Monday, December 15, 2008

Beyond Subprime: Alt-A, Option ARMs, and Weak Financial Stocks

Back in August, Calculated Risk pointed out some good news/bad news: subprime delinquencies had peaked, but the Alt-A rate resets don't peak until late 2009, suggesting that delinquencies and foreclosures could be with us well into 2010. They made the excellent point that, relative to subprime, a smaller proportion of Alt-A mortgages had been securitized. That means that vulnerable mortgages remain on bank balance sheets and are likely to weigh those down for some time to come.

A third set of mortgages, Option ARMs, also have yet to reset. These will pose significant foreclosure problems once the initial teaser rates skyrocket. Together, Alt-A and Option ARMs mortgage problems could lead to losses as large if not larger than the initial subprime mess. While lawmakers are apportioning blame for the mortgage debacle, proposals are on the table to address the foreclosure crisis, including lowering mortgage rates, extending maturities on mortgage loans, and packaging these revised loans through Fannie and Freddie with explicit government guarantees. Questions abound, however, as to whether government-mandated financing will make a difference, particularly if household incomes fall more than such financing will save.

Meanwhile, the banking index ($BKX) fell another 4% today, as the financial stocks continue to lag other S&P 500 sectors. As of Monday's close, Decision Point notes, only 23% of financial shares are trading above their 20-day moving averages, compared with 41% for NYSE common stocks overall. With overhanging mortgage concerns and no clear path for resolution, TARP has failed to rescue the stocks of vulnerable financial institutions.