I think it comes down to the investors. The teaser rates already represent a negative cash flow and every year at that rate only increases the amount of the principal. Bear in mind that some of these teasers are a lot lower than 4.5%.
If the investors are dumb enough to think that the market is going to turn around and cover the borrower’s positions they might agree to the short term losses with a view of recouping them later. The question is, how dumb are these investors?
If I’m holding one of these SoCal-backed CDOs I’m going to recognize that my loss upon liquidation in 2007 is going to be less than if I wait until 2009 or 2010. I’m going to recognize that the only way I break even is if the current trend stages a spectacular reversal and my borrowers’ positions – which have degraded even further by the extension of the teasers – get covered. That would take price increases well beyond the original purchase/refi values that got them into this mess.
As far as I’m concerned, this is posturing on the part of the polticians and the banks. Meanwhile, we still have 10+ months of inventory sitting around in SD County and a sizable number of other would-be sellers casting about in search of an exit that doesn’t involve a short sale or foreclosure. At most, a bail out will only slow the pace of correction down, increase the amount of collateral damage; and worse, burn the investors beyond all recognition.
