Three Stocks Tied to Risky Debt

During the housing bubble when home prices were strong, lenders were able to handle defaulted mortgages simply by reselling the home for an appreciated price. Now, with home prices falling, it grows impossible to recover the full value of the loan.

Even worse, most lending institutions that securitized mortgages and sold them on the open market as collateralized debt obligations, or CDOs, are contractually obligated to repurchase those securities if the underlying mortgages default. These repurchase provisions are what sunk American Home Mortgage(AHMIQ Quote) and New Century Financial(NEWCQ Quote).

Where the Hurt's Likely to Continue

Since it appears that we have not seen the end of the subprime-mortgage repercussions, it's not too late to make money on these stocks! Here are three companies that I believe may be brewing the next financial meltdown:

MGIC Investment(MTG Quote): This company is in the business of providing insurance for home mortgages. When a borrower defaults on a mortgage, MGIC takes up the bill. Many home buyers who are unable to scrape up the 20% down payment on their home's value are required by their mortgage lender to purchase this type of insurance.

A concerning number of mortgages insured by MGIC are in the subprime and A-minus traunches. The 2006 10-K shows that 181,141 of its 1.28 million insured loans (14.1%) fall in this troublesome category. This figure does not include insured bulk transactions, which contain various mixes of subprime credit quality.