$469 Billion in Alt-A toxic mortgages floating in the U.S. Geithner toxic PPIP program starts in July. Most of the toxic loans implode starting in Q3

By Dr Housing

Let me be abundantly clear. We still have a Pay Option ARM and Alt-A mortgage problem. This will hit in full force in 2010 and we are already seeing many mortgage holders having trouble with actual recasts brought on by negative amortization. Yet there is a crew of people saying that Alt-A mortgage products will not bring any trouble because of the low interest rate environment. Unfortunately the low rate misses the bigger issue. Low rates are helping but the problem that we will be seeing is the massive onslaught of recasts, not resets that will be occurring over the next few years. This is a big reason why we won’t see a housing bottom in California until 2011 at the earliest. Many of these loans were made to supposedly better qualified borrowers in mid to upper priced areas. These areas will begin to crack like an egg dropped on the floor late in 2009. The Notice of Default tsunami will guarantee this much.

I’m am stunned that some people are actually saying that Alt-A mortgages or Pay Option ARMs will create little problems in the market. Okay. Then how about we remove the public-private investment program that conveniently has a cap with the FDIC of $500 billion? After all, if there isn’t any problem with toxic mortgages why should we have a toxic mortgage program that has the design to eat up $1 trillion in loans. Exactly. Let me break down the latest figures from data by none other than the Federal Reserve:

California

At the end of March 2009

Subprime loans active: $119 billion

Alt-A loans active: $288 billion

U.S.

Alt-A active: $469 billion

When we talk about the $500 billion in Alt-A mortgages this is what we are talking about. Last time I checked $469 billion does not mean the problem has gone away. Businessweek came out with a chart only last month showing how Pay Option ARMs will be recasting over the next few years:

Click for sharper image

I’ve added a reference point for all those people who seem to think that Option ARMs and Alt-A loans have somehow disappeared from the market. The game is just starting. Currently, we are seeing less than $2 billion per month of these loans recasting. However, in 2010 we are going to start seeing $8 to $10 billion per month recast, nearly 5 times the current rate. The chart states “months to 1^st reset” but they are referring to recasts brought on by negative amortization. And as you will see, since the majority of these loans are in California the bulk are underwater Jacque Cousteau style.

Wachovia in their infinite wisdom swallowed up Golden West at the height of the lending insanity. This cratered the bank which was taken over by Wells Fargo. Just because you eat a bank doesn’t mean the toxic waste suddenly disappears. In fact, there is still well over $100 billion in Pick-A-Pay mortgages in their portfolio. Wells Fargo has written off a portion of the portfolio but there is still a significant amount remaining:

This is from their most recent 10-Q. Wells Fargo alone has $42 billion in unpaid principal linked to Pick-A-Pay mortgages here in California. The Pick-A-Pay was basically the Pay Option ARM World Savings Style. Here were the terms:

Source: Mortgage X

These are the crappiest loans in the world. World Savings which was owned by Golden West thought that by simply having a little more collateral and looking at FICO scores that handing out toxic waste would be smart. Some of these insane loans don’t have the first adjustment until 10 years later! Of course, if Wells Fargo had any sense they would look at that absurd 152% LTV and freaking recast the entire lot. Somehow I doubt they are doing this since they are too busy sucking up taxpayer money through the crony bailout and pretending everything is fine through manufactured stress tests. Look at the LTV on some of the toxic foursome. Arizona actually beats California out with a 161% LTV which is astonishing in itself. But again, out of this little section of $61 billion in Pick-A-Pay loans $42 billion are in California, a state that has seen the median price drop by 50% in one year.

Wells Fargo seems to have the biggest amount of this crap on their books. Yet Bank of America and JP Morgan now have a lot since they acquired toxic mortgage experts Countrywide Financial and WaMu. Let us first look at Bank of America:

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Bank of America has $20 billion in Pay Option ARMs courtesy of Countrywide. But keep in mind Countrywide was a toxic mortgage expert and other Alt-A crap producer. They are the 31-Flavors of toxic waste. We can find some of that junk in the whopping $261 billion residential mortgage portfolio. If you haven’t realized it yet, if you lose your job any mortgage becomes toxic if you are underwater and can’t make the payment. So many of these “prime” loans are equally bad. The only difference is these Pay Option ARMs are monstrosities of epic proportions born in the laboratory of financial meth labs. Take a look at what the California Attorney General shows through one glorious example of a Countrywide Pay Option ARM:

Here we get a firsthand look of a toxic mortgage product in action. This is for a $460,000 loan which is what is sitting in many of those mid to upper priced areas in California. Initially, the first year payment is $1,479 which of course is absurdly low. But by the time we hit the first 5 year adjustment our payment jumps up to $3,747! The payment more than doubles. These craptastic loans were made throughout the bubble from 2004 to 2008 (yes, 2008 with freaking Wachoiva). A large number of these will have major adjustments in 5 years (that is why we are seeing the first batch now) while some like the idiotic Pick-A-Pay loans can go on for 10 years. Like I stated before, I highly doubt that Wells or BofA are going to push to recast many of these loans since they are going to fold the minute they do it. Most people in these loans can’t sell and are basically renters. That is until they hit recast and you will be seeing some massive moonwalking from homes. Yet buyers are walking because they are not building equity (aka, renting). If you bought a place for $500,000 and now know it is worth $250,000, you might make that $1,500 a month payment but are you going to make the payment once it goes up to $3,700? Heck no! You are out. These banks are praying the market will recover. It will not. At least not under their delusional expectations and V-shaped bubble recovery plans.

Let us look at JP Morgan who ended up swallowing up WaMu, another Pay Option ARM fanatic. Before WaMu went under like the titanic they had a gigantic amount of Pay Option ARMs:

Right before WaMu bit the banking dust, it had $52 billion in Pay Option ARMs. And where were the bulk of these loans? If you guessed California you win a prize:

Now JP Morgan wrote down a large part of this portfolio. But how much of it? That is the real question. If we are to take the stress test as any guide, banks are still insanely optimistic of potential losses. Let us pull up the latest 10-Q for JP Morgan:

According to the above, they still have $40.2 billion in Option ARMs and $21 billion in subprime loans. But another major issue that I won’t address here but should be obvious is that massive “home equity” line item. JP Morgan has $140 billion in these loans. Many times, these loans are combined with Pay Option ARMs which makes for a dynamic duo of crap. These loans are secured by home equity which doesn’t even exist anymore! These will implode simultaneously as things get worse with these loans. In the Pick-A-Pay portfolio with Wells, the majority of people make the minimum payment meaning negative amortization. Meaning, the bank most likely will recast the product based on the appraised price at time of sale. Many will say otherwise but this is the only logical conclusion. If we are to appraise those loans in today’s current market, the vast majority of the portfolio would shatter the 110% or 125% (insane) caps and all these mortgages would hit recast oblivion. I doubt that since banks are waiting for the PPIP so the taxpayer can assume the position at the worst time. And that is why this problem hasn’t been solved. I’ve heard a few misguided pundits say that most of these loans have been refinanced. Sorry, the data above doesn’t show that. Most of these are still out there. The only refinancing going on with these toxic mortgages occurs in the foreclosure process.

So why has refinancing activity picked up? Because buyers in no financial trouble have taken advantage of the low mortgage rate environment and this is smart. But don’t think all the activity was because of subprime and Alt-A borrowers running to get new government backed mortgages. They don’t qualify!

I’ll leave you with the most recent graph from Credit Suisse:

The big hit is going to be in 2010. With 135,000 Notice of Defaults in California for Q1 of 2009, the second half of the year is going to expose the eye of the hurricane we are currently in. The pundits who say these loans have been taken care mistake silence with a problem being solved. The data does not back them up but since when do we expect pundits to pay attention to data?

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Diamonds pile up worldwide as consumers finally realize their worthlessness.

Diamonds pile up worldwide as consumers finally realize their worthlessness.

By ANDREW E. KRAMER May 11, 2009

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Each day, the contents of the bags spill into the stainless steel hoppers of the receiving room. The diamonds are washed and sorted by size, clarity, shape and quality; then, rather than being sent to be sold around the world, they are wrapped in paper and whisked away to a vault — about three million carats worth of gems every month.

“Each one of them is so unusual,” said Irina V. Tkachuk, one of the few hundred people, mostly women, employed to sort the diamonds, who sees thousands of them every day.

“I’m not a robot. I sometimes think to myself ‘wow, what a pretty diamond. I would like that one.’ They are all so beautiful.”

It could be years before another woman admires that stone. Russia quietly passed a milestone this year: surpassing De Beers as the world’s largest diamond producer. But the global market for diamonds is so dismal that the Alrosa diamond company, 90 percent owned by the Russian government, has not sold a rough stone on the open market since December, and has stockpiled them instead.

As a result, Russia has become the arbiter of global diamond prices. Its decisions on production and sales will determine the value of diamonds on rings and in jewelry stores for years to come, in one of the most surprising consequences of this recession.

Largely because of the jewelry bear market, De Beers’s fortunes have sunk. Short of cash, the company had to raise $800 million from stockholders in just the last six months.

The recession also coincided with a settlement with European Union antitrust authorities that ended a longtime De Beers policy of stockpiling diamonds, in cooperation with Alrosa, to keep prices up.

Though it is a major commodity producer, Russia has traditionally not embraced policies that artificially keep prices up. In oil, for example, Russia benefits from the oil cartel’s cuts in production, but does not participate in them.

Diamonds are an exception. “If you don’t support the price,” Andrei V. Polyakov, a spokesman for Alrosa, said, “a diamond becomes a mere piece of carbon.”

In an attempt to carefully calibrate its re-entry on the global market, without forcing prices still lower, Russia is relying on two things: the Soviet-era precious gem depository — created to hold jewelry confiscated from the aristocracy after the 1917 revolution — and capitalist investors, whom Alrosa hopes will buy diamonds as an investment, like gold.

Russia is taking a leadership role in other ways, too.

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Sergei Vybornov, Alrosa’s chief executive, said that he had helped persuade the central bank of Angola — which, like Russia, is still relatively flush with oil money — to buy 30 percent of the production of Angola’s diamond mines, keeping these stones off the market.

And last fall, Alrosa began what it called the St. Petersburg Initiative, along with De Beers and other large producers, to invest collectively in generic diamond advertising, akin to De Beers’s promotion of the slogan “Diamonds are forever.” Russia assumed the task as De Beers has principally shifted to promoting its own branded gems.

Still, it is a precarious time for the Russian diamond company to assume leadership of the industry.

Until last year, De Beers produced about 40 percent of the global rough stone supply, and Alrosa 25 percent. But De Beers, which is prohibited under its European Union antitrust agreement from stockpiling, closed mines in response to the glut in rough stones. Russia is loath to do that, as authorities in Moscow, gravely concerned about potential unrest by disgruntled unemployed workers, try to keep workers on the payroll.

In the first quarter, De Beers reduced output by 91 percent compared with the previous year. The diversified mining companies Rio Tinto and BHP Billiton also curbed production.

Meanwhile, the market for wholesale polished diamonds, worth about $21.5 billion, is expected to fall to about $12 billion in 2009, according to Polished Prices, an analytical service for the industry.

Rough diamond prices have fallen even more, as much as 75 percent since their peak last July at some auctions.

The two markets are distinct. Typically, about 60 percent of a rough diamond is lost as dust or shavings in the cutting process.

Mr. Vybornov blames diamond traders who pledged diamond stocks as loan collateral for part of the world glut. When credit dried up last fall, banks and other creditors seized those gems and sold them, he says, flooding the market. By December, his company decided to withdraw entirely from the market rather than further erode prices.

Russia historically remained mostly a behind-the-scenes player, perhaps because Soviet authorities would have had to perform some ideological gymnastics to promote a product consumed principally by the rich of the capitalist world.

Instead, twisting politics, the Soviets concluded a semisecret agreement with apartheid-era De Beers to sell Siberian diamonds in a way that would not undercut the market.

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After the collapse of the Soviet Union, the Russian diamond industry created a formal alliance with De Beers, selling the South African company half of each year’s production at a discount intended to subsidize De Beers’s generic diamond advertising undertaken in the 1990s, mostly in the United States.

Now, the Russians are in the driver’s seat.

Charles Wyndham, a former De Beers evaluator and co-founder of Polished Prices, said Russia had thus far managed the transition well: withholding gems to make more money in the long run rather than further depressing the market.

“Whatever one wants to say about the Russians, they certainly aren’t stupid,” Mr. Wyndham said.

Alrosa is seeking to jump-start demand by selling gems under long-term contracts to wholesale buyers in Belgium, Israel, India and elsewhere. Under these contracts, six of which have been signed, prices are set at a midpoint between the peak last August and this winter, and fixed for a period of several years.

“A diamond ring should not cost $100,” Mr. Vybornov said. “We don’t want that type of client.”

Alrosa is also working with a Moscow investment bank, Leader, a subsidiary of the Russian natural gas monopoly Gazprom, to market diamonds to investors. Under the plan, investors would buy diamonds but the gems would not be released to jewelers for several years.

It is a program, essentially, of outsourcing the stockpiling function to investors in exchange for the chance to profit from a possible recovery in the market.

At one of Alrosa’s cutting shops in one of Moscow’s outer districts, Aleksandr A. Malinin, an adviser to the president of Alrosa, showed a typical collection that might become the basis for such an investment vehicle.

The gems fit in a felt box about the size of a laptop computer.

The larger stones, a circular-cut 10 carat flawless white and a princess-cut yellow, were estimated at about $400,000. The smaller ones ranged from $16,000 to $100,000. But the value of the box, while surely several million dollars, is something of a mystery just now given the depressed market.

How the buy-in price for the stones will be set, and how the company will determine when the price goes up and down, is unclear, Mr. Malinin said.

“We have to tell people that diamonds are valuable,” he said. “We are trying to maintain the price, just as De Beers did, as all diamond producing countries do. But what we are doing is selling an illusion,” meaning a product with no utility and a price that depends on the continued sense of scarcity where there is none.

At the Alrosa unit that receives diamonds, called the United Selling Organization, where about 90 percent of the output of the Siberian mines arrives for processing, Elena V. Kapustkina pours about 45,000 carats of diamonds though a stainless steel sieve every day to sort them by size.

“It’s just a job,” she said.

When asked whether diamonds had lost their romance for her, Ms. Kapustkina paused, looked down at the pile of gems on her table and blushed.

In fact, she said, her husband, a truck driver, gave her a half-carat ring 22 years ago. “Of course I love it,” she said. “It’s from my husband.”