they knew, and as early as early 2007 or 2006. As laid out in this piece (entitled "Perfect Storm in Default") by a mortgage default professional in response to a Wall St. Journal article:

Some "money" quotes, and a trend:

"In the movie the “The Perfect Storm” three storm systems converged to create the storm of the century which had a horrendous impact on the east coast of the United States and Canada. What does it mean when we have 16 major economic indicators pointing to problems with the housing industry and the national economy. It means “The Perfect Storm in Mortgage Default” is not only possible but extremely likely."

This and the following are tablesetters, stuff we mainly knew already.

"Mortgage Companies are going out of business, being sold or looking for acquirers particularly in the sub-prime market it is beginning to resemble the exodus of the late 1990’s.
Record Fraud levels, The FBI reported in December 2006 that fraud had hit the $1 Billion mark for the year. Unfortunately that number is severely under reported. Fraud has become the new big money game in many locations.
Several of the mortgage companies going out of business have reported that loan buy back programs are a major problem because of the non-performing loans. It is clear such agreements with Walls Street investors will continue to have a big impact when you understand the dynamics of origination profit versus the loss on a buyback loan that goes to foreclosure. Origination fees on a $100,000 loan may generate $2,500 on the closing and another $2,500 on the sale but the average loss on that home when going to REO is in excess of $35,000. In other words you have to make seven loans that are good just to break even, and that does not include the commissions paid and processing costs."

Did you get that? The loss on each bad loan is typically over 35%. To break even, an investor who buys a loan needs to have only 80% not go south, but every one over that is a major hit against profits. But even if they all went bad....

"If even 40% of these loans go to REO with a loss rate of 25% (very conservative, average losses in REO are running 35 to 45%) the loss would be on the scale of $20 Billion[Whaaaa!!!!!? What happened to $700billion?] and that does not include the impact of losses related to the other 60% where short sales, forbearances, modifications and other workout solutions would have a significant impact.

That is like another Katrina, and look at all that has been done to try and minimize that disaster."

That second bold emphasis was his, but how does $20 billion all of a sudden become $800 billion, let alone $1.8 trillion?????

"The other potential impact of this magnitude of default is the source of funding dollars. If in fact we do take a beating on losses related to these 1 million homes, what will that do to Walls Streets/Investors willingness to continue to be the funding source for new loans? If nothing else, Wall Street is a risk reward enterprise, the cost of funds will go up and so will the cost to borrowers through interest rates. It does not make sense for MBS loans to have coupon rate that is higher than the underlying notes rate."

What indeed? For argument sake, let's say the 1 million homes are now 3.5 million homes. In one years time, how can about $75b (3.5 times 20 billion) become $800billion? Am I just that thick?

"Up until now it was easy and losses were minimal. The reason being the continual rising market made it possible to dump the bad loan/house with a refinance or sale. That was a time when most foreclosures never went to sale. The industry did its part earlier in the 2000’s by creating the negative amortization and interest only products when the traditional product sales were starting to slow down. The losses did not come, they were deferred, and the new products stimulated even more appreciation and sales. Like most games of musical chairs the music does come to an end and someone has to pay the piper."

I think I see a trend....

"Yet, I can tell you on many of the short sales that we present on behalf of borrowers to various lenders, the lender is looking at values from last year and saying that is way to low and we can not accept it. Departments that manage short sales and Deed in Lieu need to be working with the best local information they can. They need to be looking at MLS information for average time on market, value, sales versus asking prices, etc. Instead many just say our investor will not accept that amount. I can guarantee you that the investor will really not accept the amount when it is finally sold out of REO 4 or 5 months from now for considerably less than you were offered now. These become trigger point breakers for securities."

A trend, definitely!

"The final solution is the pre-foreclosure sale. This should be one of simplest, but it has become truly time consuming unless a full payoff is achieved. Again, many lenders want everything about the borrower, and many also are using last year valuations to compare to today’s offers. It cracks me up that investors will spend a fortune on BPO’s to buy a portfolio and then 12 to 18 months later will not take into account what they have learned about the borrower and the property and get a new value and make a decision. It’s too big of a loss… as if it is going to get better five to 12 months from now..."

Oh yeah, a clear trend. Maybe they knew they could just stall and get paid everything and more?

And this is what was written in March of 2007 in the Wall St. Journal entitled "Subprime Games Reckoning Day":

" these so-called subprime borrowers continue to have problems paying their debts, the lenders that target them likely will have to boost how much money they set aside for bad loans, cutting into their bottom lines."

But you could find dozens of articles like that at the time, so now the response is "who coulda known"?????

There's more though and maybe this is the trigger, because afterall, just who are these lenders? Maybe that's part of the problem!

"A series of startling court decisions nationwide have ruled against subprime lenders attempting to foreclose on borrowers after failing to legally establish ownership of the loans in question because they had been 'transferred' multiple times."

I mean, OUCH!:

"Schack recently ruled in a foreclosure suit brought by Wells Fargo that the bank "lacks the standing to foreclose" because it "failed to establish ownership of the mortgage.""

Does this mean that they realized in Treasury that these loan transfers weren't legally executed and were backed with basically zero collateral?

A 35% loss is bad, a 100% is a little worse. So now we are seeing that $75 billion multiply about 3 times, making $250 billion. Getting closer....

Nigerian letter "bust out" indeed.