Coming Soon: The Alt-A Bust

The turmoil in mortgage market may appear to be settling down by some standards - although certainly not with respect to impending foreclosures, as those are still projected to reach 2.5 million this year - but there is another wave of foreclosures that may soon begin. Many so-called Alt-A loans (also referred to as "no-doc loans" or even "liar loans") are projected to reset beginning in the latter part of 2009 through the beginning of 2012. (For an illustrative chart, visit: http://www.dailymarkets.com/economy/2009/02/08/default-of-mortgage-loans-alt-a-and-option-arms-are-next/.) This category encompasses loans with very risky structures that include things like interest-only payments (I/O loans) and Option-ARM loans that are all but pre-ordained for default. Under these structures, borrowers are permitted to pay less than what would otherwise be required each month, with the unpaid balance from each month being added to the loan principal at a later date. That capitalization of monthly underpayments will cause monthly payments to jump substantially (increases of 60%-70% in monthly payments are quite possible and will likely not be uncommon) when the terms of the loan reset. This wave of trouble will crest during 2009-2012 because many Alt-A loans have 5-year introductory periods, which accords with the bulk of origination activity of "innovative loans" between 2004 and early 2007.

In fact, the graphic representation of the instance of reset of those Alt-A mortgage correlates with Alt-A loan origination information, which information can be found in a GAO report at: http://www.gao.gov/htext/d09922t.html. As can be observed from the data (numbers available in the text version of the report), the origination of Alt-A loans rose substantially from 2002 to 2003, jumping from 231,000 to 436,000 loans. In 2004, that number rocketed to 937,000 Alt-A loans. In 2005 and 2006, the origination of Alt-A loans was well over 1 million for each year. Given the typical 5-year introductory period of these instruments, the wave of Alt-A loan resets will build substantially this year and then continue to crescendo through 2011, as depicted in the graph referenced above. As the origination of Alt-A's plummeted in 2007 to 436,000 loans, so too will the wave of defaults likely tail off in 2012, again, as depicted by the graph.

Unfortunately, this second wave of foreclosures will likely be just as devastating as the first, and last just as long.