Tuesday, June 10, 2008

Pick-a-Pay or Pick-a-Prayer?

Ever see the movie Aliens?

In this movie classic, there are hostile alien creatures whose facehugger larvae spring from their eggs onto the faces of their host victims, with the requisite screaming and hysteria of the hosts. However, within a few minutes the facehuggers fall off, and the hosts wake up, seemingly returning to normal.

But all is not normal... soon the hosts feel something throbbing... deep under their ribs.. and then one-by-one a gruesome alien burst out of their chests, instantly killing him. The hatched aliens then proceed to go on a killing rampage.

While the market has seen its fair share of chest bursts over the past 18 months: writedowns for subprime loans and actual subprime portfolio losses, a variety of commercial banks, investment banks, and MBS REITs are still incubating chest bursters of a different breed, in the form of Option ARMs and Alt-A loans.

In order for us to full comprehend the magnitude of the issue, we have to first understand exactly how Option ARMs and Alt-A mortgage loans were issued and how they operate.

Option ARM
A) Option ARM Minimum payment mortgage borrower
B) Option ARM Interest only payment mortgage borrower
C) Option ARM Fully amortizing payment mortgage borrower

Alt-A
X) Alt-A: Intended recipient mortgage borrower
Y) Alt-A: Little white liar mortgage borrower
Z) Alt-A: Big fat liar mortgage borrower

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