To understand the truly complex and impossible unwinding of the “toxic” mortgage pools Washington and Wall Street are trying to accomplish, let’s look at one REO we’ve been following for months and will be coming on the market soon. It’s a beautiful, 3,000 square foot, dockside home in the 2 year old Seabridge development by D.R. Horton in Oxnard (off Wooley and Victoria). These homes originally sold for well north of a million bucks. This home had a mortgage of $1,000,000 with Countrywide.

After the mortgage was made, it was sold and was lumped into a big pool of other mortgages to the tune of $469,065,744 with the Bank of New York as trustee for this asset.  This bundle of loans was rated by Fitch. Quote: “Fitch believes the above credit enhancement will be adequate to support mortgagor defaults. In addition, the ratings also reflect the quality of the underlying mortgage collateral, strength of the legal and financial structures and the master servicing capabilities of Countrywide Home Loans Servicing LP”. Hmmm…

We know the Adriatic loan went bad, but when the property is sold and some sort of amount is paid for it, how much will the pool/trust get back?  All of that $1,000,000? Some of it? This REO may not even be a “loss” for the pool because the home is probably worth more than that $1M in today’s depressed market.

But here’s the problem – most homes, especially entry level type homes, have been decimated. A lender may have loaned (100% financing) $600k on a home that’s now selling below $400k. In a 500 $billion$ pool of “toxic” mortgages, with maybe 70 – 80% of the loans still keeping their payments current, lenders understand that a whole bunch of those current loans are still going to go bad.

Two more profound issues compound the problem:

• The $600k home was probably 100% financed like this: a $480k first mortgage, and a $120k second mortgage (called an 80/20; there’re other combos like 90/10, etc). If the first mortgage foreclosures on the home, the $120k mortgage gets wiped out. That’s where a lot of the blood bath is occurring today. Often, those 2 mortgages are sold to different investors. If the home owner really tries to save his home through a loan modification process, neither lender wants to lose $$, so the “cleanest” and cheapest way for the 1st mortgage lien holder is to simply allow the property to go through foreclosure to wipe out the 2nd. The 1st doesn’t want to “share” any of the net proceeds with the 2nd if it doesn’t have to. That’s why short sales with 2 different investors can be difficult to pull off.
• The other issue is that many of these mortgage pools have been “securitized”, meaning the entire pool stands as collateral for instruments called CDOs (collateralized debt obligations). These CDOs have been sold to investors all over the world who own a “slice” of that pool – which “slice”? The good performing loans, or the bad ones?

So what’s that pool worth? Ultimately, how many of the loans will go bad? When the homes get sold as REOs at distressed prices, how many cents on the dollar will the pool get back? That’s why these are “toxic” loan pools – nobody knows!

These problems are too big for any one person to figure out. Thus we turn it all over to algorithms, but that’s another story!