Spillover is mainly developing in 3 fronts.

First, it will be more expensive to sell the securitized mortgages packages to income oriented investors. The premium of these packages is still very narrow over risk free government bonds, this is about to change.

Second, most of the time, the contract of the sale of such a package stipulates that if the default rate of the mortgages in the first six months is too high the seller is obliged to take the entire package back from the buyer.

Third, the return of such failing mortgage packages on one hand, and the higher default rate of the mortages which the originating banks (and GMAC) kept for their own investment purposes on the other, requires them to make higher provisions for the losses stemming from the delinquent loans. Unsurprisingly, many of the banks have very low, between 0.5% and 1.5%, reserves and to bolster from such low levels they will have to pull from their profits. The impact, expressed in lowering of the share price of the banks, will be one visible aspect of the spillover.

Things that are unclear to me is why would banks, and financial institutions as GMAC, keep the worst of the mortgages for themselves and why didn't they unload them to mutual funds and other yield-chasing investors. Didn't they "keep" them because they failed to find buyers for the riskier packages?!

Gretchen Morgenson is Today's NYTimes 'Mortgages May Be Messier Than You Think'

[snip]

"Loss-mitigation practices grew out of the significant losses incurred by big lenders in the real estate collapse of the late 1980s. Because lenders were experiencing losses of 30 percent to 60 percent of the outstanding home loans in foreclosures, they started identifying ways to keep borrowers in their homes.

Some plans allow a delinquent borrower to add missed payments to the mortgage and pay them over time. Others extend the life of the loan, or allow the suspension of payments temporarily, bringing the mortgage current by using an interest-free loan from the Federal Housing Administration.

While it is a splendid idea to do whatever is necessary to try to cure a sick borrower, it is worth remembering that the rollover of nonperforming loans was central to what made the savings and loan mess of the early 1990s so disastrous. And it is well worth asking: are loss-mitigation practices predatory since they give lenders an opportunity to squeeze the last ounce of blood out of a terminally ill patient?

Aggressive approaches to loss mitigation, Mr. Rosner said, mean that less than half of mortgages that in prior years would have been foreclosed no longer are. Unfortunately, how many of these workouts actually succeed is a question for which investors and even regulators have no answer."

[snip]

'Financially, the US economy has degenerated into a sort of cargo cult, where people feel that they can continue to attract recycled petrodollars by dancing around piles of internet servers with their cell phones and their laptops.' - Dmitri Orlov

It’s Monday morning, 8:00AM EST. Asian markets are still moving down. The prime culprits appear to be the Yen Carry Trade (as suggested by Adi Nath in his letter on Friday) and by emotion (as mentioned by Paul Guinnessy on the same day). “Locutus” predicted a “dead cat bounce” for today, and “Pocket Marginalist” responded with sooting noises about letting the air out slowly.

Regardless of what happens today (and for anyone on the floor in NY it’ll be “interesting” as they say), one BIG question comes to mind:

Where’s Mr Leonard?

The rest of the World is UP and moving (down).

Is Mr Leonard going to wait until AFTER the fact to tell us “How the World Works”?

AT 8 a.m. EST, Mr. Leonard was sound asleep in his bed in Berkeley, where it was 5 a.m. The world goes on, but sometimes I have to take a break!

When everyone caught it in the neck with falling CMO's (collateralized mortagage obligations) which were modified into a weird kind of hybrid strip. Maybe the one lesson take away from all of this is that when corporate economies are as large as national economies, if they aren't as conservative as the Federal Reserve then the market gyrations caused by derivatives are bound to get very messy. No big fan of that kind of debt regulation but honestly, why is it that firms as large as GMAC aren't required to maintain SOME kind of risk mitigation instruments in the face of

WHAT WE ALL KNOW IS SECONDARY, TERTIARY AND QUATERNARY DERIVATIVES MARKET THAT FUNDAMENTALLY NOT UNDERSTANDABLE.

Seems that they should be REQUIRED to lay off some of the risk into monolines.