Tuesday, August 14, 2007

Ignoring risk and the credit bubble

The linked article is titled "Robert Rodriguez On the 'Absence of Fear'" and describes Mr. Rodriguez's "concept of RISK since there appears to be little concern about risk in the financial markets currently." Per the link, "Rodriguez is CEO of First Pacific Advisors, an $11-billion investment management company located in Los Angeles."

Rodriguez says that
"Two years ago, we noticed a problem developing in our bond portfolios involving Alt-A securities. Despite having average FICO scores of 718 on the underlying loans, these securities experienced rapidly escalating delinquencies and defaults after just nine months. We sold them since we did not want to wait around to find out the reason why this was happening."
Doubtless, his firm had little trouble selling the bonds at the time. He follows up by stating that
"Our worst fears were recently confirmed in a study by First American Financial entitled, "First American Real Estate Solutions Report, Alt-A Credit: The Other Shoe Drops" This report shows the following changes in underwriting standards between 1998 and 2006, with the major changes occurring in the last two or three years:

* ARM % of originations rose from 0.7% to 69.5%
* Negative Amortization rose from 0% to 42.2%
* Interest Only rose from 0.1% to 35.6%
* Silent Seconds rose from 0.1% to 38.7%
* Low Documentation rose from 57% to 79.8%
* FICO scores were essentially unchanged at an average of 706.

What is interesting is that the origination volumes for the last two years, when the most egregious deterioration in underwriting standards occurred, total more than the previous seven years of originations combined. "
There is much more in the linked post...well worth your time. To me, this data just confirms the emerging picture that financially sound homeowners got caught up in the tide of buying larger houses than they could afford, or sucked out all of their equity to spend.

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