After CRYO, HOKU, there was one another stock that has given multibagger returns…BCGI

Is it any wonder that only now we are seeing defaults and foreclosures on these mortgages increasing.  I believe the worst is yet to come and only after we pass by the next 12 months will we get some relief to this real estate crisis.

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One trend that has held up Countrywide has been the refinancing of loans that were originally ARM loans. With Washington Mutual (WM), Countrywide Financial (CFC) and H&R Block (HRB) deciding to curb new subprime loans, some of these resets may not be refinanced by Countrywide. 

I am inclined to believe that there is additional downside risk to Countrywide and this is also the reason I have been keeping away from financials (except for Barclays and WisdomTree) despite their low valuations.

Maybe it is time to take a closer look at TJX Companies (TJX) and Ross Stores (ROST) again.

They may not refinance to new subprimes but will probably push their borrowers to refinance under longer termed fixed mortgages. Lenders enjoy a 7-8% rate of return and their borrowers will appreciate the stability.

It is typical of the average real estate owner to not be able to time the markets very well. In previous market cycles when short term rates (90 day) trend down, property owners refinance to take advantage of those low rates. The problem is that instead of refinancing and locking in the lower fixed rate and saving they instead realize that these low rates allow them to afford more property. So they took on ARMs to upgrade to even larger and more expensive houses. More than they could afford at longer term fixed rates. That was the problem.

Now the cycle has come full circle the the most speculative and clueless are feeling the effects of the ARMs and are now trying to refinance out of them for fear that rates will continue to go higher. This explosion in refinancing to longer term mortgages means that mortgage brokers see some new business.

As far as the lenders are concerned the downside going into mid 2008 will be limited. Lenders base their rates against 10y treasury rates which have been fairly high (naturally). The Federal Reserve has made a commitment to keeping rates flat for the time being. That means lenders borrowing costs for not money is higher that it was a few years ago. If they are willing to convert their ARMs to longer termed fixed mortgages then they are expecting that rates are not going to move much higher than they are now. If they do then the lenders would have to expect to be loosing money on every mortgage they accept below those higher rates. If they refinance the majority of mortgages to fixed at 7-8% and inflation runs up to 8-10% then the money already lent is inflating away at the difference between the agreed on fixed rate and the rate of inflation. It is in their best interests to keep inflation capped at these levels and they will pressure their central banks and the Federal Reserve.

You probably know all this. I guess I’m writing it for my own peace of mind.

The mortgages I have all are under 5.8% at fixed rates and it has been a little frustrating to have seen them sold and resold to various other lenders because I am hurting their bottom line. Payment schedules have been a nightmare as I am seeing changes at least every 3 months. I think they may be hoping that I will drop the ball in the transitions or on their watch.

You are right about most ARM mortgages being refinanced into fixed rate mortgages. However since both state and federal regulators are cracking down on subprime mortgages (I doubt Countrywide and fellow lenders decided to stop subprime 2 year ARM lending out of higher moral values), many of these subprime borrowers will have to look for other sources for their refinancing and hence loan volume at Countrywide may not rise a whole lot, if at all.

The key is figuring out where interest rates may head 6 months or a year from now. Inflation is tame right now and the Fed expects it to stay in pretty much the 2% to 3% range through much of 2008. However the spreads have tightened for most lenders over the last couple of years and are likely to stay tight unless the fed lowers interest rates.

I just finished reading the hilarious and eye opening book Liar’s Poker by Michael Lewis about bond trading at Salomon Brothers in the 80s. There is a whole section about how mortgage bonds were created by Salomon and describes exactly what is happening to your mortgage loan. If you have not already read it, I highly recommend checking it out.