One friend and reader remarked that my recent post (Good Intentions) seemed to imply that I was going to publish the weekly e-mails from my time managing a subprime bond and equity hedge fund.

Au contraire.

Those e-mails will remain my virtual diary of the runup and meltdown.

Still, they do make interesting reading, especially during the time in mid to late 2007 when Washington and the media establishment decided that “subprime” was as likely to boost ratings as Lindsey Lohan’s latest DUI.

After the break, I’ll post a couple of weekly missives (appropriately scrubbed of portfolio performance, specific trades, or other proprietary information).  They dated to late summer, 2007, and showed that the political and financial world was definitely, positively going mad and looking to find scapegoats.

Now that I think about it, not much has changed these past four plus years, has it?

Merryall weekly, August 24

In the same logic that makes any resistance to US military action “terrorism”, it seems that now that any credit difficulties anywhere are somehow linked to US subprime mortgages.  Today’s folly is the report I just read that tracks corporate bankruptcies, expected to be up 51% in 2007 vs. 2006.

Strangely enough, the reason so many corporations are declaring bankruptcy is reported as “contagion” from subprime lending, as is the marked increase in delinquencies of super-prime seven figure mortgages and the substantial year-over-year rise in credit card and auto loan delinquencies.

Somehow, the 14% of the subprime mortgage loans that are delinquent are directly responsible for any late payment or default, anywhere.  All that from a group of mortgage loans that are themselves only about 15% of the total US mortgage market.

I’d be willing to bet that this particular 1% of the population never knew they had that kind of economic power (14% of subprime loans times 15% of mortgages times 69% of households that own homes times 70% of homes with any mortgage at all).

In fact, the subprime borrowers themselves would probably guess that the 1% of the population on the other end of the economic spectrum had more to do with today’s financial stress than those people on the bottom rung of the ladder.

I’m not trying to make light of the very real difficulties facing these two million or so households, but I do think it’s a cheap excuse for something much larger.

This raises the question of what the economic world will look like (and when) we come out of the other side of this de-levering .

If we assume that the credit standards will tighten more or less permanently on the bottom quintile of borrowers, we might assume that half of them won’t qualify for the kind of loans lenders will be willing to make in 2008 and beyond.

That still leaves a pretty substantial $300 billion per year market to be divided among a vastly smaller universe of lenders.  Anyone who thinks the depositories will take up the slack has never experienced a Bank Examination.

The whole reason non-bank lenders exist is that the Fed, the FDIC, and the OTS (Office of Thrift Supervision) already have it as a given that any bank is playing with radioactive material if it has subprime loans in its investment portfolio.

They’ve treated it that way since the melt-down of the 1980’s led to the RTC bailout, and the news this year can only have made their bias against poor credit borrowers even more black-and-white.

In fact, if we look at the handful of lending institutions that do still hold market share in the subprime mortgage sector, we see that they do so only in the context of truly huge balance sheets, with names like Wamu, Wells Fargo and Citi leading.

In a development that was probably just as significant as GE leaving the subprime sector (shutting down their WMC subsidiary), Lehman Brothers announced they were shutting down BNC Mortgage last week.

A skeptic would say that both these operations had the wrong people and wrong systems, since their credit performance was abysmal compared to peers, and the current environment just gave cover to senior management that knew they had bet on the wrong horse for some time.  Still, capacity leaving the market this way can only benefit the survivors.  First they have to survive.

Speaking of survival, what will happen to the “prime” borrowers if the general economy takes a downturn?  As a friend pointed out recently, the subprime borrower is used to living on the edge, and may actually be better equipped to deal with real economic trouble than their “flabbier” FICO 710 prime borrower cousins.

Consider this:  Press written by innumerates likes to talk about payment shocks for subprime borrowers, but the reality is that those borrowers were paying 8% and may soon have to pay 11% if the Fed gives no relief by this time next year.  That amounts to a jump in mortgage payments of a few hundred dollars a month for the typical subprime borrower.

On the other hand, about half the “prime” loans in California are Interest Only, and a huge percentage of them are extremely low payment Option ARMs that allow negative amortization.  A significant fraction of these loans, many of which have balances in the high six figures, can go from a starting payment of $1,500 a month to a fully amortizing payment north of $5,000.

Try that with a middle class family that thinks economizing consists of leasing a less expensive car when the current lease ends.

What I’m saying is that poor people are probably better at dealing with tough times than we give them credit for, while our middle class may not be nearly as well equipped, if it comes to that.

Merryall weekly, special pre-holiday [Labor Day] message

In response to CNBC’s success after converting into the Subprime Channel, Bloomberg television has done the same.  Even PBS is jumping on the bandwagon, along with every politician in America.

The underlying assumptions for the media and political hacks is that any credit weakness from any borrower anywhere is caused by US subprime problems, and that any borrower not paying their debts must have been tricked into lying about their income by predatory lenders, especially if they did it on ten different mortgage applications for ten houses at the same time after reading “Rich Dad, Poor Dad.”

Confirming a suspicion some have held since Medicare was expanded into a giant prescription drug giveaway at full list price, it is now clear that Vladimir Putin actually replaced George W. Bush with a communist puppet when George made the mistake of “looking into his eyes” at that Camp David weekend five years ago.

The latest purely socialist proposal from our Decider in Chief is to continue to keep private enterprise restricted from using prudent investment criteria to add to the portfolios of shareholder-owned Fannie Mae and Freddie Mac, but rather to use real taxpayer money in the fully government guaranteed FHA program to refinance subprime borrowers, but only those who are 90 days’ delinquent.

What looking glass have I fallen through?

The Democrats want private enterprise to be able to invest more, and the Republicans say “No, we want the taxpayers to foot the bill”….

On top of that, they’ll only foot the bill for the borrowers that shouldn’t have gotten the loans in the first place.  Screw the 86% of the subprime borrower universe that have managed to pay their mortgages on time every month.

While the Presidential replacement theory has its adherents, there are others who suggest there is a more spiritual explanation for the radical change in behavior from the West Wing.  The psychic phenomenon called “channeling” has been suggested by this smaller contingent of observers.

They are divided on whether the spirit of FDR or that of Eugene V. Debs is actually controlling the situation.  The tendency to attack foreign countries Americans can’t find on a map argues for FDR, but bailing out only those who don’t work or even try argues for Eugene.

No matter the cause for this bizarre behavior, it’s good for our mortgage lender stocks, and might even help our bonds, assuming some sort of liquidity relief is in the offing.  Still, if the ABCP (Asset Backed Commercial Paper) continues to shrivel up and die, there just isn’t enough money in the world to buy the amount of AAA ABS bonds that will have to be sold.  We’ll find out soon enough if Ben Bernanke deserves his Helicopter appellation.

War is Peace.  Freedom is Slavery.  Ignorance is Strength.

Tuesday we’ll return to our normal program with month-end figures on the Merryall Fund.

PS — Now that we have healthy competition in the blockbuster prescription drug arena for “Restless Leg Syndrome”, I just want to ask whether anyone reading this even knows anyone who ever complained of this malady before the drug companies invented a treatment.  Personally, I’ve never had a dinner guest call and cancel at the last minute saying “Ruth and I won’t be making it tonight — it’s those darn restless legs again.”

hh – (The preceding was written during the storm in 2007, presented without additional comment on December 29, 2011)


3 Responses to Clarification

  1. hhill51 says:

    By way of explanation, Bryan’s recent appearance in our commenter’s community and Dan J’s comment reminded me how we (on the the trading desks) were fully into the whirling maelstrom of the subprime bond crisis throughout 2007. I pulled out the old file of weekly e-mails I was writing back then, and found these two which looked at the “macro” situation and how our problems were being used and abused by the rest of the world. I hope the non-practitioners and the insiders both enjoy my somewhat irreverent observations of the foolishness we were being fed as “news” or “policies” at the time.

  2. Chris Gordon says:

    Actually I was aware that I had an occasional problem with Restless Leg Syndrome back in the mid-80’s.(may have been my party habits at the time) I’m not sure if it had a name then….and I’m also unaware of the effectiveness of any treatments.
    Mine ended up easing over time.

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