Mortgage guru: ""This is going to be a meltdown of unparalleled proportions. Billions will be lost."


Why doesn't everyone see the obvious, and see what's obviously coming?

The subprime disaster doesn't start and stop there. It starts there. Alt-A, or "liars loans", are obviously next. I would actually suggest that liars loans (think Casey Serin) are actually in worse shape than subprime, since investors mistakenly trusted these higher-rated debt holdings more than subprime.

Head to the bunker HP'ers. Calm may have settled in again, but it would appear to just be the eye of the storm passing over. Get ready for the wall of wind to resume.

BusinessWeek: The Mortgage Mess Spreads - The subprime lending industry is getting hammered, and hedge funds and investment banks are feeling the pain

The canaries in the coal mine are keeling over fast. After years of easy profits, the $1.3 trillion subprime mortgage industry has taken a violent turn: At least 25 subprime lenders, which issue mortgages to borrowers with poor credit histories, have exited the business, declared bankruptcy, announced significant losses, or put themselves up for sale. And that's just in the past few months.

Now there's evidence that the pain is spreading to a broad swath of hedge funds, commercial banks, and investment banks that buy, sell, repackage, and invest in risky subprime loans.

According to Jim Grant of Grant's Interest Rate Observer, the market is starting to wake up to the magnitude of the problem, entering what he calls the "recognition stage." Says Terry Wakefield, head of the Wakefield Co., a mortgage industry consulting firm: "This is going to be a meltdown of unparalleled proportions. Billions will be lost."

Hedge funds, those freewheeling, lightly regulated investment pools, seem particularly vulnerable. BusinessWeek has learned that $700 million Carrington Capital and $3 billion Greenlight Capital may have gotten badly burned because of their intricate dealings with New Century Financial, a major subprime lender whose stock has plunged 84% in four weeks amid a Justice Dept. investigations into its accounting. Magnetar Capital, a $4 billion fund formed two years ago, may be on shaky ground, too. The question is, how many others may be suffering?

"This is a very opaque industry, so no one really knows," says Mark M. Zandi, chief economist and co-founder of Moody's Economy.com (MCO) "My guess is that if you look at the top hedge funds, they're bearing most of the risk."

Other hedge funds that have feasted on mortgage-backed securities will be hit hard if rating agencies start downgrading them, as is widely expected. That would be likely to send their values plummeting. "This is indeed a stress scenario," says Glenn T. Costello, co-head of the residential MBS Group at Fitch Ratings. Kevin J. Kanouff, who heads bond surveillance for Clayton Holdings (CLAY), a consulting firm for institutional investors, adds that "hedge funds are getting very nervous about their investments."

There's also growing talk that many firms, in particular Goldman Sachs, incurred steep losses in trades based on the ABX subprime index. As market makers, the big banks were forced to take the other side of clients' short trades, or bets that the index would fall. When the index plunged 34% in the first 10 weeks of the year, the banks lost. Goldman, which reports first-quarter earnings on Mar. 13 and is a big player in the ABX market, declined to comment.

While subprime loans accounted for 20% of mortgages originated last year, David Liu of UBS estimates that fully 40% of last year's loans are "showing a lot of signs of stress." Says Nouriel Roubini, economics professor at New York University's Stern School of Business: "The risk that prime borrowers will start to feel financial stress in 2007 cannot be underestimated."