The Diverging Fortunes Between Bond and Borrower

A DOOMED LOAN

Wolfeboro, where Monzione lives, is a summer resort town on Lake Winnipesaukee. A home called Lakeside Manor, where former French President Nicolas Sarkozy stayed in 2007, is listed for sale at $13.6 million. Mitt Romney, last year’s Republican presidential candidate, has a home by the lake, too. During the campaign, he made pancakes there for a TV news show.

Monzione’s house is a converted barn in the less desirable middle of the town, a few blocks from the lake. He wouldn’t have been able to buy the place were it not for last decade’s housing boom and an inheritance from his parents in 2005. He had his share of troubles before that, some self-inflicted, including divorce, bankruptcy and a drug addiction. (He says he went clean in April 1996.)

In 2005, when he decided to buy a house, his credit score was 532. A score of 640 or less is considered subprime. Still, Monzione wasn’t among the many Americans who put no equity into his house. He did just the opposite.

The property, a “real fixer-upper,” cost $130,000. A mortgage broker arranged for Monzione to get a $100,000 loan from Fremont Investment & Loan, based in Brea, California. He used $30,000 from his inheritance for a down payment, and made another $30,000 in repairs.

“I thought this is where I was going to stay forever,” he said.

He figured the income from his wedding and studio photography business and a disability payment would cover the monthly mortgage bill. But he ignored the fine print. The mortgage had an adjustable rate, which meant payments would rise, stair-step, from $754.79 to $894.90 to a peak of $927.22 over the ensuing three years.

Ailments requiring stomach and sinus surgeries ate into his finances. Meanwhile, the advent of digital cameras hurt business. To make up for lost income, he turned to scouring estate sales for antiques and housewares to sell on eBay. It wasn’t enough. The mortgage ate up almost all his income.

The housing market has been recovering in parts of the country, and many homeowners have been able to refinance their loans at low rates, a product of the Fed’s stimulus. But as in much of America, the comeback is uneven in Carroll County, of which Wolfeboro is a part. The number of homes sold rose 18 percent in 2012, but median sale prices stayed flat at $180,000.

A BOND IS BORN

Monzione got his loan from a unit of Fremont General Corp. Of the financial institutions that imploded last decade after providing too many risky home loans, Fremont ranked as one of the worst. The company was the fifth-largest U.S. subprime lender, with $13 billion in assets and 3,500 employees in 2006, according to a 2011 U.S. Senate report on the financial crisis.

In 2007 and 2008, after being sanctioned by regulators for aggressive lending, Fremont General filed for bankruptcy protection.

Well before that, in February 2006, Monzione’s mortgage was bundled with 1,924 others that Fremont had originated, valued at a total of $472 million, according to a securities filing. They were packaged into the bond formally called MASTR Asset Backed Securities Trust 2006-FRE1, which UBS AG sold to investors. The Swiss bank declined to comment.

The deal was typical of the times. Subprime bonds worth hundreds of billions of dollars were created and sold between 2005 and 2007. In 2006, when MABS 2006-FRE1 was born, Wall Street sold $483.05 billion worth of such securities, according to Inside Mortgage Finance.

Securities such as MABS 2006-FRE1 were divided into layers, or tranches, based on risk and return. Revenues from the pool of home loans flow downward through the layers, waterfall-like. Buyers of the safer, top tranches get smaller payments than owners of lower layers, but they have first dibs on the stream of mortgage payments. Buyers at the bottom are paid more but are the first to suffer when borrowers stop paying.

The MABS 2006-FRE1 bond, which included Monzione’s loan, had 14 tranches, according to securities filings and court documents.

Loans in the bond began souring almost from the start. That led a mortgage-bond trader at Deutsche Bank AG to tell a hedge fund in a September 2006 email that the security was a “crap bond,” according to the 2011 Senate report. The email was one of a dozen or so cited by the report to illustrate how the German bank was advising clients whether to bet against poorly performing mortgage securities. Deutsche Bank declined to comment.

In February 2007, Grant’s Interest Rate Observer, an influential Wall Street newsletter, cited the bond as a typical example of subprime bonds that were quickly souring and needed to be downgraded.

“Though only 12 months old, it is already shot full of holes,” the newsletter said. Grants noted that 10.5% of the loans backing the security were delinquent as of January 2007, compared with 7.6 percent as of August 2006.

In May of 2007, Moody’s downgraded three layers of the bond, blaming a “rapid rise in delinquencies in the past few months.”

Five years later, in 2012, the bond caught the eye of a trader at a small hedge fund in Steamboat Springs, Colorado.

• Become A Funded Futures Trader