Tuesday, October 23, 2007

Why banks aren't renegotiating defaulted home loans

MSN's Jim Jubak does his normal excellent, reader-friendly job of financial explanation, this time telling why mortgage lenders are so loath to refinance defaulting subprime mortgage loans:

Who has an incentive to work out a deal with that mortgage borrower before he or she gets into trouble? Not the mortgage service company. These companies operate on the slimmest of margins, and any mortgage that requires extra work eats into that profit. Not the mortgage broker, certainly. Many brokers have gone out of business in the housing slump. Those that haven't, having already been paid for originating the mortgage, have no incentive to help with any debt workout. ...

And there's no reason to think that Countrywide Financial is the only mortgage company feeling this squeeze. Remember, 1.3 million subprime adjustable-rate mortgages are due to reset between October 2007 and the end of 2008.

That's much more than the number that have reset in the past 18 months.

More below the fold, including a non-economist reader-friendly explanation of just what these collateralized debt obligations are and how they got started.

Meanwhile, here's a new acronym you'll hear more of: SIV, for structured investment vehicle. It's an attempt to package those mortgage-based collateralized debt obligations into some even newer package.
The SIVs were set up as off-balance-sheet vehicles so that banks could invest in these markets without putting the risk of these deals on their own books. This is especially important for Citigroup, which, as the largest creator of SIVs, is on the hook for about $100 billion. ... By creating this conduit, the banks that created these SIVs — and that are on the line to fund them — avoid having to shell out big dollars or take these assets onto their own balance sheets.

But, because these SIVs, like their predecessor CDOs, haven't been priced on the market yet (amazing how places like banks and hedge funds can scream about capitalism until they get hoist by their own petard) SIVs are moving slowly:
This workout for SIVs and the big banks (and investment companies such as Fidelity Investments and Federal Investors that hold a lot of asset-backed commercial paper in their money market funds) is turning out to be a hard sell. Some big banks and investment companies are balking at the idea of ponying up money to buy risky assets that don't have market prices. How can they be sure, they ask, that the conduit will pay a reasonable price for these assets when there is no public market for them and no accurate method of assessing their risk?

Jubak says this could be very good for mortgage holders, in that it would finally forces lenders such as banks to revisit the idea of negotiating more of their bad loans to where they were still repayable.

Bonus: to help understand what these collateralized debt obligations are all about, Jubak gives an easy-to-understand explanation:
Think about the life history of the average mortgage.

* Some company originates it. That could be a mortgage broker, who qualifies a potential borrower and then puts that borrower together with a mortgage lender, or it could be a mortgage lender itself that also serves as the originator.

* That mortgage is usually then sold to another mortgage company, to a quasi-governmental entity like Freddie Mac (FMC, news, msgs) or to an investment bank.

* After purchase, those mortgages are most commonly bundled into securities, called residential-mortgage-backed securities, that are then sold to investors such as insurance companies and pension funds.

* Even that's not the end of the road for many mortgages because many residential-mortgage-backed securities, a bundle of, say, 1,000 or more mortgages, are then themselves bundled and then re-sliced into pieces of varying risk. These are then sold as collateralized debt obligations (CDOs) that might own as many as 100 residential-mortgage-backed securities, or 100,000 mortgages.

And, columns like this are why I'm a regular reader of his.