How long does it take to go from “Exotic” assets to “Toxic” assets?

The answer is simple: from one Fed Chairman’s term to the next.

 It was not that long ago when the Pay Option ARM, also known as Negative Amortization Loans, where offered attractively by all major lenders such as Washington Mutual, Countrywide, Downey Savings, and World Savings (formerly Bank of The West).  Wall Street’s hunger for these products was insatiable.  As a direct lender based in California, the pressure from major investors in New York to offer these products before any Fannie, Freddie or other Alt-A products was tremendous.  In 2004, Fed Chairman Alan Greenspan began calling these products “exotic mortgages”.  Ironically, rumors were flying around the lending community that several of his own properties had such mortgages.

Fast forward past the bubble, to Bernanke’s term and the beginning of 2007 when the downturn began to rear its ugly head.  Mass numbers of defaulted loans and the subsequent implosion of the aforementioned major lenders, and we now have “toxic assets”.  Wall Street has absolutely no interest in continuing to offer them, and “bailout” has become a household term.

Having lived in New York City for years I had a chance to gamble at times with Stock Options. We know that there are several hedge funds that are exclusively investing in Calls or Puts.  At times these options outperform every major index but there are probably just as many, or more, that go bankrupt.  Yet for whatever reason, these Hedge Funds are not called “toxic” (nor are any type of bailout by the government.  Well, not officially).

The validity of the comparison between Stock Options and the Pay Option Arm is not as outlandish as Barney Frank (D. Massachusetts) would argue.  The similarity lies in the risk factor and subsequent payoff.  The difference lies in the absence of regulation on behalf of Frank’s Finance Committee, until now of course that the real estate bubble has burst like a mushroom cloud.  

Everyone that’s ever bought Stock Options has had to sign additional disclosures acknowledging the fact that they understood the risks associated with these investments.  The Pay Option Arms were also targeted towards the investor that was bullish on the sustained and rapid appreciation of their investment: their most valuable material possession, their home.  However, the disclosures associated with these loans were free from the foreboding language of risk that the borrower was taking. To be fair, not many had the foresight to predict the severity of the current fall of the housing market, but the Finance Committee is supposed to do more then play Monday-morning quarterback with our economy, right?

So now all of these products are deemed toxic.   The Wall Street investor for these mortgages is now suffering for the lack of regulatory checks and balances for not only the Pay Option ARMS but the Sub-Prime and Alt-A, no-documentation home loans (no documentation!).  The Mortgage Broker is the subsequent fall guy, even though the lenders allowed the de-regulated system to run amuck.  Bailouts abound.  Party over.

As the current leadership fights for a recovery plan to stop the wave of foreclosures (no documentation!) the question remains:  Will some of the products that are currently toxic come back as the lending industry shows signs of life?  Or will we have to wait until the next Fed Chairman?