So by now everybody’s read about the subprime mortgage meltdown, right? Well thankfully Countrywide doesn’t seem to be so affected, but I’ve been reading some interesting analysis by Gretchen Morgenson over at the New York Times. She’s way sharp and although I frankly don’t know enough about all this, I tend to agree with her prognosis. Let’s just say it’s going to be a bumpy ride for the next 3 or 4 years when it comes to Real Estate in the U.S.
The thing is, you had all these mortgage lenders pretty much lending trillions of dollars to just about anyone who’d walk into their office, qualified or not. This of course drove housing prices way up since you had flippers gobbling up houses like crazy. Demand went through the roof but supply remained a constant. So now these lenders all have tons of expected payments but they want to liquify their assets, so they securitize these loans into asset backed securities. Subprime loans magically become BBB and BBB- asset tranches. Investors start buying these up since they offer a pretty good return on investment. Hell, you’ve even got investors borrowing Yen, converting into dollars just so they can gobble up all these asset backed securities.
Fast forward to the present. The Fed’s had to raise its lending rate quite a bit to curb inflation. Inflation is a risk thanks to instability in the Middle East and the growing demand for oil, especially in China. Americans are consuming as much as ever, not saving anything. All of a sudden, however, a lot of these ARMs are resetting so homeowners who were 2 years ago paying 4.5% are all of a sudden paying 8%. In subprime land, it’s more like 7% to 12% or some such nonsense. All of a sudden, the mortgage payment goes from $2,000 a month, which was a stretch, to $3,500 or more. So all these homeowners start defaulting on their loans. The lenders in turn pass the bad news to investors who start seeing interest shortfalls on their BBBs and BBB-s. So these guys are pissed and selling the assets. In the meantime, Japan’s raising rates and there’s a lot of Americans owing a lot of Yen.
What a mess…
Anyway, I’ve totally rambled on, but what’s cool about all this as far as I’m concerned is that I’m currently implementing Credit Derivatives on Asset Backed Securities (CDS on ABS, for short) and my employer plans to go live on indices within a month. All this is so very a propos especially with the subprime mortgage meltdown. Basically lenders use credit derivatives to minimize their credit risk. If you’re a lender, you buy protection by paying a monthly premium to a third party in exchange for them to cover you if there’s a default on the loan.
Right now our focus is to finish the implementation of ABX indices as we’re going live with that early April. I’ve been spearheading the effort, making enhancements and especially interfacing with MarkIT data feeds. It’s cool because it’s still so new everyone is trying to figure out how these creatures work. I’m pulling XML data from MarkIT before it’s even completely ripe… I’m on the cutting edge of finance and lovin’ it!