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Here's the good news: The worst of the subprime mortgage carnage is behind us.
Here's the bad news: That was just the tip of the iceberg. There's probably much worse ahead.
Fool retirement guru Robert Brokamp recently sat down with noted value investor (and former Fool writer) Whitney Tilson to talk about his thoughts on the continuing mortgage crisis. In the interview -- which appears in the new issue of the Fool's Rule Your Retirement newsletter, available online at 4 p.m. EDT today -- Tilson talks about where we currently stand in the mortgage crisis.
I thought this was a subprime problem!
It was, at first.
Many subprime mortgages started out with a low "teaser" interest rate that then increased to a market-level subprime rate after a set period of time. When that happened, the payments would go up -- often by a lot -- and the hapless overleveraged borrower would go, "Oh fiddlesticks, I can't afford to pay the mortgage anymore."
(Except that most of them probably didn't say "fiddlesticks." But I digress.)
Tilson notes that the number of loans facing payment shock started climbing in early 2006, reached a very high level in early 2007, and stayed high until about the end of last year, at which point they started falling off sharply. Likewise, the massive wave of defaults and foreclosures triggered by these higher payments is abating. That wave is behind us.
But subprime mortgages weren't the only ones with teaser rates.
Now, it's mostly not a "subprime" problem
The emerging problem is with prime mortgages, those issued to people with good credit. The crash in housing prices has left many of those folks "underwater" -- owing more than their house is now worth. And the crash in the global economy has left many of those folks unemployed -- and many who are still employed are making less money now than they were a year or two ago.
Tilson cites figures that about a quarter of all prime U.S. mortgages are underwater at the moment, and that number is likely to grow if housing prices continue to fall. Despite some beliefs that home prices are bottoming, unemployment is still a big problem -- Deere (NYSE: DE ) , among others, just announced new rounds of layoffs. And now mortgage interest rates are suddenly rising -- the average 30-year mortgage is up to 5.32% this week, up from 4.91% just last week, according to the most recent Freddie Mac (NYSE: FRE ) survey.
Nobody knows quite how all these factors will play out, but clearly the potential for a huge wave of defaults in the near future is growing.
What, you thought things were stabilizing?
Tilson recently argued that the appearance of stabilization in the housing market is a "head fake," caused by the usual spring surge in homebuying and a temporary reduction in the inventory of foreclosed homes sitting on the market. The crisis, Tilson says, is actually getting worse.
As Tilson sees it, although the worst of the losses suffered by speculators and subprime borrowers are over, problems with prime loans are just now starting to pick up steam. Many conforming prime loans are owned by Fannie Mae (NYSE: FNM ) and Freddie Mac. But other mortgages will likely also prove problematic, including home equity lines and prime "jumbo" mortgages, as well as the scarier Alt-A and Option ARM loans.
Why scarier? According to Tilson, nearly half of Alt-As and over 70% of Option ARMs are underwater. Alt-A resets are just starting to take off -- they won't peak until 2012 or 2013. And Option ARMs don't just reset, they recast -- borrowers go from making just interest payments, in many cases, to making full proper 30-year-amortized mortgage payments. Some could see their monthly payments increase by 60% or more.
And after that, commercial real estate could be the next problem area. That won't just hit the property owners -- REITs like mall giant Simon Property Group (NYSE: SPG ) and New York-based heavyweight Vornado Realty (NYSE: VNO ) -- but will also impact regional banks such as Fifth Third (Nasdaq: FITB ) and Regions Financial (NYSE: RF ) that have heavy exposure to commercial real estate loans.
Protecting your portfolio
In the Rule Your Retirement interview, Tilson explains how he expects all of this to unfold. He also offers some thoughts on positioning your portfolio in the months and years ahead -- including some ideas that may surprise you.
If you're not a Rule Your Retirement member and you'd like to read the interview, help yourself to a free 30-day trial. Sign-up takes just seconds and there's no obligation to subscribe.