Moody's and S&P Faux Subprime Downgrades

Moody's and S&P are reducing ratings on hundreds of mortgage pools and watching nervously on probably every other pool that exists. There is much commentary about the sophisticated nature of these pools and how some pools are better than others because of the way the mortgages were sliced and diced.

Here is the reality. When a subprime borrower defaults he/she defaults on the entire mortgage. They do not send in a cheque for the top 25% of the mortgage and stiff the lower strata. Quite frankly they are usually completely unaware of the mechanics that have been applied to their mortgage.

Some pools may hold the more senior portions of the mortgage so they will eventually recover most if not all of their capital and perhaps some of their overdue interest. But first the dirty work of an eviction and power of sale must occur. Given the legalisms that apply several more months will pass.

Investors in the lower strata will have all of the above problems plus worries about market value erosion and whether there is a sufficient equity cushion. A repo house usually needs repairs which again reduces values.

When the administrator works out the problem mortgage they work on a specific property. The slicing and dicing is a concept that does not truly manifest on the front lines.

What does this all mean? The individual ratings are truly nonsensical. Also the workouts will take a long time which means the subprime mess will continue to fester. Subprime mortgage securities represent about 2.13% of the $565.3 billion of the U.S. residential mortgage-backed securities industry rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006.

The mortgage industry will stay constipated. The housing business will also continue to slow because so many repo houses will be available savvy buyers will want the bargains not the brand new fancy stuff. Some hope for hardware companies as the repo's will need some fixing up.

If you are liquid and have good credit go visit your bank manager. He may have some bargains for you.