Tuesday, March 13, 2007


Subprime mortgage market is done

The credit crunch rolls on.

I started writing this post, in my mind, days ago. It's nice when events confirm your beliefs. But first the technical look at the market. The area around 12,000 should be tough for the market to get through. I think it will but once it does, if we are in for a long bear market, it should be a ceiling. I don't have any idea whether this bear will be slow grind or a crash. I am guessing slow grind at least until more people become conscious of what is happening. Bear markets love to keep hope alive. As of this moment Asian stocks are just mimicking our loses and the futures are down slightly from today's close. The next support after 12,000 is 10,800, the beginning of the run that started in June of last year.

The subprime mortgage market no longer is lending. Subprime lenders are scrambling to stay afloat and even larger lenders are suffering from the deluge of poorly considered loans.

Subprime loans, a term applied to some of the riskiest home mortgages, are made to borrowers unable to qualify under traditional, more stringent criteria. The loans often carry interest rates 2 to 3 percentage points higher than regular mortgages and sometimes have low initial ``teaser'' rates that adjust higher in later years. Some lenders also lowered their standards last year to bolster revenue because slumping home sales had hurt demand.

The combination made the loans more prone to default, with delinquencies at more than 12 percent in the third quarter, according to the Mortgage Bankers Association. The Washington- based trade group is scheduled to release updated numbers for the fourth quarter tomorrow. Investors are increasingly shunning bonds backed by subprime loans.

``It's like a hot potato with these loans, no one wants them,'' Fitch's Arscott said.

What you will hear from the bubbleheads tomorrow is that the subprime market was only a small percentage of the mortgage market and that this crisis will not spread. There is some truth to this. Subprime lending is only between 15-20% of all mortgages. These loans are more popular is the areas that have had the biggest run ups and they will likely suffer the most. But credit crunches have a way of spreading and this is why what I am talking about is more psychology than economics.

It is very difficult to predict if a decline will turn into a panic and whether a panic will become a change in mass psychology know as a depression. Depression is really the correct word because it takes a tectonic shift in the collective world view of the majority of investors to a state of overwhelming pessimism. Difficult is not impossible and I am keying in on a simple indicator. Simple because our asset bubbles were the product of one institutions dereliction of duty and for the bubbles to pop, there has to be a realization of the folly of creating prosperity through ever expanding credit given to ever worse credit risks.

I knew that the end was near in 2000 when I heard about a company called Microstrategy had blown up. This company had catapulted to amazing heights and was crushed just as quick. It was an a-ha moment for me. People had decided that this stock was being driven by mass hysteria and when it stopped this tiny bubble popped. We are witnessing the same thing in the mortgage market right now. The weakest fail first.

So what can save the mortgage market? The answer is obvious, more credit. What prevented the bear market of 2001-03 from becoming an economic disaster was a massive influx of government spending and a fire sale on credit courtesy of the Fed. It was only right. The Fed caused the problem so it is fitting that they solved it. But solving a credit crunch with more credit only delays the pain. That is why we are here. That is why I am going to watch for the inevitable surprise interest rate cuts that are coming as soon as the Fed feels asset prices have fallen enough or there is a danger that they might fall too quickly. Panics are caused by collective realization that prices are too high. When the panic comes and the Fed cuts just watch the reaction of the market. If they can stop the plunge then we will have to find a new asset class to buy up. But I think we are done. There are no more assets left to bubblize. So the markets reaction should be to stop falling for awhile and then continue down. It is a little early to say if for certain we are going to see the worst possible scenario but it is not too early to prepare for it.

All the news that fits my opinions:

Late mortgage payments reach high

Retail sales barely rise.


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