And Boom Goes the Dynamite - Subprime Value Gets Redefined by Wall Street

That gong you just heard was the subprime mortgage act being shooed off-stage by Standard & Poors. The ratings agency decided today that they aren’t playing along with the outdated and inaccurate ratings of the credit derivatives backed by subprime mortgages. This tidal wave announcement has major implications on the lending industry as the liquidity and value of mortgage backed securities has been bouyed by questionable ratings from companies like Moody’s, Fitch and S&P. This departure from the pack by S&P is earth-shattering. From MarketWatch:

Standard & Poor’s just drove a huge harpoon into the heart of the mortgage credit bubble, and it’s going to take a long time to clean up the mess once the beast finally dies.

S&P, one of the three main credit-rating agencies that served as enablers of the subprime-mortgage boom, announced Tuesday that it would lower its ratings on 612 bonds, a small portion of the mortgage-backed securities it had given its seal of approval to. See full story.

But the bigger news is that S&P isn’t going along with the charade anymore. S&P said it would change its methodology for rating hundreds of billions of dollars in residential-mortgage-backed securities. And it would review its ratings on hundreds of billions of dollars in the more complex collateralized debt obligations based on those subprime loans.

A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money.

S&P’s announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust.

“We do not foresee the poor performance abating,” S&P said.

Those are some strong words. If you have trouble following along at home think of it this way. If everyone in a neighborhood believes that homes are worth a certain dollar amount and agrees that the way they value the homes supports that belief then the world that they live in supports that view. If one of the neighbors steps out of line and says “wait a minute, these homes are shanties” and slashes their home value in half the whole neighborhood price structure comes tumbling down. This is what is happening in Wall Street; although we’re not talking about a neighborhood - we’re talking about the economic engine that has been driving the subprime mortgage industry for 5 years.

What types of implications are we talking about? How about the near-complete evaporation of money for home refinancing and purchasing for subprime borrowers? How about the complete elimination of subprime mortgages? How about lawsuits and loan buybacks coming down in droves from investors, Wall Street, consumers - you name it?

I don’t think I can understate the importance of this move. But for more perspective read Housing Doom, Housing Wire, Calculated Risk and the OC Register.

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