Yet another 'mortgage crisis' article. But ignore the fine details of this article at your own risk. They, in part, have already prompted me to completely rebalance my portfolio. The details in this article are simply hard to believe, and if true, create the kind of downside risk to the U.S. and world economy that people are failing to comprehend. Crisis Looms in Mortgages By GRETCHEN MORGENSON Published: March 11, 2007 http://www.nytimes.com/2007/03/11/business/11mortgage.html?hp On March 1, a Wall Street analyst at Bear Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and its stock, at around $15, had lost half its value in three weeks. What happened next seems all too familiar to investors who bought technology stocks in 2000 at the breathless urging of Wall Street analysts. Last week, New Century said it would stop making loans and needed emergency financing to survive. The stock collapsed to $3.21. The analystâs untimely call, coupled with a failure among other Wall Street institutions to identify problems in the home mortgage market, isnât the only familiar ring to investors who watched the technology stock bubble burst precisely seven years ago. Now, as then, Wall Street firms and entrepreneurs made fortunes issuing questionable securities, in this case pools of home loans taken out by risky borrowers. Now, as then, bullish stock and credit analysts for some of those same Wall Street firms, which profited in the underwriting and rating of those investments, lulled investors with upbeat pronouncements even as loan defaults ballooned. Now, as then, regulators stood by as the mania churned, fed by lax standards and anything-goes lending. Investment manias are nothing new, of course. But the demise of this one has been broadly viewed as troubling, as it involves the nationâs $6.5 trillion mortgage securities market, which is larger even than the United States treasury market. Hanging in the balance is the nationâs housing market, which has been a big driver of the economy. Fewer lenders means many potential homebuyers will find it more difficult to get credit, while hundreds of thousands of homes will go up for sale as borrowers default, further swamping a stalled market. âThe regulators are trying to figure out how to work around it, but the Hill is going to be in for one big surprise,â said Josh Rosner, a managing director at Graham-Fisher & Company, an independent investment research firm in New York, and an expert on mortgage securities. âThis is far more dramatic than what led to Sarbanes-Oxley,â he added, referring to the legislation that followed the WorldCom and Enron scandals, âboth in conflicts and in terms of absolute economic impact.â While real estate prices were rising, the market for home loans operated like a well-oiled machine, providing ready money to borrowers and high returns to investors like pension funds, insurance companies, hedge funds and other institutions. Now this enormous and important machine is sputtering, and the effects are reverberating throughout Main Street, Wall Street and Washington. Already, more than two dozen mortgage lenders have failed or closed their doors, and shares of big companies in the mortgage industry have declined significantly. Delinquencies on loans made to less creditworthy borrowers â known as subprime mortgages ârecently reached 12.6 percent. Some banks have reported rising problems among borrowers that were deemed more creditworthy as well. Traders and investors who watch this world say the major participants â Wall Street firms, credit rating agencies, lenders and investors â are holding their collective breath and hoping that the spring season for home sales will reinstate what had been a go-go market for mortgage securities. Many Wall Street firms saw their own stock prices decline over their exposure to the turmoil. âI guess we are a bit surprised at how fast this has unraveled,â said Tom Zimmerman, head of asset-backed securities research at UBS, in a recent conference call with investors. Even now the tone accentuates the positive. In a recent presentation to investors, UBS Securities discussed the potential for losses among some mortgage securities in a variety of housing markets. None of the models showed flat or falling home prices, however. The Bear Stearns analyst who upgraded New Century, Scott R. Coren, wrote in a research note that the companyâs stock price reflected the risks in its industry, and that the downside risk was about $10 in a ârescue-sale scenario.â According to New Century, Bear Stearns is among the firms with a âlongstandingâ relationship financing its mortgage operation. Mr. Coren, through a spokeswoman, declined to comment. Others who follow the industry have voiced more caution. Thomas A. Lawler, founder of Lawler Economic and Housing Consulting, said: âItâs not that the mortgage industry is collapsing, itâs just that the mortgage industry went wild and there are consequences of going wild. âI think there is no doubt that home sales are going to be weaker than most anybody who was forecasting the market just two months ago thought. For those areas where the housing market was already not too great, where inventories were at historically high levels and it finally looked like things were stabilizing, this is going to be unpleasant.â Like worms that surface after a torrential rain, revelations that emerge when an asset bubble bursts are often unattractive, involving dubious industry practices and even fraud. In the coming weeks, some mortgage market participants predict, investors will learn not only how lax real estate lending standards became, but also how hard to value these opaque securities are and how easy their values are to prop up. Owners of mortgage securities that have been pooled, for example, do not have to reflect the prevailing market prices of those securities each day, as stockholders do. Only when a security is downgraded by a rating agency do investors have to mark their holdings to the market value. As a result, traders say, many investors are reporting the values of their holdings at inflated prices. âHow these things are valued for portfolio purposes is exposed to management judgment, which is potentially arbitrary,â Mr. Rosner said. At the heart of the turmoil is the subprime mortgage market, which developed to give loans to shaky borrowers or to those with little cash to put down as collateral. Some 35 percent of all mortgage securities issued last year were in that category, up from 13 percent in 2003. Looking to expand their reach and their profits, lenders were far too willing to lend, as evidenced by the creation of new types of mortgages â known as âaffordability productsâ â that required little or no down payment and little or no documentation of a borrowerâs income. Loans with 40-year or even 50-year terms were also popular among cash-strapped borrowers seeking low monthly payments. Exceedingly low âteaserâ rates that move up rapidly in later years were another feature of the new loans. The rapid rise in the amount borrowed against a propertyâs value shows how willing lenders were to stretch. In 2000, according to Banc of America Securities, the average loan to a subprime lender was 48 percent of the value of the underlying property. By 2006, that figure reached 82 percent. Mortgages requiring little or no documentation became known colloquially as âliar loans.â An April 2006 report by the Mortgage Asset Research Institute, a consulting concern in Reston, Va., analyzed 100 loans in which the borrowers merely stated their incomes, and then looked at documents those borrowers had filed with the I.R.S. The resulting differences were significant: in 90 percent of loans, borrowers overstated their incomes 5 percent or more. But in almost 60 percent of cases, borrowers inflated their incomes by more than half. A Deutsche Bank report said liar loans accounted for 40 percent of the subprime mortgage issuance last year, up from 25 percent in 2001. Securities backed by home mortgages have been traded since the 1970s, but it has been only since 2002 or so that investors, including pension funds, insurance companies, hedge funds and other institutions, have shown such an appetite for them. Wall Street, of course, was happy to help refashion mortgages from arcane and illiquid securities into ubiquitous and frequently traded ones. Its reward is that it now dominates the market. While commercial banks and savings banks had long been the biggest lenders to home buyers, by 2006, Wall Street had a commanding share â 60 percent â of the mortgage financing market, Federal Reserve data show.