How it worked

Consider the Bear Stearns Alt-A Trust 2006-7, a $1.3 billion drop in the sea of risky loans. Here’s how it worked:

As the credit bubble grew in 2006, Bear Stearns, then one of the leading mortgage traders on Wall Street, bought 2,871 mortgages from lenders like the Countrywide Financial Corporation.

The mortgages, with an average size of about $450,000, were Alt-A loans — the kind often referred to as liar loans, because lenders made them without the usual documentation to verify borrowers’ incomes or savings. Nearly 60 percent of the loans were made in California, Florida and Arizona, where home prices rose — and subsequently fell — faster than almost anywhere else in the country.

Bear Stearns bundled the loans into 37 different kinds of bonds, ranked by varying levels of risk, for sale to investment banks, hedge funds and insurance companies.

If any of the mortgages went bad — and, it turned out, many did — the bonds at the bottom of the pecking order would suffer losses first, followed by the next lowest, and so on up the chain. By one measure, the Bear Stearns Alt-A Trust 2006-7 has performed well: It has suffered losses of about 1.6 percent. Of those loans, 778 have been paid off or moved through the foreclosure process.

But by many other measures, it’s a toxic portfolio. Of the 2,093 loans that remain, 23 percent are delinquent or in foreclosure, according to Bloomberg News data. Initially rated triple-A, the most senior of the securities were downgraded to near junk bond status last week. Valuing mortgage bonds, even the safest variety, requires guesstimates: How many homeowners will fall behind on their mortgages? If the bank forecloses, what will the homes sell for? Investments like the Bear Stearns securities are almost certain to lose value as long as home prices keep falling.

from the NYTimes

About dowbrigade

Semi-retired academic from Harvard, Boston University, Fulbright Commission, Universidad Laica Eloy Alfaro de Manta, currently columnist for El Diario de Portoviejo and La Marea de Manta.
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23 Responses to How it worked

  1. Scott says:

    How it happened is interesting and there are many more risky derivatives that are worthy of a look too. The key is how are we going to move forward balancing free market ideals and economic reality? We have to find the path between letting “the invisible hand” regulate the economy and deal with the fact that brokers invariably lie and manipulate clients.

  2. This all happened because no one cared at the time about the real value of the products. The companies packaging these derivatives only cared about one thing the commissions on the sales nothing else. They really did not care what they sold to their clients.

  3. Not to point the finger or cast blame, but much discussion has come from what caused this whole fiasco.

    Cramer recently said that Clinton was to blame for allowing an ideological desire get the better of reality by allowing banks to open the doors to those who could not afford homes.

    Yet, the current administration had plenty of time to recognize and recover any mistakes.

    Just fuel for argument i suppose 🙂

  4. So, we know what caused all of this, but what’s to prevent it from happening again?

    I think a lot of the “blame” for our current situation needs to be pointed at ourselves. We’re the ones who took out loans, we’re the ones spending money that we don’t have, and we’re the ones who are complaining.

  5. Okinawa says:

    The world is in for a rude wakeup call, or the dollar is anyway, once the world finishes all of this deleveraging….

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    The premise inverts stereotypes of heroes and power while embracing the contradiction of championing reason in a world where it is clearly shown there are many things beyond reason.

  7. How does this relate on foreclosure process?

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  12. There are still billions of dollars of ‘risky’ loans out there just waiting to fall over. I wonder how long this current recession will last for?

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  15. Braydon Rohan says:

    I think one has to be very cautious in making a business deal. Do any one possess knowledge on Foreclosures in canada? How to invest safely in it ?

  16. Ronaldo Waylon says:

    The Economy is so much lopsided that it requires lot of Caution.I can help you out by giving info on a very good foreclosure company in Canada.

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    A lot of people who bought their homes in 2004,2005 used 5 year fixed loan. Those mortgages will be reset in 2010 which will result in another wave of bank foreclosures, the worst time is still ahead.

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