I love it when Wall Street seems to think that putitng make-up on a pig somehow changes the dynamic of the pig itself.

First of all, the idea that one can insulate ones-self from the ravages of default is technically correct on an individual basis. But from an overall economic basis, the selling of Mortgage Backed Securities is nothing more than a game of Hot Potato. Someone at the end of the day is going to lose out if the original parties to the transactions (home and corporate borrowers) default.

Secondly, the entire mortgage mess could have been predicted by any of these MBA's had some of them ever decided to venture to any of these new sub-divisions built in the burbs. Had they ever bothered to ask any of these people what they did for work, or asked about the nature of their mortgage agreement (over 50% of mortgages generated in California in the past three years have been "Interest Only"), they might have raised an eyebrow,

Instead, these guys (amazingly less than 10 years after the collapse of the internet bubble in March of 2000) convinced themselves there was a new paradigm, and that the ravages of the debt market were spead out enough that a sneeze would not result in a hurricane. Unfrotunately, as we have seen, this is not the case. This is because while the lenders themselves initially rid themselves of these crappy mortgages, the bulk of the Mortgage Backed Securities were purchased by hedge funds and private equity enterprises. So now, rather than the banks going under, the private equity/hedge funds are collapsing.

But you ask, what about the other mortgage lenders like American going under? Due to the sheer number of loans these lenders have processed, and due to the speed at which the markets have shunned Mortgage Backed Securities, American, Country-Wide and others got caught with a significant number of mortgages that they financed, but for which they could not get rid of. In addition, many of these loans American and others cannot get rid of are to borrowers who never should have been given a credit card, or to borrowers who bought way too much house. Once the decline in the housing market hit on top of the increase in interest rates, you have the significant growth in foreclosures.

One of the best parts was the idea that only sub-prime loans were going to be impacted. Again, this was Wall Street failing to stop at Elm Street once in a while. We have been in a 30 year period of stagnating middle-class wages, yet, somehow, all these middle-class home buyers could continue to afford more and more home? Why was that? Did anyone stop and think that cheap credit, borrower stupidity (ARM's anyone) and rising housing prices was leading to home buyers purchasing too much house?

And anyone who thinks this is bad now, just wait. Upcoming in the next couple of years will be the triple whammy of:

- Declines in housing prices

- Slowing housing market

- Recession

- Rising Interest rates.

All of these will fuel the other, and quite frankly, I am not sure when the dust will settle. As people lose their jobs, they will be less likely to afford their house, which as an increasing monthly payment due to rising interest rates. With a slowing housing market and declining values, many, many more Americans are going to have to foreclose.

This may be the tip of America's next great depression, and with China looming, I am not sure how we will ever get out of it.

"many of these loans American and others cannot get rid of are to borrowers who never should have been given a credit card, or to borrowers who bought way too much house."

With American (and Countrywide) its really just the "too much house" (or, in California, any house) rather than the borrowers being objectively poor credit risks. When the underwriting lets people spend over half of their gross income on a mortgage, there will be significant problems with defaults, even if every single borrower has perfect credit when the loan was made.

"the selling of MBS is nothing more than a game of Hot Potato"

Not if the buyers of the MBS are applying non-speculative, non-bubble analysis to their risk underwriting. When the securitization market is not in a speculative frenzy, the risk is borne by those entities with high risk tolerance. The problem has been that the pricing of the subordinated pieces has been too high and the underwriting of default reserves has been to generous to the issuers. That caused a double whammy where not only were the most risky pieces of the MBS too expensive, they were too small of a percentage of the overall pool; thus, you have a situation where the risk/reward was out of whack for a significant percentage of the market and then everyone overreacts causing our current situation.

The problem was, among other things, that the ratings agencies were applying speculative, growing-bubble analysis to their risk profiles -- among other serious methodological flaws. They used default rate assumptions that projected a similar default rate moving forward as had been the case when real estate prices were skyrocketing upward. The effect of this is obvious: no one mails the keys in to the bank when they have substantially positive and rising equity. Therefore, the ratings agencies said these bond pools had low default risk, so with a thin set of cushion tranches you could have 80% AAA, and everyone brings wheelbarrows of money to the bank.

That is seriously bad methodology, but not nearly so bad as what has recently been revealed, which is nothing short of fraud. Fitch has recently revealed that its methodology relied on the poorer HTI (mortgage payment to debt ratio) over the universally-understood-to-be-s­uperior DTI (total debt to income), resulting in a bias in its ratings. The real kicker, and this is, to my eyes, indisputably fraudulent, is that when this number was not available, they just provided a default assumption of 50%. In other words, when they didn't have the data for what is unquestionably one of the most important factors in determining default likelihood, they simply made a number up.

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The writing was on the wall.

As a mortgage broker in Canada I have often questioned my counter parts in Atlanta Georgia the question of their lax lending guidelines (an example: clients claimed he worked for GM Motors with an income of 50K. In Canada we require two docs to prove that. In Atlanta office the clients word is the proof)

The sub prime in Canada is stable unless the equity shrinks considerably (40% or more)

kind regards

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