Interest Rate Roundup

Thursday, December 07, 2006

11th largest subprime lender goes POOF!

The fallout from the housing bust continues. This week, the 11th largest subprime mortgage lender in the country, basically went POOF! Here's a MarketWatch story with the details. The culprit appears to be the forced buyback of loans from mortgage investors. In a nutshell, subprime originators make loans, then sell them off to end investors. If those loans go bad quickly, or if other conditions are met, the investor can put those loans back to the originator. The company, Ownit Mortgage Solutions of California, reportedly ran out of cash to buy those loans back. According to one employee, the company (which made more than $8 billion in loans last year) basically shut down overnight.

I'm not surprised one bit. I've been following this industry in one capacity or another since 1998 -- ironically, the last time there was a mega-implosion in the subprime lending sector. Back then, the Russian bond default that led to the Long-Term Capital Management crisis also caused ALL high-risk debt markets to seize up. Subprime lenders had been originating lots of high-LTV loans, particularly a hot product called the 125% LTV home equity loan. Just like the name suggests, you could borrow up to 125% of your home's value as a second mortgage.

Almost overnight, the demand for bonds backed by pools of high risk mortgage loans dried up. Went Poof! That caused several firms to fold or sell themselves off to better capitalized institutions. It's worth noting that the 1998 implosion happened at a time when home prices were still relatively reasonable vs. incomes, and when housing wasn't coming off the biggest bubble in U.S. history (like it is now). Will the fallout be worse in this cycle? We'll see.


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