Reuters’ Al Yoon — one of the few major media journalists who has a track record of being spot-on in his coverage — has co-authored a report that gets to the core of my questions yesterday over Countrywide’s push to modify $4 to $6 billion in troubled mortgages. I noted yesterday that Countrywide’s loan modification commitment likely illustrated a change of approach from at least one party in the secondary market. From the Reuters story, insight into a market in chaos:
Making loans current today that might go bad later may improve the short-term performance of the bond, triggering a liquidation of reserves for those who are supposed to shoulder the biggest risks. This eliminates important protections for more conservative investors, again rewarding the reckless. The release of reserves on a bond deal typically occurs if enough underlying loans are current after a period of three years. With the worst of the bonds being created in late 2005 and beyond, the issue is likely to heat up toward the end of 2008, said Roelof Slump, a managing director at Fitch Ratings. He added that some modifications may have been done in recent months to massage performance on older bonds … Investors who own the highest, AAA-rated portions of bonds have already voiced their opposition to loan modifications for investors in lower-rated securities in “many” instances, said Ted Tozer, National City Mortgage’s head of capital markets … “The AAA holders say ‘why are you doing these mods?’ We say we are servicing loans for the whole security,” Tozer said.
The above should illustrate first and foremost that when it comes to Wall Street’s objectives, the borrower is rarely part of the equation. I’m fond of quoting one of the early investors in the RMBS market, who said “People actually still think we’re securitizing this stuff out of the goodness of our hearts — let them think that, while we mint money.” Times like these are putting the entire structured securities market on edge, however, with the “stressed market scenario” putting investors at different levels in favor of very different outcomes — and the Rueters article only begins to touch on what hedge fund investors in a short position on something the like ABX indices would want to see. (In the attempt to disintermediate risk, Wall Street has managed to create a complex ecosystem where risk is redefined at varying levels and in differing terms.) HW readers will likely know John Paulson, who started a very public row with Bear Stearns in June over loan modifications and “tampering” with markets. He’s grown quiet recently as his short positions on the ABX have raked in outsized returns — but the problems that “stressed scenarios” are creating among secondary market participants is likely to rear its ugly head many more times before the current housing and mortgage crisis is over. In my mind, Countrywide’s got the right idea here – let’s do what’s right for the borrowers as much as we can. But as I alluded to earlier, something tells me there are good number of investors in the mezzanine and equity classes of various RMBS that are right behind the nation’s largest lender here as well. These investors simply have too much to lose by sitting idly on the sidelines.