Housing Piggyback Loans: The Next Banking Nightmare

Well I see nothing but more bad news for stocks after doing some research this morning. This probably means the DOW will rise another 1000 points the way this irrational market has been acting.

I actually think you are going to see a lot of selling over the next few days as the people take profits from the 5% rise we saw last week. During periods of stress in the markets, everyone tends to sell into rallies because the market is vulnerable to bad news.

Piggyback Loans/HELOCS:

Here is what I wanted to talk to about today. Everyone on Wall St. is trying to figure out if the writedowns are over for the financials. Many have placed bets that the worst is over as many financials were being bought last week even though they reported bad news.

I still think there are many shoes that will drop forcing more losses for the banks. The next big set of writedowns will be in the secondary mortgage market. These are the 20% part of the 80/20 piggyback loans that were common during the peak of the housing bubble.

Many people bought houses with these loans because it allowed them to avoid having to pay the PMI insurance that is required if you don't have at least 20% equity in the house. So by securing a secondary loan at 20% you were able to avoid having to pay for the PMI insurance every month.

Home equity loans or HELOCS are also considered to be secondary mortgage paper. The piggyback loans and the HELOCS are sold together in the credit markets as secondary mortgage paper. I have a source thats involved in this area of the credit market.

According to my Wall St. source, the bid for these securities in the credit markets is one penny on the dollar!!!

This tells you that Wall St. predicts that these loans are worthless and will never be paid back. According to my source the the reason the bids for this paper are so low is because the 20% piggback loans and HELOCS get paid back secondarily to the 80% part of the home loan.

So if a house that has a 80/20 piggyback loan is sold at less then 80% of the price of the full loan amount then the piggyback loan doesn't get paid back. The home equity loan doesn't get paid back either because the intitial 80% loan gets paid back first buy law.

So as foreclosures mount and housing prices continue to freefall these loans will essentially become worthless. This debt for the most part hasn't been written off yet. As prices continue to drop, banks will be forced to give up on these loans and write them off. This will mean billions of additional writedowns.

Buying financials right now is a lot like gambling at a casino. No one has any idea of how many losses they are hiding. Eventually they will be forced to take their medicine and mark their bad loans to market.

The ones that survive this disaster will end up being excellent bets that will pay off down the road. The problem is there will be many that don't survive which means their stock will go to zero. This risk/reward ratio simply isn't there when your downside risk is zero on some of these financials.

Investing on speculation versus fundamentals is a fools game. It reminds me a lot of buying tech stocks during the tech bubble at $400 a share that hadn't even made a profit yet. Many are still licking their wounds from their "speculative" bets in 1999. I imagine that many housing speculators are feeling the same way right now as their investments continue to plummet in value month after month.

If you want to speculate then head to Las Vegas and play some Roulette. More on the financials later tonight. There was a big profit warning from Bank of America over the weekend. Enjoy your Sunday!