Monday, September 18, 2006

A Fallback Plan?

From the New York Times:

Who Bears the Risk?

The housing boom would never have lasted as long as it did if mortgage lenders had to worry about being paid back in full. But instead of relying on borrowers to repay, most lenders quickly sell the loans, generating cash to make more mortgages.

For the past few years, the most voracious loan buyers have been private investment banks, followed by government-sponsored housing agencies, like Fannie Mae. The buyers carve up the loans into mortgage-backed securities — complex i.o.u.’s with various terms, yields and levels of risk. They then sell the securities to investors the world over, at breathtaking profit. The investors earn relatively high returns as homeowners repay their mortgages.

The process has encouraged homeownership and created wealth. But there is a downside, too, which demands attention.

As the boom thundered on, the pool of available credit grew larger than the pool of creditworthy borrowers, resulting in an explosion of risky mortgages with features like no money down, interest-only payments and super-low teaser rates. Investors — including mutual funds, pension funds, hedge funds, insurance companies and foreign central banks, to name a few — currently hold $2 trillion in mortgage-backed securities from investment banks, triple the amount from three years ago. Investors also own $4 trillion in mortgage-backed securities from government-sponsored agencies.

In a market so vast and dynamic, everyone knows that if mortgage defaults should rise, damage could reverberate throughout the financial system. So far, defaults have inched up. But many homeowners are at a dangerous juncture. Interest rates on adjustable mortgages are rising as home values are weakening, precluding for many the chance to refinance. Economists calculate that $750 billion of outstanding mortgage debt is now at measurable risk of default — about 7 percent of the total.


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