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Paul Kiesel
Paul Kiesel
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Subprime Crisis was the Tip of the Iceberg

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As subprime defaults begin to level off for the first time in almost two years, a bigger problem is quickly building: Homeowners with good credit are falling behind on their monthly mortgage payments in increasing numbers.

Alt-A mortgages, or mortgages with a slightly better interest rate than subprime mortgages (and mortgages that, unfortunately, were offered to people with good credit scores during the housing boom), are going into default at escalating rates. Since April, 2007, alt-A mortgages have quadrupled in the number that are past due (12 percent in April, 2008).

IndyMac was one of many lenders that wrote copious amounts of alt-A or “creative mortgages” during the housing boom, and, now famously, lost billions of dollars due to mortgage defaults and other credit risks because of its lending strategy; the bank was subsequently taken over by the Federal Savings Bank.

The fear on Wall Street is that several banks are at risk of taking large hits in the same manner that Indymac did and that the result could be much greater than what the subprime crisis presented.

Thomas H. Atteberry, president of First Pacific Advisors, an investment firm in Los Angeles that trades mortgage securities, said that, “Subprime was the tip of the iceberg [. . .] Prime will be far bigger in its impact.”

According to the New York Times, James Dimon, the chairman and chief executive of JPMorgan Chase, said that he expected losses on prime at his bank to triple in the coming months and described the outlook for them as “terrible.”

The reality is that prime and alt-A loans have longer introductory periods of special interest rates, therefore, it makes sense that over the next six to 18 months we should see an increase in the amount of prime credit borrowers defaulting on their mortgages — the Housing Bill will do little if anything to prevent this from occurring.

Subprime loans typically had a introductory period of two to three years; prime loans have a five-to-seven year period. And before the subprime boom, many prime borrowers were taking out what are now called “creative mortgages,” (i.e. alt-A loans) while home prices were skyrocketing, in hopes of refinancing before the interest rate reset and taking advantage of the home’s appreciated value. Now credit markets will see that too many of the borrowers that got these type of loans and that had good credit scores, are in housing situations where their loan is worth more than the home itself. Analysts believe that many will not be able to or want to make higher payments when the interest rate reset occurs.

Fannie Mae and Freddie Mac, the two mortgage giants that own half of the $12 trillion market of mortgages, and they’re financial soundness are about to be tested throughout 2009, as they have yet to feel the pangs of prime borrower defaults. If they’re unable to weather the punch of the “prime” storm, the American people will be subjected to the tab of bailing out the government sponsored enterprises.