The subprime mortgage crisis and the many legislative attempts to curb its economic wrath are daily news items. Triggered by the numerous mortgages issued in recent years as subprime (those loans with little or no downpayment made at inception to borrowers with insufficient or troubled credit histories), the effect of additional defaults on these loans is still unclear. With the economy in recession, the last thing the nation needs is more bad news. Unfortunately, that may be inevitable.

While the focus of the news has been the sub-prime mortgages, two other types of mortgages are prepared to create a second economic dilemma. These mortgage types include "Alt-A" (for Alternative A-Paper) and "option ARM" loans.

Alt-A interest rates are determined by credit risk. Alt-A loans are considered more risky than "A-Paper" (prime) loans but less risky than subprime loans.

An "option ARM" typically consists of an adjustable rate mortgage which offers several monthly payment options including a specified minimum payment, an interest-only payment, a 15-year fully amortizing payment, and a 30-year fully amortizing payment (based on 30-year ARM). The interest rate is periodically adjusted based on indices such as the 1-year constant-maturity Treasury securities (CMT), the London Interbank Offered Rate (LIBOR) and the Cost of Funds Index (COFI).

The option ARMs offered low initial interest rates which "reset" after a given time period. Now those rates are scheduled to change. More specifically, the rates will reset upwards, thus increasing borrowers' rates.

Now the Alt-A and option ARM loans are starting to reset, increasing the borrower's mortgage payments and, in many cases, causing the loan to default.

Fitch Ratings, an international agency which rates bonds and issuers, recently updated its loss predictions for U.S. Alt-A residential mortgage-backed securities. The agency noted that losses on Alt-collateral will significantly exceed earlier estimates due to the ongoing problems in the financial and housing markets. Average cumulative losses on Alt-A loans initiated in 2005, 2006 and 2007 are expected to reach 2.72, 6.78 and 9.58 percent, respectively. Additionally, delinquencies over the past six month period, despite efforts to halt foreclosure sales, have not decreased. For example, Alt-A 60+ day delinquencies have risen from 8.80 percent to 14.65, according to the agency.

In a recent 60 Minutes news story about this impending wave, Whitney Tilson, an investment fund manager who has researched the problem, noted that whereas the sub-prime crisis has amounted to approximately $1 trillion in losses, the possibility of Alt-A defaults could double that amount, with another $500 billion or more in additional option ARM defaults on top of that.

The same story noted that National Association of Realtors, which tracks the number of available housing units on the market, shows available units have more than doubled to 4.5 million units this year from three years ago. With the impending Alt-A and option ARM loans crisis still looming, that number may increase. In other words, the worst may be yet to come.