Standard & Poor’s just drove a huge harpoon into the heart of the mortgage credit bubble,

[LA_Renter]

“But is there any huge impact to the home price? to the lenders?”

This will speed up a slowly deflating bubble.

I found this very sophisticated explanation discussing the differences between various bubbles and how they play out on youtube. Enjoy!

[LA_Renter]

“But is there any huge impact to the home price? to the lenders?”

This will speed up a slowly deflating bubble.

I found this very sophisticated explanation discussing the differences between various bubbles and how they play out on youtube. Enjoy!

[Allan from Fallbrook]

I hate to say I told you so…

The big news here is what this will mean as far as spreading the pain. If a credit contraction ensues then the whole house of cards starts to come down.

This will strike CDO/CDS investors (including pension funds, which is a whole different can of worms to be opened) first and then trigger a whole slew of peripheral, but just as important, follow on actions.

There will be a massive amount of scrutiny paid to everything connected to this market and Fannie/Freddie will be right back in the hot seat. They both hold major positions in the market and, while not officially a government agency, they give the impression that the “full faith” of the goverment is behind them. If they have to unwind their position and are forced to substantially withdraw from purchasing any more MBS products of any stripe, then this will literally have the same effect as a credit contraction, in that the single largest player in the game will be sidelined.

The downside “ugly” potential of this is huge.

[Allan from Fallbrook]

I hate to say I told you so…

The big news here is what this will mean as far as spreading the pain. If a credit contraction ensues then the whole house of cards starts to come down.

This will strike CDO/CDS investors (including pension funds, which is a whole different can of worms to be opened) first and then trigger a whole slew of peripheral, but just as important, follow on actions.

There will be a massive amount of scrutiny paid to everything connected to this market and Fannie/Freddie will be right back in the hot seat. They both hold major positions in the market and, while not officially a government agency, they give the impression that the “full faith” of the goverment is behind them. If they have to unwind their position and are forced to substantially withdraw from purchasing any more MBS products of any stripe, then this will literally have the same effect as a credit contraction, in that the single largest player in the game will be sidelined.

The downside “ugly” potential of this is huge.

[Anonymous]

I hate to break up the bear fest but isn’t this old news? Kind of like an analyst downgrading a stock after it has been beaten down to the ground? I’ve seen S&P do this to stocks many times.

It’s old news to many bloggers, but I doubt it’s old news to the average dude who goes online and messes with his stocks once in a while. Now he will see all the news about this and possibly think about it a bit. I think that the change in sentiment about the economy for the average person is the big story here.

[Anonymous]

I hate to break up the bear fest but isn’t this old news? Kind of like an analyst downgrading a stock after it has been beaten down to the ground? I’ve seen S&P do this to stocks many times.

It’s old news to many bloggers, but I doubt it’s old news to the average dude who goes online and messes with his stocks once in a while. Now he will see all the news about this and possibly think about it a bit. I think that the change in sentiment about the economy for the average person is the big story here.

[lniles]

Sharkey, CD’s are just as safe (although not as liquid) as money markets and give a much better return. Shouldn’t your 401(k) funds be in cds?

[lniles]

Sharkey, CD’s are just as safe (although not as liquid) as money markets and give a much better return. Shouldn’t your 401(k) funds be in cds?

[DaCounselor]

Agreed, Allan. The issue at hand for housing is the likely fallout from downgrades (aka credit contraction/removal of invstor demand). Certainly is likely to be an acceleration and expansion of fallout once the downgrades get underway.

At this time we’re still talking about a mere sliver of the market, as S&P apparently intends to analyze only $12 billion of the $565 billion subprime paper issued in ’05 and ’06. I believe they will be looking primarily at BBB rated paper (aka New Century, Fremont, etc paper) There’s alot of junk in there and I expect it to be rated as such shortly. The A paper appears high and dry, at least for now.

While I know of no one who knows for sure, the best guestimates that I am hearing suggest that foreign investors are holding the majority of equity and mezzanine tranches in harms way. We see evidence now of pension fund investment in some of this riskier paper, obviously bought to boost fund performance. They will get hurt on these deals but I would be surprised to see more than a few % of a fund’s assets placed in these risky investments, so they’re not going to get wiped out.

At the end of the day, this is not unexpected news, it was going to happen, lender/investors are going to lose lots of money (but how about those folks that are short equity and/or short mezzanine – looking pretty good right about now…) and there’s very likely going to be a decreasing appetite for funding/investing in subprime paper. This is another link in the chain reaction.

[DaCounselor]

Agreed, Allan. The issue at hand for housing is the likely fallout from downgrades (aka credit contraction/removal of invstor demand). Certainly is likely to be an acceleration and expansion of fallout once the downgrades get underway.

At this time we’re still talking about a mere sliver of the market, as S&P apparently intends to analyze only $12 billion of the $565 billion subprime paper issued in ’05 and ’06. I believe they will be looking primarily at BBB rated paper (aka New Century, Fremont, etc paper) There’s alot of junk in there and I expect it to be rated as such shortly. The A paper appears high and dry, at least for now.

While I know of no one who knows for sure, the best guestimates that I am hearing suggest that foreign investors are holding the majority of equity and mezzanine tranches in harms way. We see evidence now of pension fund investment in some of this riskier paper, obviously bought to boost fund performance. They will get hurt on these deals but I would be surprised to see more than a few % of a fund’s assets placed in these risky investments, so they’re not going to get wiped out.

At the end of the day, this is not unexpected news, it was going to happen, lender/investors are going to lose lots of money (but how about those folks that are short equity and/or short mezzanine – looking pretty good right about now…) and there’s very likely going to be a decreasing appetite for funding/investing in subprime paper. This is another link in the chain reaction.

[PD]

Many knew the downgrade was coming. However, now that it has happened, it will probably force some liquidation in funds that that have liquidation thresholds.
There is a huge set up of dominoes right now. Some are falling. A few people are up in the bleachers and can see the whole thing. Most people are watching the last few dominoes in the series and don’t think anything is wrong.

[PD]

Many knew the downgrade was coming. However, now that it has happened, it will probably force some liquidation in funds that that have liquidation thresholds.
There is a huge set up of dominoes right now. Some are falling. A few people are up in the bleachers and can see the whole thing. Most people are watching the last few dominoes in the series and don’t think anything is wrong.

[Allan from Fallbrook]

Da Counselor: I agree with your assessment, but it largely focuses on this as a market related situation.

If you take a step back, there are other variables at work here that make this a problem with potentially far larger implications. Most of those variables are not within the market (so to speak), but rather impinge on the market (in terms of event triggers) or are peripheral to the market (in terms of compliance or oversight).

Think about this scenario (in terms of cascading effects): S&P downgrades a small section of the sub-prime and begins to scrutinize other portions of the MBS market, including CDO/CDS products backing the MBS market. Concurrent with this, Fannie/Freddie are constrained from further participation as regards purchasing additional risk in the MBS market. The Fed, forced to finally acknowledge the inflationary risk posed by increased core and non-core pricing, raises interest rates another 250bp.

These three events (two fairly small, one fairly significant) would cause a major contraction in credit. Now imagine you’re a distressed homebuyer trying to finance his/her way out of a bad sub-prime product into a better fixed rate product. This loan would be: More expensive (in terms of cost of funds), as well as far more difficult to get (in terms of the lender reselling the loan to Freddie or Fannie).

We have seen some inklings of this in terms of more stringent underwriting guidelines and the new limits placed on state income loans. These events, however, predate the notification about S&P and the potential retrenchment of Fannie/Freddie regarding purchasing MBS risk.

Is it too far out of the realm of imagination to think that this is just round one and there are additional rounds of even greater severity set to come? You mention a chain reaction. I think that is an excellent description of what is about to come.

[Allan from Fallbrook]

Da Counselor: I agree with your assessment, but it largely focuses on this as a market related situation.

If you take a step back, there are other variables at work here that make this a problem with potentially far larger implications. Most of those variables are not within the market (so to speak), but rather impinge on the market (in terms of event triggers) or are peripheral to the market (in terms of compliance or oversight).

Think about this scenario (in terms of cascading effects): S&P downgrades a small section of the sub-prime and begins to scrutinize other portions of the MBS market, including CDO/CDS products backing the MBS market. Concurrent with this, Fannie/Freddie are constrained from further participation as regards purchasing additional risk in the MBS market. The Fed, forced to finally acknowledge the inflationary risk posed by increased core and non-core pricing, raises interest rates another 250bp.

These three events (two fairly small, one fairly significant) would cause a major contraction in credit. Now imagine you’re a distressed homebuyer trying to finance his/her way out of a bad sub-prime product into a better fixed rate product. This loan would be: More expensive (in terms of cost of funds), as well as far more difficult to get (in terms of the lender reselling the loan to Freddie or Fannie).

We have seen some inklings of this in terms of more stringent underwriting guidelines and the new limits placed on state income loans. These events, however, predate the notification about S&P and the potential retrenchment of Fannie/Freddie regarding purchasing MBS risk.

Is it too far out of the realm of imagination to think that this is just round one and there are additional rounds of even greater severity set to come? You mention a chain reaction. I think that is an excellent description of what is about to come.

[rb_engineer]

OK, the doom and gloom scenarios are making me feel lousy. Here’s a lighter (say more neutral) take on the situation:

http://us.rd.yahoo.com/finance/external/cbsm/SIG=12ihu9f27/*http://www.marketwatch.com/news/story/stocks-feel-subprime-sting-debt/story.aspx?guid=%7B7B5B1C8B%2D5E0D%2D4C11%2D890E%2D96DA77B7C562%7D&siteid=yhoof

[Author]

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