Last night 60 Minutes aired an episode entitled, The Mortgage Meltdown, Where’s The Bottom?, that revealed the mortgage mess that touched off the financial meltdown is far from over, with a second wave of expected defaults on the way that could deepen the bottom of this recession.

Alt-A and Option ARMs Next To Implode

As correspondent Scott Pelley reports, it turns out the abyss is deeper than most people think because there is a second mortgage shock heading for the economy. In the executive suites of Wall Street and Washington, you're beginning to hear alarm about a new wave of mortgages called Alt-A and Option-ARMs that will begin to reset in 2009, 2010, and 2011.

Scott Pelley interviewed Whitney Tilson, an investment fund manager, who, a year ago, saw that sub-prime mortgages were just the start of the mortgage meltdown.

"We had the greatest asset bubble in history and now that bubble is bursting. The single biggest piece of the bubble is the U.S. mortgage market and we're probably about halfway through the unwinding and bursting of the bubble," Tilson explains. "It may seem like all the carnage out there, we must be almost finished. But there's still a lot of pain to come in terms of write-downs and losses that have yet to be recognized."

"The defaults right now are incredibly high. At unprecedented levels. And there’s no evidence that the default rate is tapering off. Those defaults almost inevitably are leading to foreclosures, and homes being auctioned, and home prices continuing to fall," Tilson explains.

"What you seem to be saying is that there is a very predictable time bomb effect here?" Pelley asks.

"Exactly. I mean, you can look back at what was written in '05 and '07. You can look at the reset dates. You can look at the current default rates, and it's really very clear and predictable what's gonna happen here," Tilson says.

"How big is the potential damage from the Alt As compared to what we just saw in the sub-primes?" Pelley asks.

"Well, the sub-prime is, was approaching $1 trillion, the Alt-A is about $1 trillion. And then you have option ARMs on top of that. That's probably another $500 billion to $600 billion on top of that," Tilson says.

Asked how many of these option ARMs he imagines are going to fail, Tilson says, "Well north of 50 percent. My gut would be 70 percent of these option ARMs will default."

"How do you know that?" Pelley asks. "Well we know it based on current default rates. And this is before the reset. So people are defaulting even on the little three percent teaser interest-only rates they're being asked to pay today," Tilson says.

The Great American Housing Nightmare is Progressing in Three Phases Says Financial Expert Weiss

Dr. Martin Weiss*, a leader in the fields of investing, interest rates, financial safety and economic forecasting gave a similar warning in his financial alert on November 3, 2008 entitled, The Great American Housing Nightmare: Next Phase. 

Weiss, in part, wrote: "One of the greatest blunders of our time is made by those who blindly assume home prices are so low they couldn't possibly go any lower.

In reality, home prices don't stop going down at some particular level that appears to be "cheap." Nor do they stop falling because they match some historical price that was previously a low. The end of the decline in home prices will come only when there are no new economic forces driving them down.

When will that be?

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I'd love to say it's just around the corner. But everything I see tells me that, despite the sharp declines already recorded, a steeper plunge in home values is dead ahead.

The reason: So far, most of the troubles in the housing market have been caused by bad mortgages going sour. Meanwhile,

• The more common causes of housing slumps — high interest rates, rising unemployment, and recession — are just starting to kick in. And …
• The most powerful causes — depression and deflation — are still on the horizon.

In the boom leading up to the Great Depression of the 1930s, most Americans did not borrow money to buy a home. Variable rate mortgages didn't exist. And Wall Street investors rarely got involved in the business of financing homes. Home prices did fall dramatically. But those price declines came mostly after the stock market crashed, after the economy shrunk and after millions of workers had lost their jobs.

The crux of the problem today: That phase of the housing crisis still lies ahead. Moreover, this time, because of massive debts, the pressure to abandon or sell homes is far greater.

Conclusion: If the U.S. sinks into a depression, home price declines could be as deep as, or deeper than, those of the Great Depression, especially in the hardest hit regions of the country.

It is a frightening thought. Yet, on the positive side, a sharply reduced price for the average home is the only fundamental, enduring mechanism for making homes more affordable and restoring demand — especially if the days of easy credit are gone.

The Great American Housing Nightmare is progressing in three phases:

Phase 1. The bust in the subprime mortgage market. This is now history.

Phase 2. A severe U.S. recession. As of this writing, this phase is just beginning.

Phase 3. Depression and deflation. Still ahead.

Therefore, no matter how far home prices in your area have already fallen and no matter how cheap they may appear, they could still fall a lot further.

How Low Could Home Prices Go?

In the hardest hit regions, an individual home that was once priced for $400,000 at its peak could fall to as low as $200,000 by the end of Phase 1. But don't blindly assume that's the bottom. In Phase 2, it could fall in half again, to $100,000. And in Phase 3, it could fall by at least half for a third time, to as low as $50,000 or $40,000.

Homes with peak prices of $1 million could sell for as little as $100,000; some, originally priced for $10 million may have no buyers at all — even with asking prices as low as $1 million.

Nationwide, the median home price will not fall nearly that far. But that factoid alone will do nothing for homeowners in bubble areas like Florida, Nevada or California. Nor will it help those in blighted regions where factories are closed and unemployment rises far above the national average.

Never before in history have we witnessed home price declines of this magnitude! But that fact alone does not make them implausible, let alone impossible.

Remember: Never before in history has so much debt, speculation, government manipulation, fraud, corruption and consumer abuse been heaped onto any housing market! And if there's one thing that history teaches us, it's that unprecedented causes lead to unprecedented consequences," end quote.

What is an investor to do?

OPTION A -Safety first

Investors can play it completely safe and horde all the cash they can gather.  The safest place Weiss recommends for your cash is in short-term Treasury Bills backed by the U.S. Treasury Department.  You can open a money-market fund with a checkbook that only invests in these Treasury Bills. 

So even if a bank holiday is declared, you can still get quick access to your money secured by T-Bills.  Weiss thinks this is a better strategy than keeping most of your money in bank accounts that are FDIC insured because [1] you cannot access your money if a bank holiday is declared and [2] if your bank fails in the coming months, even with FDIC insurance, you don’t know how long you may have to wait to get your hands on your money. It could be a day or it could be weeks or months as the bank failures pile up.

By the way, do you know if your bank is safe or a future failure candidate?  Check out this post for help.

OPTION B - Profit opportunities

With all the inevitable foreclosures coming, those former home owners will be renters again.  Why not buy an apartment complex with a, built-in, growing demand for rentals? 

Of course, you need to buy right.  That means buying in bargain towns around the country - this is ideal.  If you don’t want to buy outside your immediate area, then buy a value-added type property at the right price.

What do I mean by value-added?

This would be a building with, perhaps, some deferred maintenance that needs a cosmetic update or better management or an otherwise motivated seller (someone retiring or tired of managing the building) You can make those easy changes to the building and increase the rents.  Cash flow, cash flow, and cash flow will be ALL IMPORTANT.

If you’ve never considered commercial property investing in apartment buildings before (I wouldn't touch any office, retail buildings or other commercial property types used by business operations until the bottom is well established) and would like to know how to buy without cash or credit and how to avoid costly mistakes, review the recommended guides in my Real Estate Investing Section now.

* Disclosure: This investment news is brought to you by Money and Markets. Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit http://www.moneyandmarkets.com.

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