Alternative A-Paper Mortgages: The Next Trillion Dollar Housing Problem.

Anytime someone tells you that a mortgage is less risky than “subprime” you know you have a problem.  The Alt-A mortgage is largely absent from the current mainstream housing debate but is really the next wave that will further depress housing prices.  Data produced from a June 2009 OCC and OTS report highlighting market conditions for 64 percent of U.S. mortgages finds that some 3.5 million loans are categorized as Alt-A.  California issuing IOUs is home to many of the Alt-A mortgages.  


The report categorizes Alt-A mortgages as those that fall between a FICO score of 620 and 659, which isn’t anything to be proud about.  What is even more disturbing is these mortgages originated at the height of the bubble.  There were two bubbles working here, one being the housing bubble and the other the FICO score bubble.  During the housing boom, it was very common for people in deep debt to refinance their home, take money out and payoff old debts.  This action simply reinforced high credit scores for many people that would have defaulted in times that were more reasonable.


Another major issue with Alt-A mortgage products and option ARMs is they cater to a supposedly more affluent audience.  Of course, if you aren’t verifying income then how do you know your borrower is affluent?  Let us first look at 64 percent of the U.S. mortgage market:


Alt-a, subprime, prime


Just to clarify what the “other” category is the OCC and OTS describe these loans as:


“Approximately 14 percent of loans in the data were not accompanied by credit scores and are classified as “other.” This group includes a mix of prime, Alt-A, and subprime loans. In large part, the lack of credit scores result from acquisitions of loan portfolios from third parties where borrower credit scores at the origination of the loans were not available.”

Well that is reassuring.  So in reality, if we add the Alt-A, subprime, and other categories we find that some 32 percent of all mortgages in this large analysis are questionable at best.  What makes Alt-A mortgages even more disastrous than subprime loans is their average balance amount:


alt-a and subprime average balance


The Alt-A average balance is nearly twice the average balance of subprime loans.  Many of the Alt-A products were made to homeowners that never qualified under standard underwriting guidelines and bought more home than they were capable of handling.  Many of these loans exist in states like California with record unemployment and record shattering deficits compounding the problem.  Alt-A loans are now defaulting at high rates catching up to subprime default patterns. 


Using this sample size and using our average balance numbers we find that there are over $1 trillion in loans that fall under the Alt-A umbrella.  Unfortunately, the OCC and OTS do not tell us the total amount of the Alt-A loan portfolio in their report but only tell us the number of loans active in their sample.  We do know that their entire sample of mortgages totals over $6 trillion.


It is safe to say that the Alt-A category has the largest average balance of all four-mortgage sets measured in the report.  Prime mortgages make up the bulk of the market but we need to remember that during the boom these products started taking the back seat in many overheated markets like Florida and California.  The Alt-A mortgage and option ARM have no viability outside of a housing bubble. These products only work if housing operates in a perma-growth model. 


Now why is this a problem?  Let us look at California.  Currently some 643,000 Alt-A mortgages are active in the state.  These loans carry an average balance of $442,000.  That means with a high rate of probability that $284,206,000,000 in Alt-A loans are underwater.  This is for one state, and California has seen the median home price crash by over 50 percent to $230,000.  Some of the recent mortgage modification attempts in California amount to kicking the can down the road.  The current idea of a modification is to attach a teaser interest rate, extend the term to say 40-years, and even go as far as negative amortization.  These are the same characteristics of Alt-A mortgages but apparently that is what they think will solve the problem.


Banks and Wall Street realize that this Alt-A toxic waste is going to implode soon.  That is why many are itching to unload this crap into the public-private investment program which begins this month.  The Treasury is set to name 9 ‘Toxic’ Managers next week.  These Alt-A loans will start defaulting in large numbers late this year and well into 2012.  The bottom line is someone is going to pay for this mess and if it were up to banks and Wall Street, it would be the taxpayer.  Looks like they’re setting that plan in motion.                


Dr. Housing Bubble