Home > FAQ > Are subprime mortgage backed securities (MBS) and collateral debt obligation (CDO) problems likely to get worse?
Are subprime mortgage backed securities (MBS) and collateral debt obligation (CDO) problems likely to get worse?
Over recent months the business press has reported extensively on the nature and extent of problems attributable to the subprime mortgage market. These problems have had a swift and dramatic impact on many investments and losses already run into the billions of dollars.
Unfortunately the problems in the subprime mortgage market will almost certainly get worse for several major reasons.
First, over the next 18 months, the interest rates on hundreds of billions of dollars of adjustable rate first mortgages will reset to higher, in many cases much higher, levels. The higher mortgage payments resulting from these resets will place heavy financial burdens on subprime borrowers who are already financially strapped and will significantly increase the probability of default. The following table shows the approximate amount of first mortgages that will reset to higher interest rates in 2007 and 2008.
| Month | Approximate Amount of Mortgages Resetting to Higher Rates |
| January 2007 | $27 trillion |
| February 2007 | $23 trillion |
| March 2007 | $26 trillion |
| April 2007 | $38 trillion |
| May 2007 | $38 trillion |
| June 2007 | $38 trillion |
| July 2007 | $44 trillion |
| August 2007 | $44 trillion |
| September 2007 | $48 trillion |
| October 2007 | $50 trillion |
| November 2007 | $46 trillion |
| December 2007 | $41 trillion |
| January 2008 | $44 trillion |
| February 2008 | $32 trillion |
| March 2008 | $37 trillion |
| April 2008 | $46 trillion |
| May 2008 | $40 trillion |
| June 2008 | $32 trillion |
| July 2008 | $35 trillion |
| August 2008 | $37 trillion |
| September 2008 | $30 trillion |
| October 2008 | $18 trillion |
| November 2008 | $14 trillion |
| December 2008 | $12 trillion |
Many defaults will occur as these rates reset.
Second, recently the value of homes in many areas of the country has been stagnating or even declining. Further declines in the value of homes are projected to continue through at least 2008. This development significantly restricts the ability of subprime borrowers to refinance their homes or take other action to avoid defaults. In many situations, this development has resulted in houses being worth less than the amount of debt owed by subprime borrowers on the house.
Third, in recent years, many subprime borrowers (and other borrowers) have used second mortgage loans and/or home equity loans to acquire homes or finance other needs. This has resulted in many such borrowers having little or no equity in their houses and has greatly reduced their options of dealing with credit squeezes. In fact, there have been numerous reports of borrowers who owe significantly more on home loans than the value of their homes.
These dynamics, along with other factors, have created a “perfect storm” for disaster in the subprime MBS, CDO, SIV and Conduit investment markets. This “perfect storm” appears likely to continue for the foreseeable future and will almost certainly result in some heavy losses for these investments.
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