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Vultures Descend on Mortgage Market


But profits still remain elusive.

In early 2006, when subprime powerhouse New Century went bust, vulture investors began to salivate at the opportunities a collapsing mortgage market would offer up like manna from the trading gods. They started raising money. And lots of it.

Billions were poured into so-called "mortgage opportunity funds," which planned to pick through the wreckage of the once-high-flying housing market. Some investors aimed to focus on mortgage-backed securities, hoping to buy in at pennies on the dollar so just a few bond payments would reap sizable returns. Others, however, delved into the realm of whole loans, buying troubled mortgages from floundering banks.

As noted in the Wall Street Journal this morning, an investment strategy that seemed like a slam dunk on paper -- buying distressed mortgages on the cheap, and working out equitable arrangements with borrowers -- has proven extremely difficult to execute.

The prevailing wisdom was that, as delinquencies rose, and banks amassed a seemingly limitless portfolio of troubled loans, the likes of JP Morgan Chase (JPM), Bank of America (BAC) and Citigroup (C) would be forced to unload assets at firesale prices. Because they were buying at super-low prices, investors expected to have the necessary cushion to forgive principal, lower interest rates, or otherwise get borrowers back on track. They would, of course, earn a hefty profit for the effort.

But the housing market, which tumbled further and faster than all but the most pessimistic experts thought possible, had other plans.

Throughout 2007, any player that dipped a toe into the market lost a foot. Property value declines accelerated, securities prices tumbled, and economic conditions continued to deteriorate. Sellers, hoping for a rebound, were reluctant to accept lowball prices. Few trades were executed, and the lack of liquidity drove the market to new lows.

Then, in 2008, as delinquencies began to spread from the subprime to the prime market, home prices continued to slide, and it became clear there would be no easy fix to the housing market's woes, big banks recognized their need to raise capital by selling assets.

The market for distressed loans began to flourish as liquidity entered the market: Sellers accepted painfully low prices, and investors started deploying more capital. Prices for pools of mortgages in various stages of default began to stabilize, typically around $.50-$.60 on the dollar.
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