Friday, September 29, 2006

Hedge Funds and Risky Mortgages

I saw a story the other day that really solidified my belief that the housing market is going to get much worse before it gets better. The story, which now I can't seem to locate, was about how a few hedge funds are buying tranches of sub-prime mortgages and simultaneously shorting the equity of the company that sold them the mortgage.

The strategy of the hedge fund is to scrutinize the mortagages in the tranche for technical violations (ie. insufficient documentation, collateral etc.) and then "put" the mortgage back to the seller. Putting the mortgage back to the seller will cause the seller to take a writedown on the mortgage, which if done enough times, causes earnings to decrease and the stock price to fall. Since the hedge fund is short the equity of the mortgage seller, the fund profits when the stock goes down.

Now imagine a sub-prime lender like New Century getting a few mortgages put back to it by an aggressive hedge fund or two. Do you think they are going to write future mortgages with the same lacking standards that they might have 6 months or a year ago? I don't think so.

[By Mark Trumbull | Staff writer of The Christian Science Monitor
A great shift toward adjustable mortgages helped push America's housing boom into high gear. Now, as the boom unwinds, the riskier side of those mortgages is coming home to roost.

The ultimate impact of all those "teaser" interest rates, the "no money down" mortgages, and exotic loans where homeowners' debt can rise over time will be muted somewhat, economists say, because it will be spread over the rest of this decade.

But that doesn't necessarily mean the mortgage shakeout will be easy. And for many individual borrowers, finance experts say, the sad result will be foreclosure.]

Full article...


Post a Comment

<< Home