As the mortgage implodometer just ticked from 9 to 10, I want to re-re-post a great comment from Tanta from Calculated Risk:
Cal, you want to be careful about the boldface delinquency percentages in the Piggington piece. (Of course you probably already know this, but some people who aren’t used to looking at seasoned securities get confused by it.) The issue is whether you’re using current pool balance or original pool balance: those delinquency percentages in the twenties are based on current pool balances, after prepayments have been applied (hence on a much lower balance). They aren’t pretty, of course, hence the downgrade, but if you want to gauge the general credit quality of the whole pool of loans that went into the security, you look at percentage delinquent of original balance. Percentage of current balance will tell you what the security is worth today and what its prospects are for getting over its interest shortfall problems–precious little, as far as I can see. All seasoned mortgage-backed securities end up eventually with an extremely high percentage of delinquent loans, as the performing loans pay off out of the pool and the nonperforming loans can’t (unless and until they foreclose). The problem with these pools seems to be that the delinquencies and losses came so early in the life of the pool that overcollateralization (excess interest) didn’t build up sufficiently to cover them. That’s really the important point for me, since I’ve spent the last couple years being patronized by mortgage bulls who keep ’splainin’ to me that all risk has been priced properly. It certainly might have been “proper” if those loans had simply decided to perform on a historically “normal” curve–no significant losses and limited prepayments until after the first two or three years, leaving time for excess spread to accumulate–but strangely enough, historically-unprecedented lending standards (which include more than usual refi opportunities, as “affordability products” substitute for rate reductions) have resulted in a historically-unprecedented accelerated loss curve. I am shocked, I tell you, to discover that every risk got priced into these puppies except the risk that risk-based pricing itself would cannibalize the securities past the point of recovery. I can’t wait to hear the arguments over this lunch tab (”Wait a minute, I didn’t get the Option ARM platter, I only ordered a HELOC appetizer and a Diet FRM. I’m not paying for your lunch. And surely we don’t have to tip the waiter . . . I heard they got record Christmas bonuses . . . does anyone have change for a five? I seem to be a little bit short . . .