The Run On the Banks

September 19th, 2008

To some long term observers of the mortgage market, the rout on Wall Street isn’t just a shock, it’s absurb. Banks, hedge funds and other investors are dumping mortgage securities at fire sale prices, either because they have to get them off their balance sheet or because they’re just plain scared. But some of these investments now trade at riduculously low prices. Will a bond at 60 cents on the dollar come back? The housing market is bad but will 40% of all homeowners really default? If they do, how much will you really lose?
“Our basic premise is that market pricing is unduly pessimistic,” says Tad Rivelle, who helps manage $27 billion in fixed income securities at Metropolitan West Asset Management in Los Angeles. “It does seem more of a run on the bank.”
A study on MetWest’s Web site illlustrates the potential for recovery of your investment under various scenarious. Let’s say you own a first mortgage on a house that sold for $500,000. The owner defaults, you foreclose. The equity and second loans are wiped out. The house falls in value by 30% and you lose $50,000 in legal fees, interest and property taxes. You’re still going to recover $300,000 or 70% of your loan.
Housing prices will be under pressure “for years,” Rivelle says. But the market has “discounted a severe amount of negative outcomes, massive foreclosures.” Believe it or not now may be just the time to be putting your money into mortgage bond funds.