According to Bloomberg, Citigroup is estimating losses from Option ARMs at 34% (this is way up from last week's JPM/WaMu estimate of 20%.)
I think this is the first valuation of these loans that approximates reality. Bloomberg says that the loans are made in areas with 40% price declines, and the loans typically reset at 120-125%, so best-case returns on foreclosed homes will be 50 cents on the dollar, and much less after costs.
According to these numbers, Citi will stay above water if about 70% of these loans foreclose (or a smaller number based on continued housing price declines). As high as this number sounds, this isn't unlikely, considering that 80% of California homeowners pay the minimum payment every month.
But at least Citi is trying to keep its swimming trunks on.
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