There’s a great deal I don’t understand about Gretchen Morgenson’s column on Sunday, about mortgages. If nobody understands the mortgage market, how is she so sure that it’s a train wreck, and that the decline in the mortgage securities index is not an overreaction? She concedes that MBSs are “far tougher to value than other securities” — but she seems pretty darn confident that she knows what way the mortgage market is going. She also seems convinced that loss mitigation procedures — where mortgages in default are renegotiated — are a bad thing. Here’s how her column ends:
Academic studies suggest that within the first two years of a workout, re-defaults can approach 25 percent…
No one likes to face ugly realities like financially ailing borrowers who are so strapped that nothing can save them. Not the lenders, not the Wall Street firms that sell the securities, not even the holders. But experienced investors know that a reliance on fantasy will only prolong the pain that is racking the huge and important mortgage market.
If re-defaults are less than 25%, doesn’t that mean that workouts succeed more than three-quarters of the time? And does Morgenson really think that all of Wall Street is deluding itself, because it doesn’t like “to face ugly realities”? The one thing that you can be sure of is that if Wall Street smells blood, nothing will stop its sharks from attacking. And so far MBSs have been relatively unscathed: the triple-B indices are down, to be sure, but the underlying securities are doing much better. Is it really true that the MBS market, as opposed to the mortgage-origination business, is racked with pain?
I’m not sure myself of the answers to these questions, but I’m told that Josh Rosner, the chap who seems to have been Gretchen’s main, if not only, source for this column, might be willing to talk to me too. So if you have any questions for Mr Rosner, let me know. First on my list: What is the relationship between default rates and MBS prices? Most of the commentary on the MBS market seems to be predicated on the idea that it’s very simple, and that if default rates go up, then MBS prices should plunge. Is that true?
Sounds like another case of a reporter forgetting that the market is smart, has all the same information, and has factored it into pricing long before the article appears. The article might make the issue slightly more pressing, but surely the market has already taken into account any facts the reporter references?
I would put it slightly differently: Morgenson is quite right when she says that no one really knows how this mortgage situation is going to play out. But in the absence of any real information on that front, the market isn’t panicking.
I’d say it’s a case of excessive moralizing, not unlike the sort of thing gold-bugs are prone to whenever the markets look shaky.
Working in a similar arena to the sub-prime mortgage industry, I’ve had people tell me with a straight face that the won’t lend relative small sums to prior own-defaults, that is, folks who previously defaulted on an obligation to our firm. Given that we operate in the non-prime segment, though, virtually everybody who walks through the door has defaulted on somebody, and we’re happy to work with 99.9% of them. Unless one imagines that the folks who defaulted on us did so out of some particular animus towards us, rather than what is euphemistically called a “life event”, the objection to own-defaults makes little sense. When pressed, the ultimate argument that I get from these people is a sense of moral outrage that the customer defaulted on us, followed by “fool me once, shame on you, fool me twice…”
I suspect Morgenson is indulging in the same sort of moralistic irrationality in favor of the simple numbers. A 75% “cure” rate, even if it still forces a write-down of part of the asset, is far better than nothing (or having to take the collateral and unload it in a weak market.)