Three Stocks Tied to Risky Debt

Editor's note: This column was submitted by Stockpickr member Winston Kotzan.

The house of pain still has a long way to play out for the mortgage market. Even if the Federal Reserve pumps liquidity into the market or lowers interest rates, it could take months for the impact to be fully realized in the financial markets.

In the next few months, expect to see more distressed hedge funds and lending institutions as assets are re-evaluated for their true worth. With the demise of the two subprime funds at Bear Stearns(BSC Quote), we have learned that even AA-rated securities are not safe in this environment. The financial industry is currently plagued with bad credit in disguise.

The credit crunch will likely lead very soon to tighter lending standards, making it more difficult for property owners to obtain loans for refinancing or to purchase new real estate. This will cut off many potential buyers of real estate in the U.S. and perpetuate the cycle of declining home prices.

Adding to the crunch is the fact that many adjustable-rate mortgages, or ARMs, issued in the last few years are due to reset from their initial low teaser rates to much higher payments. According to Barron's, "Over the next year and a half, monthly mortgage payments on some $600 billion of subprime mortgages will be rising sharply for already financially strapped borrowers, as the loans reach the dreaded two-year reset date." When this jump in monthly payments hits the fan, it is certain to cause more waves of payment defaults.