How it worked

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Consider the Bear Stearns Alt-A Trust 2006-7, a $1.3 billion drop in the sea of risky loans. Here’s how it worked:

As the credit bubble grew in 2006, Bear Stearns, then one of the leading mortgage traders on Wall Street, bought 2,871 mortgages from lenders like the Countrywide Financial Corporation.

The mortgages, with an average size of about $450,000, were Alt-A loans — the kind often referred to as liar loans, because lenders made them without the usual documentation to verify borrowers’ incomes or savings. Nearly 60 percent of the loans were made in California, Florida and Arizona, where home prices rose — and subsequently fell — faster than almost anywhere else in the country.

Bear Stearns bundled the loans into 37 different kinds of bonds, ranked by varying levels of risk, for sale to investment banks, hedge funds and insurance companies.

If any of the mortgages went bad — and, it turned out, many did — the bonds at the bottom of the pecking order would suffer losses first, followed by the next lowest, and so on up the chain. By one measure, the Bear Stearns Alt-A Trust 2006-7 has performed well: It has suffered losses of about 1.6 percent. Of those loans, 778 have been paid off or moved through the foreclosure process.

But by many other measures, it’s a toxic portfolio. Of the 2,093 loans that remain, 23 percent are delinquent or in foreclosure, according to Bloomberg News data. Initially rated triple-A, the most senior of the securities were downgraded to near junk bond status last week. Valuing mortgage bonds, even the safest variety, requires guesstimates: How many homeowners will fall behind on their mortgages? If the bank forecloses, what will the homes sell for? Investments like the Bear Stearns securities are almost certain to lose value as long as home prices keep falling.

from the NYTimes

23 Comments

  1. Scott

    September 30, 2008 @ 10:07 am

    1

    How it happened is interesting and there are many more risky derivatives that are worthy of a look too. The key is how are we going to move forward balancing free market ideals and economic reality? We have to find the path between letting “the invisible hand” regulate the economy and deal with the fact that brokers invariably lie and manipulate clients.

  2. Dave @ Manila Law

    October 1, 2008 @ 7:09 am

    2

    This all happened because no one cared at the time about the real value of the products. The companies packaging these derivatives only cared about one thing the commissions on the sales nothing else. They really did not care what they sold to their clients.

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    October 9, 2008 @ 6:45 pm

    3

    Not to point the finger or cast blame, but much discussion has come from what caused this whole fiasco.

    Cramer recently said that Clinton was to blame for allowing an ideological desire get the better of reality by allowing banks to open the doors to those who could not afford homes.

    Yet, the current administration had plenty of time to recognize and recover any mistakes.

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    November 18, 2008 @ 11:25 am

    4

    So, we know what caused all of this, but what’s to prevent it from happening again?

    I think a lot of the “blame” for our current situation needs to be pointed at ourselves. We’re the ones who took out loans, we’re the ones spending money that we don’t have, and we’re the ones who are complaining.

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    November 29, 2008 @ 3:07 am

    5

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    March 31, 2009 @ 9:33 am

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    How does this relate on foreclosure process?

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    September 9, 2009 @ 10:44 am

    12

    There are still billions of dollars of ‘risky’ loans out there just waiting to fall over. I wonder how long this current recession will last for?

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