Subprime Bloodletting Update

You really should not listen to what you hear on the news. I have been tracking Elaine Ser-whatever-gamas(?) on CBS and have to say her understanding of the information and the presentation of the data she gathers is not at all clear or accurate.

Paraphrase: "These companies closing will hurt subprime borrowers and make them more likely to foreclose."

That implies that the closing of a subprime company does something bad to the existing mortgage. NO, that is not the case. If the borrower fails to pay his loan that will cause foreclosure. A company closing does not cause my loan to foreclose. It is a secured contract that someone else will buy and service.

If Mr. Borrower has a loan that he can't afford maybe he shouldn't have gotten it in the first place. IF the loan is adjustable that's a slightly different tale: it might adjust a MAXIMUM of 2% TWICE A YEAR. Depending on your home size, that might be significant, but as a percentage of income it is relatively flat as the mortgage to income should be proportional.

Also to keep things in proportion, lets review the numbers. IF we listen to the news we think that it has "NEVER been like this and it is like 300% worse than ever before...?"

rates of default October to December:
2003: 4.97%
2006: 4.95%


I'm only pointing out the obvious fact in the historical perspective. You have heard "default rates jump 20%" from CBS commentators but the difference of .3% of the total (difference between 4.6 and 4.9%). Is POINT 3 PERCENT a huge jump that should make the market crash or is it just a cyclical correction?

Just so you know, point 3% is still a humongous pile of cash if it were in your checking account. For an investment firm point 3 is what they can spend that on long distance calls and Starbucks in three months.

I would also submit to you that all of these companies who are going under have an acceptable margin of default in ranges from 3 to 5% of portfolio. Any overages have to be bought back. Recently we have seen a trend where investors are forcing more buybacks than usual which put many of these companies in financial crisis.

Other very interesting sources
statistical models for mortgages and defaults (circa 2003-4)
very boring paper with some fascinating distributions
more concise with nice projection models

Bloodletting has been applied and fear has gripped the joe blow investor and some under-informed analysts and newsies. I see rationality on the horizon but will it be soon enough to save these people's jobs?