Mortgage Backed Securities

[DiveUrge]

I have a question about the risks to mortgage backed securities in the event of what I expect will amount to a significant number of loan defaults in the not too distant future.

I hold a fund through my 401K plan that has as one of its principal holdings, mortgage backed fixed income securities. I am intersted in preserving captital with this fund in the event of a severe financial downturn (recession) that I fear could be triggered by the likely residential real estate collapse. It’s called a stable value fund and some of it seems safe but I am wondering where else I might park my 401K $$$$ to safeguard against a downturn? I’m of the opinion that the domino effect might hit even foreign funds?

I would assume some of these mortgage backed securities have some fairly safe mortgages and others have more risky ones although from the prospectus I can’t tell.

Do you have any historical perspective (if it even applies given the sheer dimensions of the current bubble) on how the mortgaged backed securities performed in previous meltdowns (say the 1990 RTC scam) that might be useful?

[RightSide]

I think one of the major risks that the mortage market faces, is that this market used to require 20% down payments and never before have we seen such loose lending standards. Therefore I’d caution looking backwards when evaluating the risk, because as far as this bubble goes, it really is new territory.

You could hedge some of your risk by buying some PUT LEAPS (Long Term Equity oPtions) on stocks like LEND, which happens to have a big portfolio of sub-prime mortage. I expect the stock, which trades at $50 right now to go all the way to ZERO before this mess is over.

I’m not ready to start betting on the decline just yet, but I’ve got my finger on the trigger.

[powayseller]

I don’t have historical perspective, but complement you on your foresight. I told my family to make sure that none their holdings included MBS or any GSEs. Avoid Fannie Mae (GSE).

I anticipate some pension funds will be wiped out by this. They chase the high yields and perceived safety of second deeds of trust and MBS. But there seems to be no data on who holds these securities.

Another point – this time IS different regarding loan losses, because the loose lending standards were applied to the masses. There are more subprime borrowers now than last time, and these tend to default sooner. Combine this with no doc, 100% and 120% financing, and you get more people willing to walk away from their home in a downturn. We also have a large percentage of recent employment growth in real estate fields and consumer spending driven by home equity withdrawals.

The question is whether the stock market will be the next bubble. Forget about gold – that’s pure speculation. It could go way up, it could fall. Based on nothing but speculation. There is no fundamental reasons for its movement. It defies logic. People say it’s a safe haven. Can you ever pay for gas with gold coins? Can you pay your rent, mortgage with it? Can you go to Trader Joe’s to buy milk with gold? No way! Gold bugs are just in love with the flashy metal, with the beauty and allure of it. And if it ever got so bad that money lost value, then no one would go to work, and we wouldn’t have electricity or running water or cashiers at the grocery store, so what good is gold?

The dollar should remain strong, as the spread between interest rates in the US and the EU and Japan stays high; as long as investors can earn more on treasuries, they will keep buying dollars. The euro and yen are poised to pay low interest for a long time since inflation risk is low, and the dollar is going to pay higher interest after 2 more hikes.

I don’t see a dollar demise anytime soon. I’m staying in stocks and am trying to figure out how/if to short homebuilders and retailers. I would love to short MBSs, but how do you do that? My husband’s 401K allows him to buy stocks. Does yours?

[DiveUrge]

Thanks for the responses. Well, shorting LEND is something I’ll investigate for my trading account. My trading account will be going to 35% cash just before the next hike – I want to save some gunpowder.

For my 401k I have about 10 funds that I can choose from – can’t pick stocks. My allocation, after the next rate hike will bump up in the bond fund and down everywhere else except foreign fund which has been on a tear (20% 2 years+) and then once again after the second hike. I figure that asia will take a little longer to experience the pain of any RE collapse, provided it move along swiftly.

[powayseller]

DiveUrge – be careful w/ bond funds -some can hold GSEs. Or they could own bonds in real estate related companies.

[DiveUrge]

I looked. The allocation is USG bonds, municipal bonds and some coprorate AAA. ALl lower yielding but presumably “safe”.

[DiveUrge]

I took a look at LEND. This stock has about 50% of its shares registered as sold short and it’s basically at its all time high. Kinda strange? The way I read these numbers is… If their quarter’s numbers are OK and they don’t sound bearish a short squeeze could be nasty.

Comments?

[RightSide]

Yeah, that’s why I haven’t pulled the trigger yet. We enlightened folks here on Piggi’s forum aren’t the only ones who see the writing on the wall. It makes for a crowded trade, but that doesn’t mean we aren’t eventually going to be proven right.

Check it out, LEND has $9B in debt. This is the sub-prime mortgage debt that is going to be most at risk when the housing market turns. What’s really fasicinating, is that they estimate reserves against this bad debt using past performance. Well, in the last 10 years, the default rate has been almost non-existent and the actuaries have run all these monte-carlo simulations saying that in a worse case scenario, only X% of the total debt is at risk. Well, I respect their math skills, but they are forgetting some basic common sense and the fact that this crash isn’t going to be like anything we’ve ever seen before.

So against this $9 Billion dollars in debt, care to guess how much cash LEND has to defend itself in tough times?

$20 million bucks!!!!

If there is a big mortage failure rate, this company is on a one-way ticket to bankruptcy court.

Now, you are right to point out the high short interest and its precisely why I’m not yet short this stock as I think there might be one last gasp up to the upside forcing a small short squeeze. I’m also waiting till Rich here tells us the downside has started for sure. Then I will buy some long-term PUT Leaps and just sit tight and ride the wild ride it is sure to be.

I’m also eagerly waiting the coming trading of the housing futures market on the CME. I’m hopeful there will be some liquidity in that market that could make trading the san diego housing market very profitable.

[DiveUrge]

I believe your skepicism about LEND is warranted and evidently a lot of others share it with 50% of the shares listed as short.

But, the more I looked the stranger it got. I haven’t seen a company with shares (except on the pink sheets) trade like this. 5% of the outstanding shares trade on an average day @ $50ea, 1M sh, and the cap is $1B.

You’re probably right about this going to $ZERO but given the heavy trading activity and short interest it could go either way in a hurry. I think it’s too risky for me.

[DiveUrge]

poway, In case you’re interested, the MBS losses are already filtering in – Friedman, Billings, Ramsey Group reported a Q4 loss which they blame on their MBS losses. Brace yourself for a rash in ’06…

http://yahoo.reuters.com/stocks/QuoteCompanyNewsArticle.aspx?storyID=urn:newsml:reuters.com:20060223:MTFH11386_2006-02-23_02-36-19_N22218417&symbol=FBR.N

[DiveUrge]

Here’s another clunker, ECC Capital, a REIT. Not paying its dividend this qtr and getting crushed. Around $7 this past July now down to $1.30. Losing 31% today.

http://yahoo.reuters.com/stocks/QuoteCompanyNewsArticle.aspx?storyID=urn:newsml:reuters.com:20060227:MTFH04513_2006-02-27_12-29-36_N27342788&symbol=ECR.N

This could get ugly in a hurry…

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