A Piggyback in a Poke (Subprime model)
Hindsight may be 20-20 but Floyd Norris’s latest New York Times column leaves one wondering whether buyers of subprime “piggyback” home loans had any sight at all. Norris nominates a Merrill Lynch offering as candidate for the worst ever mortgage security. Piggyback loans cover the remaining 20% of a home’s purchase price after the original 80% mortgage, allowing the buyer to finance 100% of the purchase.
Would you invest money — at a very low interest rate — to finance mortgage loans made to risky borrowers who put no money down?
What’s interesting about the offering was that not only was it risky, but the yield was low, Norris notes.
“Although market interest rates were low when these mortgages were written, the mortgages had rates averaging 11.2 percent. Yet investors who put up most of the money were willing to accept a floating rate of just 30 basis points — three-tenths of one percentage point — over the London interbank offered rate. At the moment, that gives them a yield of 3.2 percent. ”
“Making the situation worse is the nature of many of the mortgages in the Merrill securitization,” Norris writes. “Fewer than 30 percent of the loans were made to borrowers who provided full documentation of their income and assets. Many of the other borrowers probably lied about their income. Nearly all had borrowed the full appraised value of the home, either for the purchase or for refinancing, and it is possible that some appraisals were unreasonably high even before home prices began to fall.”
Moody’s forecasts that by the time it is wrapped up, so many of the mortgages will have gone bad that 60 percent of the money lent will not be paid back.
Also worth a listen is This American Life’s podcast “The Giant Pool of Money” in which Alex Blumberg and NPR’s Adam Davidson teamed up to look at the mortgage meltdown from the inside out.
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