Pandora’s Box – Prime Mortgages May Get Transparency

Posted on December 20th, 2008 in Daily Mortgage/Housing News - The Real Story, Mr Mortgage's Personal Opinions/Research

Everyone says ‘the market is dysfunctional and irrational’ when referring to performing/non-performing whole loans and mortgage backed bonds. This is absolutely not the truth. The market is fully functional at the right price.

At the right price, there are plenty of funds who will buy hundreds of millions of loans and MBS’s and do the right thing with them. I personally know of many. Vultures do not kill things, they clean up the mess. We should be relying on the distressed players more in the clean-up of the mortgage mess.

Most loans, even ‘Prime’ 30-year fixed with 20% down, made from 2003-2007 should have been classified as ‘exotic’ at origination.  This is mostly by virtue of the extremely lax underwriting guidelines that allowed things such as 50% debt-to-income ratios, qualifying at the interest only payment on an ARM (that will turn fully amortized at some point in the future), stated income, high CLTV second mortgages, etc. But due to a skewed sense of risk, everything but the very worst got dumped into the ‘Prime’ bucket, including most Pay Option ARMs.

Most loans made during that time are definitely ‘at-risk’ and exotic now.  In addition to the list above, this is mostly due to the amount house prices have fallen.  The majority of home owners in the highly populated bubble states are in a negative or near-negative equity position, rendering them unable to refi or sell. This promotes default and/or walking away. Throw in the macro-economic conditions, and most mortgage debt created from 2003-2007 is a high-risk play regardless of classification.

Most banks that own whole loans and MBS that have not been publicly attacked by the raters still have them valued at face in the case of whole loans or through a discounted cash flow model in the case of a security. They are doing this despite the fact that they get back only 30-50% of the note amount in foreclosure.

The industry has never seen anything like this before, and it has only been happening a year. Tumbling house prices have rendered all mortgage debt highly suspect and most institutions that hold it insolvent. This is the exact reason why the banks will not allow principal balance reduction mortgage modifications: the credit hits would be too great.

Anyway, back to the story. The real reasons why whole loans and securities are not worth anywhere near what their owners say they are is becoming understood quickly. But the story below is not.

When pools of loans are sold, they come on an Excel type spreadsheet with dozens of columns of data on each loan.  Back in the day, most investors never performed deep due-diligence into the pools they were buying, relying on spot checks at best.

This two minute clip says it all — the ramifications of this go far beyond borrowers lying about their income by a grand or two.

This story and my input above is also exactly why ‘market participants’ have somehow forced Markit to pull the release of their new US Prime Mortgage Security Index. Markit are the creators of the well-known ABX index that did such a great job shedding light on what was really happening in the Subprime market. For a year, the pundits made Markit out to be a chop shop but in the end they were correct as were most waiving flags two years ago.

**Request…If any of you know anyone at Markit, I would love to help out in the creation of this index. I am absolutely positive that with the proper inputs from the right people, a very accurate tracking index can be made for all Prime securities, including Jumbo Prime. This index is very necessary, especially given the government is likely going to be buying this stuff on the tax payer dime and the Fed holds hundreds of billions as collateral for loans — that the tax payer will ultimately have to pay for as well.– Best, Mr Mortgage

The Next Financial WMD?
12/17/08 – 09:49 AM EST

The creators of an index that some say gave hedge funds the fuse they needed to blow up the subprime mortgage market postponed the expected launch of a new benchmark to track U.S. prime mortgage securities.

Markit, a 1,000-person financial technology and data firm that is highly influential among derivatives dealers such as Morgan Stanley, Goldman Sachs, JPMorgan Chase and Deutsche Bank, said in a statement Wednesday that it had “put on hold” the launch of an index of synthetic U.S. prime mortgage-backed securities after “extensive discussions” with major market participants.

Markit had been expected to disclose further details on the new index on Wednesday, a source close to the talks had told The company acknowledged the talks, but not the timing of an announcement. Market participants held a vote on the potential launch Tuesday evening, after reported on the index.

Markit said it would reassess the index’s launch in 2009.

Financial companies around the world, including large banks such as Citigroup, Bank of America and Wells Fargo, collectively hold trillions of dollars worth of prime mortgage securities on their books, but they have a great deal of latitude in how they price them. A prime mortgage index would take away a lot of this latitude, as banks carrying mortgages on their books at a significantly higher price than the index would have a lot of explaining to do to their auditors. That could lead to new writedowns on a massive scale.


Both stories about found at

More Mr Mortgage


19 Responses to “Pandora’s Box – Prime Mortgages May Get Transparency”

  1. It’s incredible how all these risky mortgages got turned into AAA securities – that’s the same rating as Treasuries! What a joke. More criminals need to be prosecuted, although with a 5 year sentence(he actually did a plea deal for less) it might just be worth it. Let’s see, $2 million divided by, say, 4 years, is $500k per year. That’s a pretty good payoff.

  2. Yes indeed Mr. M.

    Rock & roll, lock & load on a Saturday morn. F’n-A. Gotta love it.

    Hey gents (and ladies), in line with the theme here on a bright & crisp Saturday, check out this vid from August 2005.

    Dude is like a rock, that’s why I admire him. Standing firm in a sea of market-think and ridicule – and right smack-down in the middle of an un-cut heroin high of (phony) wealth creation, this guy lays down the law.

    ‘I am not worthy…’


  3. MR. Mortgage said: “The market is fully functional at the right price.”
    I absolutely agree with that statement. Unfortunately true price discovery has been a real problem as you have noted in your comments. If the time ever comes to show what the real value of these “assets” are, the popcorn will hit the fan…bigtime. Maybe, that’s why Markit backed off launching this until…??? 09. With the latest batch of witches brew refi’s I think the morgage market and housing prices in general have much further to fall. The government, MSM, and banks continue to dream up ways to keep the music playing. It will not be sustainable much longer.
    Is anyone else tired of all of this bullshit??

  4. 5755hsa:

    Ding, Ding, Ding…!

    Same value as the $2Trillion of assets the Fed refuses to disclose on balance sheet from the FOIA request of Bloomberg a few weeks back…

    I think Stu mentioned in another thread that this ‘party’ is going to be played out for as long as it can. Spring time market bounce will not matter because it doesn’t address the underlying fundamentals of total destruction.

    Fear not though – quantitative easing is revving up as we speak and the PSI (lbs. per sq. inch) of reflation in monetary growth will be near the asset loss. Problem is, that reflation ain’t gonna do much to patch the bursted bubble, primarily because as a nation we’re BROKE.

    Peace –


    And to answer your question: Yes – I and many others I’m sure reading this forum, are definitely tired of the BULLSH!T.

  5. […] news by unknown « RGE – Credit Crunch or Not ? Subprime Mortgage Foreclosures: The Importance of […]

  6. Mr Mortgage,
    Thank you for the exposition. And yes, this rigamarole of coming up with new ways to cook the statistics behind each “rescue plan” (because no one will admit that the onlly workable solution is to allow home prices to fall to or below fundamentally sustainable levels) is becoming tedious. That said, if investors were blowing their own money on these schemes, I’d just laugh at their foolery. As it is, they’re blowing my money, through taxes, and laughing at me.

  7. MM, great work. Thanks again.
    Is it possible for you to do a little analysis of what’s going on in the Commercial real estate market for 2009? I think it may be cracking up.

  8. Said:

    “It’s incredible how all these risky mortgages got turned into AAA securities – that’s the same rating as Treasuries! What a joke.”

    I am going to have to throw one at you from the BertDilbert high school drop-out economics…

    Not really, the same people who are expected to pay for treasuries are the same people who are expected to pay for these mortgages. They both belong in the same bucket, because ultimately, the payment is expected from the same person. It is the US treasuries that are overrated.

    Essentially the US Government debt is like a pick-a-pay Option ARM. Every month goes by and each month is the same “We cannot afford it this month” In order to keep up our standard of living, we tap into our credit card that is hooked up to our national mortgage so that we can enjoy living off the low interest rate.

    This banking crisis is no different than a family having the garage burn down and now the family had to go out and buy new cars in order to continue to earn an income. The cost of these cars was stuck onto the national debt mortgage. One day in the future, all of this National Mortgage paper is going to recast and not at a time of our choosing, it will be chosen for us.

    After the recasting of debt, the government is going to say that the market to continuing to borrow has collapsed, we now have to come after you, the backstop for the treasury market. The new taxes are stuffed down your throat. In order to keep making your house payment because of higher taxes, you have to fire the maid, the gardener and wash your own car. This takes up a considerable amount of your free time. We call this free time that you used to have “Standard of Living” (SOL)

    Because you fired the maid service, the gardener and the car wash guy, these people no longer have jobs. In fact they are collecting unemployment. The Federal Government, no longer being able to raise money via the debt market can no longer fund the state shortfall in the unemployment account. The state has to reach out to business and raise the unemployment tax.

    Now while all this is going on, your employer doesn’t have the business it used to. Bossman sits you down and has that talk. “Business conditions are crappy, we cut back on everything and now we just got hit with an increase in unemployment tax. I have no choice but to cut wages 10% across the board….”

    So you go home and tighten the budget further. You hate to do it but you have to give the tax guy the axe, cut out dinner at your favorite restaurant and brown bag it to lunch everyday. Your family is now cutting each others hair. You just got hit with negative SOL again.

    The government has a problem, they have to raise your tax rate again because that 10% pay cut reduced the tax take. Plus since you fired the tax guy, the buss boy, the cook the waiter, dishwasher etc.(in essence) and the deli where you used to buy your lunch closed because everybody was brown bagging it.

    Now we have a serious problem. Between the 10% pay cut and the new higher tax rate, you are unable to pay your mortgage!

    Thus it is my contention, that since the same people who cannot pay the home mortgages are the same people expected to pay the national mortgage, they both belong in the same bucket. The only thing wrong is the rating – AAA.

    When the world realizes that the National Mortgage paper is in reality no better than the credit quality of a pick-a-pay option arm, everything will recast into a higher interest rate.

  9. Great work, as usual, MM.
    More debt chasing too much debt.
    The cat chasing its tail.
    Get ready for ‘gotcha’.
    Yes, the death spiral of debt-money is approaching its tipping point.
    Fess up.
    Hunker down.
    The family garden, and all that.
    Then, wait…
    for the next deregulated bubble to begin for the great-grandkids’ contribution.
    OR, as the song goes, ‘we gotta stop this shit’.
    Please google a simple four-pager from a decades old observation:
    Treasury System versus Federal Reserve System.
    The answer, my friends, is blowing in the wind.
    It’s OUR money.
    Let’s get on with it.

  10. i just don’t get it. Why everyone continues to worry about past guidelines and what went wrong. Why the negativity and not focus on how to turn this thing positive. Underwriting guidelines…lmao… long as companies continue to use credit scores as their main guide for risk guidelines are irrelevat. Underwriting?? At this point in the market does it matter if you are at 75% or 100% if your borrower is going to pay?? Until common sense comes back into “underwriting” and some common sense guidelines return you may as well move to Cuba. This just an 18yr. experience view. thanks for all the info. i enjoy reading different views.

  11. Mr. Mortgage,

    I know many of the folks at Markit and they consult me regularly on their product roadmaps. I plan to call them on Monday to let them know how disappointed I will be if they listen to anything you have to say.

  12. Be sure to MA – this is exactly the type of transparency is needed to bring stability back to the market.

  13. I cannot understand why rating agencies have not been held more accountable in this entire mortgage melt-down for the last year? Hello, it’s their business to verify value and accuracy of these things. It’s why they exist! Kinda hard to deny, isnt it???

  14. […] Pandora’s Box – Prime Mortgages May Get Transparency Mr. Mortgage […]

  15. Admin

    While transparency would seem logical, let’s look at who Markit is. Meanwhile you can submit your ideas here.

    Let’s review

    “About Markit
    Markit is a financial information services company with over 1000 employees in Europe, North America and Asia-Pacific.

    Markit was founded in 2001 as the first independent source of credit derivative pricing. Today, our data, valuations and trade processing services are regarded as the market standard in the global financial markets, helping our clients to reduce risk and improve operational efficiency.

    Markit has unparalleled access to a valuable dataset spanning credit, equities and the broader OTC derivative universe and we work closely with leading market makers to develop innovative solutions for the marketplace.

    Our clients include investment banks, hedge funds, asset managers, central banks, regulators, rating agencies and insurance companies – we provide round-the-clock support from our offices in London, New York, Dallas, Toronto, Amsterdam, Frankfurt, Luxembourg, Tokyo and Singapore.”

    The problem as I see it, is that the products that you are trying to bring transparency to are the very same assets that are on the primary client’s balance sheet. The developers of the derivative market are the ones that provide Markit the data that they require to exist. It appears what we have here is the old Mexican Standoff.

    When you look at the primary dealers in the derivative market, you have a “Who’s Who” of who has assets on the Federal Reserve balance sheet, the dirty laundry. Nobody wants you to know how dirty that laundry actually is, how fast it is getting dirty, or how many tons of Tide it is going to take to get that clean. Understandably, Markit would be coming under extreme pressure. Markit says that they were the first, so that may mean that there are others you could try if they bow out.

    On another subject, for the historical types that might want a feel for what is going on behind the closed doors of the Fed, may want to travel back to the last big Mexican Peso crisis in 1995 where juggling was done and issues between the Fed and Treasury. I read this about 5 years ago. I find these things fascinating, the majority likely think it is BOARING as hell, lol. Start PDF page 119, document page 117

  16. You meant to say “50% debt-to-income ratio” in the 3rd paragraph, no? Banks WISH they’d confined prime loans to 50% LTV….though in certain parts of CA even that may not save them.

    Keep up the good fight…….

  17. I just can’t wrap my head around these “liar loans”. Stated income? I can’t even use that on my student loan application or a credit card application, which is for hundreds of thousands of dollars less, and they check with Revenue Canada (IRS).

    Even if a bank was prudent, and verified every detail, and lent only to Prime borrowers at reasonable debt/income ratios, they would still be hit hard. People would just walk away due to all the other homes on the block dropping in value.

    Every bank needs to be prudent, and you need to government to be there to make sure they all play fair. Its just amazing how a change in leverage limit law, and a few years of turning a blind eye can create the largest housing crash (ever?)

  18. CanadianJack

    Liar loans were designed for business owners who for one reason or another are unable to show documented income like an employee. In a normal non manipulated market they work. In an inflated value market where the loan officer is pushed to make a number, they don’t. In a euphoric bubble market they obviously are going to be abused.

    Unfortunately, the abuse of the liar loan will make this product disappear entirely for some time, excluding those for whom it was designed.

  19. There is a simple solution to the “liar loan” lenders just need to change how they evaluate a business owners income and make it “full doc” forever. Lenders have always penalized the self employed in terms of qualification for a loan in how they underwrite a persons tax returns etc. Heck half of the time I have to show them how to read tax returns and apply their own guidelines to them.

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