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Underappreciating Risk

Here are some swirling thoughts about risk.

Although interest rates are slipping, mortgage rates are rising. James Hagerty’s page one WSJ story Mortgage Fears Drive Up Rates On Jumbo Loans [1] covers the issue of jumbo mortgages, to high end buyers with good credit, are seeing their mortgage rates climb.

One could argue that this could be an over reaction by the markets and more sanity will return soon. Of course, you could say that the Bosox are going to win the pennant (sorry, cheap shot – Yanks are now only 6.5 games back). However, this is a credit correction [2], and has taken the place of a significant housing correction anticipated by many over the past 2 years, but was largely a slow bleed.

And take a look at what the last two weeks have done to the probability of a fed cut by October. The odds of the Fed holding rates steady fell from 85% two weeks ago to 55% this week.

Floyd Norris’ The Loan Comes Due [2] gives a great break down on the different loans that are affected by the credit crunch (hint: it isn’t only home mortgages.) There’s also an amazingly large and well down flow chart of the mortgage market and hedge funds.

Click here for full sized graphic. [3]

Source: NYT

All this has happened with few defaults. Mortgage delinquencies are up, particularly on loans made in 2006 when credit standards were very low, but the real problem is that lenders and investors fear things will get much worse.“This is what we would characterize as the first correction of the modern neo-credit market,” said Mr. Malvey of Lehman Brothers. “We’ve never had a correction with these types of institutions and these types of instruments.”

It now seems likely that the rating agencies, and investors, were lured into a false sense of security by the lack of defaults. With the value of homes, and companies, rising, it was usually possible for a borrower in trouble to refinance the debt or, at worst, sell the home or business. Either way, lenders got paid.

So its not only about the bad things that happened. Its about things that may happen. Wait a second…isn’t that what risk is?