Bad Mortgages Taking Down Good Loans, Too

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Overall, housing prices continue to fall, and given the recent dire news, you might expect that millions of Americans are losing their homes. But that isn't the case — at least not yet.

Foreclosures in risky subprime mortgages have soared, but they are only a small part of the market. In fact, despite economic pain and uncertainty, the vast majority of Americans continue to make their mortgage payments.

There are about 51 million first mortgages in the United States right now — but only about 1.4 million of them are either referred for foreclosure or in foreclosure, said Mortgage Bankers Association chief economist Jay Brinkmann. In other words, fewer than 3 percent of American homes with mortgages are in foreclosure.

The problem is this: Those bad loans are having an outsize impact on the financial world. They are mixed with good loans in securities that are crippling investment banks. No one wants the securities, even though not all of the loans are bad.

"Inside these bundles of mortgages are lots of great mortgages, or at least ones where Joe Smith and wife are going to pay back all the money, they are going to make their payment every month, even if it hurts," said Max Wolff, an economist who teaches at the New School in New York.

Some investment banks were overexposed to subprime mortgages, but they also have good loans that people continue to pay. Brinkmann said that provides some underlying value to securities that some investors now view as toxic.

"Probably more than half of the loans in those securities are performing fine," Brinkmann said. "And of the loans that are not performing, your losses are still going to be limited by what is the value of the house if it goes into foreclosure and what can be worked out. So, it's not as though you lose every dollar."

Consequently, Brinkmann said, some securities are worth much more than they've sold for recently.

"Merrill Lynch not too long ago was forced to liquidate a bunch of their portfolio at 22 cents on the dollar. I think the real value was well north of 22 cents ... at a minimum, double 22 cents," he said.

The difficulty is that the mortgages have been sliced up and sold so many times, they are extremely hard to value. And investors are so worried about a continuing fall in housing prices, there's no market.

"The real problem is nobody knows which mortgages are good and which mortgages are bad," said Julia Gordon, policy counsel for the Center for Responsible Lending, a homeowners advocacy group. "I will say that most investment bankers I've talked to only partially understood what they were doing."

So a problem that began with a small percentage of mortgages now threatens the financial world. And the government will have to buy those mortgages to bring stability back to the system.

Correction Oct. 9, 2008

The story said, "[L]ess than 3 percent of all American homes are in foreclosure." The figures given in the report refer specifically to homes with mortgages; the percentage would be lower if all homes were included.



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