More Bad News for Downey Financial

One of my hedge fund manager friends sent me this:

Downey Seen As Mortgage Lender That Will Hold Up (Dow Jones Hedge Fund Trades, May 29)

“[Hedge funds] just feel that Downey is so conservative that they will not have the same problems that some of these other companies have had,” said Paul Miller, an analyst at investment bank Friedman Billings Ramsey & Co.

"Downey doesn’t issue the controversial “piggyback” loans and has trimmed its loan portfolio to cover areas with better housing markets."

The article goes on to say that certain hedge funds have been piling into Downey Financial Corp. (DSL) in recent months.

It's news to me that Downey was "so conservative" in its underwriting. Downey is the victim of adverse selection, as I explained in this anecdote. They were known among mortgage brokers for their "Downey Express" loan program that made loans with no verification of income or employment.

What kind of borrower would pay hundreds of bps extra interest to avoid having to document their income or employment? A borrower whose income is made up, of course.

I think these hedge funds just don't understand the role of the speculators, who were responsible for 20% of the house buying in SW markets and who are probably heavily represented (adverse selection) in Downey's loan portfolio. These are people who, prior to 2004 or so, were in multilevel marking schemes, or daytrading, or real estate or mortgage brokers.

As prices went up, these speculators piled in to real estate. They "bought" ten houses at a time - highly levered, of course. The result was a positive feedback loop of rising prices, with no basis in rising rents or buyer incomes.

That 20% doesn't count the straw buyer organized crime rings, or the grow-ops.

And even actual, legitimate home buyers bought houses far bigger and more expensive than they needed because "real estate only goes up."

Meanwhile, Bloomberg reports:

U.S. foreclosure filings surged 90 percent in May from a year earlier... led by California, Florida and Ohio.

From the WSJ:

Small-bank investors who hope to snare big profits from a wave of takeovers in the industry may want to put their money elsewhere..." Says Yardville National Bancorp CEO: "The pendulum has swung back from a couple of years ago when it was a seller's market [for banks] to being a buyer's market at this time..."