to investors who would have to accept lower payments as part of the plan.

There could also be political backlash if any final plan did not help the most strapped borrowers.

[via FT]

As I said on CNBC this morning, if I'm a buyer of distressed asset-backed securities, like Citadel, this plan is a piss-off. It is risky enough buying broken assets, but when those assets have returns tied to government-condoned restrictions on potential rate resets then the market for an already illiquid asset just became a lot less liquid. (And don't even get me started on whether I think we're already over-allocating for losses here.)

More on that point here:

One obvious problem with the proposal is that in many cases, the sub-prime loans in question have already been securitized and sold to investors. And many of these investors could oppose efforts to modify these loans, which are their investments.

"The banks don't own the loans anymore," Harm Bandholz of Unicredit said. "Even if the lenders agree, there could be lots of lawsuits."

Bandholz said investors were expecting loan payments to rise, and any change to the structure of these loans could be opposed by investors who are disappointed in smaller payments.

[via II]

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