Tuesday, July 24, 2007


Subprime contagion spreads to prime borrowers

First off, the 226 point drop in the Dow today is cause for concern but it is a little to early to push the sell button. The intraday low was 13,701.56, just above the high made on July 17th and the beginning of our triangle. Right now the S&P and Nasdaq futures are a little higher than their close and the Asian markets are down but not cratering. So a crash alert might be coming as early as tomorrow but until we get through 13,700 I am going to stay cautiously unpanicked.

The big news which was buried in an article on Countrywide Financials poor earnings was the spread of the housing market woes to the more credit worthy borrowers. For the record, Angelo Mozilo is the Chief Executive of Countrywide.

First nugget.

Mozilo said the number of unsold homes must fall before the market can begin to recover. He doesn't expect the market will turn around until 2009 at the earliest.

Did you get that future home buyers? 2009! No reason to buy in Chicago when rents are so low relative to mortgage cost.

Like other lenders, Countrywide has also tightened its credit guidelines and stopped selling some types of adjustable rate loans. Management said the company plans to undertake additional lending restrictions.

This is how a credit crunch gets started. It is as much about psychology as it is about economics. Lenders who have tightened their borrowing to the worst credit risks will effect the next higher level of credits and so on and so forth. The thing is no one wants to jump in front of this bus without a compelling reason such as prices getting ridiculously cheap. We are a long way from there.

The company said the delinquencies were not due to borrowers struggling with mortgage interest rate resets, as many had expected.

Instead, the delinquencies have been largely due to people losing their jobs or similar factors, the company said. Those homeowners have been unable to refinance because the value on their home has fallen and the credit crunch has cut off other borrowing options.

"I do think it's important to observe what happens going forward," Mozilo said. "We are experiencing home price depreciation almost like never before, with the exception of the Great Depression."

This quote speaks for itself but you should really consider the last sentence because those are the stakes we are playing with. A housing bubble which collapses and affects consumer spending can snowball into deflation. It is just a matter of a large enough crowd of people panicking and closing their wallets and our consumer based economy will grind to a halt. So when a seemingly unstoppable juggernaut of a stock market breaks off its highs then you better pay attention. This might not be the beginning of the third leg of the bear that began in 2000 but you should always consider that possibility given the flashing warning signals coming from the technical side and from the economy.

Update: A special report on the subprime market from Bloomberg TV. Subprime Shockwaves. Do yourself a favor and watch it.

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