Vultures descend on mortgage market
Posted
Jun 10 2009, 01:29 PM
by
Minyanville
Rating:
In early 2006, when subprime powerhouse New Century went bust, vulture investors began to salivate at the opportunities a collapsing mortgage market would offer up like manna from the trading gods. They started raising money. And lots of it.
Billions were poured into so-called "mortgage opportunity funds," which planned to pick through the wreckage of the once-high-flying housing market. Some investors aimed to focus on mortgage-backed securities, hoping to buy in at pennies on the dollar so just a few bond payments would reap sizable returns. Others, however, delved into the realm of whole loans, buying troubled mortgages from floundering banks.
As noted in the Wall Street Journal this morning, an investment strategy that seemed like a slam dunk on paper -- buying distressed mortgages on the cheap, and working out equitable arrangements with borrowers -- has proven extremely difficult to execute.
The prevailing wisdom was that, as delinquencies rose, and banks amassed a seemingly limitless portfolio of troubled loans, the likes of JP Morgan Chase (JPM), Bank of America (BAC) and Citigroup (C) would be forced to unload assets at firesale prices. Because they were buying at super-low prices, investors expected to have the necessary cushion to forgive principal, lower interest rates, or otherwise get borrowers back on track. They would, of course, earn a hefty profit for the effort.
But the housing market, which tumbled further and faster than all but the most pessimistic experts thought possible, had other plans.
Throughout 2007, any player that dipped a toe into the market lost a foot. Property value declines accelerated, securities prices tumbled, and economic conditions continued to deteriorate. Sellers, hoping for a rebound, were reluctant to accept lowball prices. Few trades were executed, and the lack of liquidity drove the market to new lows.
Then, in 2008, as delinquencies began to spread from the subprime to the prime market, home prices continued to slide, and it became clear there would be no easy fix to the housing market's woes, big banks recognized their need to raise capital by selling assets.
The market for distressed loans began to flourish as liquidity entered the market: Sellers accepted painfully low prices, and investors started deploying more capital. Prices for pools of mortgages in various stages of default began to stabilize, typically around $.50-$.60 on the dollar. As 2008 rolled along, the wheels of the financial markets truly lost their grip on the road, Washington stepped in with the Troubled Asset Relief Program (or TARP) in October. In the distressed mortgage market, uncertainty became the rule of the day, as buyers and sellers alike ceased trading in expectation of new clearing prices created by an asset purchase program that never came.
Traders then sat on the sidelines as the election played out, waiting to see how front-runner Barack Obama's promised foreclosure moratorium would impact the housing market.
Meanwhile, Uncle Sam poured capital into banks to try and jumpstart lending. With taxpayers bailing out the market's most leveraged players, Morgan Stanley (MS), Goldman Sachs (GS) and other Wall Street firms got a reprieve from bets gone awry.
Distressed investors hoped banks would finally be willing accept low prices for their assets. Not so. Just when it looked like a few select sellers were going to test the waters of the distressed market, the new Treasury Secretary Tim Geithner announced the Public-Private Investment Program (or PPIP).
The PPIP -- a bastardized version of TARP that employs leverage, and is purported to profit both taxpayers and private investors -- is yet to materialize.
The distressed whole loan market remains largely frozen, as sellers hope for higher prices from buyer's backed by cheap government money. Buyers, meanwhile, remain cautious, since, despite recent "positive" datapoints coming out of the housing market, real-estate prices remain volatile in most markets.
The private market for delinquent mortgages once held the potential for a market-based solution to the country's housing woes. It was no magic bullet, to be sure. But by fostering an environment where private capital could seek out advantageous investments, housing markets would have started down the path towards true price discovery.
As it happened, however, massive government intervention into the market via TARP, the foreclosure moratorium, the PPIP, and other programs forestalled the inevitable, pushing the date of the eventual recovery years into the future.
This is good news for banks that survived the maelstrom of financial market turmoil, albeit based largely on trumped-up earnings and unrealistic asset prices still on their balance sheets. For homeowners, consumers, and the public in general, however, true hope for a legitimate stabilization in housing markets, and the economy in general, has been pushed further along the curve.
Top Stocks blogging partner Todd Harrison is founder & CEO of Minyanville.com. This post was written by Minyanville Contributor Andrew Jeffery.
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