Mortgage Lenders Face Long Rehab

Home foreclosures and delinquency rates have reached record highs in the third quarter of this year, according to the Mortgage Bankers Association. This finally led to U.S. Treasury Secretary Henry Paulson's plan to help a swath of mortgage borrowers by freezing loan rate resets, but many argue the plan helps only a small group, and the least needy.

"Unless you can put a floor under home prices, you can't bail out the housing market," Rajadhyaksha says.

The housing market's slump created a wave of credit downgrades for mortgage-linked securities this summer. The fallout caused once yield-hungry investors around the world to halt purchases of the mortgage loan derivatives called mortgage-backed securities and collateralized debt obligations, or CDOs. This led to the deluge of writedowns by brokers and investment banks that sold these derivates, such as Citigroup(C Quote), Morgan Stanley(MS Quote), Merrill Lynch(MER Quote) and Bear Stearns(BSC Quote).

Rajadhyaksha notes that historically, 80% of mortgages originated in the U.S. were conforming to Fannie Mae(FNM Quote) and Freddie Mac(FRE Quote) underwriting standards, meaning that these government-sponsored entities were able to guarantee the loan.

In recent years, that ratio dropped to just 35% of mortgages were conforming, as more esoteric mortgages gained dominance in the wake of historically low 1% interest rates set by the Federal Reserve in 2003. That excess will take time to reverse, Rajadhyaksha says.