A Second Mortgage Disaster On The Horizon?

(CBS)  When it comes to bailouts of American business, Barney Frank and the Congress may be just getting started. Nearly two trillion tax dollars have been shoveled into the hole that Wall Street dug and people wonder where the bottom is.

As correspondent Scott Pelley reports, it turns out the abyss is deeper than most people think because there is a second mortgage shock heading for the economy. In the executive suites of Wall Street and Washington, you're beginning to hear alarm about a new wave of mortgages with strange names that are about to become all too familiar. If you thought sub-primes were insanely reckless wait until you hear what's coming.

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One of the best guides to the danger ahead is Whitney Tilson. He's an investment fund manager who has made such a name for himself recently that investors, who manage about $10 billion, gathered to hear him last week. Tilson saw, a year ago, that sub-prime mortgages were just the start.

"We had the greatest asset bubble in history and now that bubble is bursting. The single biggest piece of the bubble is the U.S. mortgage market and we're probably about halfway through the unwinding and bursting of the bubble," Tilson explains. "It may seem like all the carnage out there, we must be almost finished. But there's still a lot of pain to come in terms of write-downs and losses that have yet to be recognized."

In 2007, Tilson teamed up with Amherst Securities, an investment firm that specializes in mortgages. Amherst had done some financial detective work, analyzing the millions of mortgages that were bundled into those mortgage-backed securities that Wall Street was peddling. It found that the sub-primes, loans to the least credit-worthy borrowers, were defaulting. But Amherst also ran the numbers on what were supposed to be higher quality mortgages.

"It was data we'd never seen before and that's what made us realize, 'Holy cow, things are gonna be much worse than anyone anticipates,'" Tilson says.

The trouble now is that the insanity didn't end with sub-primes. There were two other kinds of exotic mortgages that became popular, called "Alt-A" and "option ARM." The option ARMs, in particular, lured borrowers in with low initial interest rates - so-called teaser rates - sometimes as low as one percent. But after two, three or five years those rates "reset." They went up. And so did the monthly payment. A mortgage of $800 dollars a month could easily jump to $1,500.

Now the Alt-A and option ARM loans made back in the heyday are starting to reset, causing the mortgage payments to go up and homeowners to default.

"The defaults right now are incredibly high. At unprecedented levels. And there's no evidence that the default rate is tapering off. Those defaults almost inevitably are leading to foreclosures, and homes being auctioned, and home prices continuing to fall," Tilson explains.

"What you seem to be saying is that there is a very predictable time bomb effect here?" Pelley asks.

"Exactly. I mean, you can look back at what was written in '05 and '07. You can look at the reset dates. You can look at the current default rates, and it's really very clear and predictable what's gonna happen here," Tilson says.

Just look at a projection from the investment bank of Credit Suisse: there are the billions of dollars in sub-prime mortgages that reset last year and this year. But what hasn't hit yet are Alt-A and option ARM resets, when homeowners will pay higher interest rates in the next three years. We're at the beginning of a second wave.

"How big is the potential damage from the Alt As compared to what we just saw in the sub-primes?" Pelley asks.

"Well, the sub-prime is, was approaching $1 trillion, the Alt-A is about $1 trillion. And then you have option ARMs on top of that. That's probably another $500 billion to $600 billion on top of that," Tilson says.

Asked how many of these option ARMs he imagines are going to fail, Tilson says, "Well north of 50 percent. My gut would be 70 percent of these option ARMs will default."

"How do you know that?" Pelley asks.

"Well we know it based on current default rates. And this is before the reset. So people are defaulting even on the little three percent teaser interest-only rates they're being asked to pay today," Tilson says.

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[800FICO]

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[suziee100]

No one really knows what is happening in the market so its tricky to guess. There are tips at
<a href"http://100-mortgage.com"> mortgage </a> and a few other places.

[thismoment3746]

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[yelowdog]

Why hasn't this topic been more "Main Stream"? If this article is accurate and I believe it is, why hasn't there been more about it in the news?

Have the governments and news people been quite about this in fear of creating an even worse case of depression, deflation and financial collapse? I suppose I have answered my own question.

[conservativeandproud]

When are dems/liberals/progressives (or any other candy-coating for socialists/fascists)
going to admit that it was their coercing of banks to make the loans to people that couldn't afford them that started this travesty. But you can all smile, because Jimmy Carter finally gets to live his second term through the "almighty" Obama.
Thanh God for the internet, talk radio and FOXNEWS to counteract the drivel spewed by ABC,CBS,ABC and CNN.

[lby54229]

I''m just wondering what''s going to happen? I know no one knows for sure.... Is there talk about not upping these rates for the Alt-A and ARMS buyers? That would be the sensible way to handle it. Yeah buyers got greedy and irresponsible but banks approved them and those loans should have never been allowed. So instead of bailing out the banks any more, can the banks just not up the interest?

I''m getting a headache worrying about what''s to come.... What''s going to happen to my family, my neighbors, my clients, my home''s value, my neighborhood? So many people are going to get hurt and there''s no way out.

[camom22]

Thank you Dasmon88! I agree. My husband makes decent money, just under $100k per year. We''d been watching as several of our friends who made far less went out and purchased these 600k homes. Logic told us that we could never afford a $600k home, it just didn''t make sense. We saw this coming a mile away as well. And so we''ve been waiting, waiting for homes to drop back to their actual values. We have perfect credit and a little extra in the bank so hopefully we''ll be able to get a nice, modest home in a few years.

I''m a person of average intelligence with no financial knowledge. It''s greek to me. But even I knew that there was simply no way a family making less than 100k/yr could afford these outrageously priced homes. When did they expect to pay them off? What did they think would happen?

I blame greedy people more than I blame the banks. Sure, the banks were stupid for extending these risky loans but no one forced people at gun point into these crazy, stupid loans. I''m sure some folks did get lied to and they have my sympathies. But for the most part people were just being greedy and short sighted, and now they''re losing their homes and crying for the government to clean up the mess they helped cause, yet refuse to take responsibility for. It irks me to hear people gripe and moan because there are those of us who have been responsible and didn''t overextend ourselves. What happened to living within your means?

[gce65]

If you simply read the terms of most ARM-type mortgages, the language states that the mortgage holder MAY adjust the rate upwards after the initial teaser rate period. It does not say that they MUST adjust it upwards.
There''s no excuse for banks adjusting them upwards in the current market. That''s like lighting a cigarette while pumping gas: don''t be surpised when there''s a huge explosion and nobody comes running to help.

[gce65]

Banks s-c-r-e-w-e-d us before in the first mortgage meltdown, they''ll do it again this time too. They''ve learned that profit is now privatized and loss is nationalized, so why would they change?

[dasman88]

The ney sayers and folks who are griping about this being "fear mongering" are having some trouble smelling the coffee...

When folks who are getting turned down for cell phones, can go out and buy a $500,000 homes... it is an actuarial fact that most of them are going to default on their loans.

When folks buy homes, that they can JUST afford, at teaser rates, and now they have lost income and their homes have dropped in value by 25%... it''s game over.

On average... in 2005 thru 2007, there was a NEGATIVE savings rate in the U.S.

All the armchair genius aside... you can''t defeat the math here. People who paid attention and did the simple math... they (we) have been talking about this since early 2005. Where the hell were the rest of you?