WC Varones lays it down on the mortgage crisis

Quite possibly the two most succinct posts you will read on the double-whamy affecting the US housing market are on the ever-irascible WC Varones' blog.

First, why funds that were heavily leveraged in mortgage-backed securities are taking it on the chin:

Bear Stearns did a pretty stupid thing, going out and buying bad mortgages from bad lenders and then using lots of debt to leverage it up. The outcome was obviously foreseeable. The question is how badly the blowup will affect the broader asset-backed market and how many other funds will have to dramatically restate the value of their assets. Asset-backeds can be thinly traded and hard to price, so many funds may be pricing their holdings too optimistically.Say they're pricing an asset-backed at 70, but they have a cash crunch and need to sell. The best bid they can get is 65. No big deal, right? A 7% drop in value. Ah, but here's where leverage comes in. These dumbasses have leveraged up their portfolio 10-1 or 20-1. A 7% drop in asset value means a 70% or 140% drop in the fund. Game over! Thanks for playing!

And why the rules of the game encourage homeowners to default:

A new study from Experian finds what we told you months ago: that borrowers with no money down facing rising rates and sinking property values will not pay their mortgages.Well, duh. You've got no skin in the game. You're paying $1500/month as a teaser rate on a home you "bought" for $500,000. A year or two later, the rate resets so that your payments are $2200. Meanwhile, the property market is sinking and you'd have trouble selling for $450,000. The obvious thing to do is stop paying the mortgage and let the bank take the house. You've lived in a nice house for cheap rent for a year or two. You can keep living there for free for a few more months as they go through the foreclosure process. That's a better choice than continuing to pay and having negative equity of at least $50,000 and increasingly difficult monthly payments. And you had a free option to get rich if the bubble continued. That's why we call them put-option ARMs. You just exercised your put.

Any questions?

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