The Big Threat of Mortgage Credit Losses

In various publications, Ben Stein has been flogging the meme that because the sub-prime mortgages are such a relatively small percentage of the total US Economy, its really not all that problematic.

Its a rather foolish, overly simplistic analysis that ignores far too many other elements of the sub-prime slime. The pyramid of Derivatives built on top of them, for instance.  It reminds me of an argument you might get intro with a child: "But daddy, the economy is so big and sub-prime is so small…"

I never bothered to respond to that meme, other than to get annoyed enough to note that malignant tumors are small relative to a person’s body weight.

Fortunately, Goldman Sachs U.S. economist Jan Hatzius has looked into the issue of sub-prime foreclosures. His conclusions, discussed in this week’s Barron’s, are noteworthy:

"Hatzius caused quite a stir with a report last week countering the simplistic arguments that the losses in subprime mortgages constitute a mere drop in the ocean that is the U.S. financial system and all this talk about their dire consequences is scaremongering.

After all, the losses in all mortgages — subprime, alt-A, prime and jumbo — come to about $400 billion. That would be equal to about 2.5% of the capitalization of the U.S. stock market, "equivalent, in other words, to one bad day in the market," Hatzius writes.

What’s different about mortgages is, in a word, leverage, he continues. Most stocks are owned by traditional investors, such as individuals, mutual funds, pension funds and insurance companies, who don’t use margin and don’t short. In contrast, most owners of mortgages are highly leveraged, including banks, savings and loans, broker-dealers and government-sponsored enterprises such as Fannie Mae and Freddie Mac, according to Fed data, which don’t count hedge funds.

This distinction makes a huge difference. If, say, these leveraged players account for $200 billion of mortgage-related credit losses, and they lever up 10 times, that hit results in a $2 trillion reduction in credit, Hatzius theorizes.

This would be a shock equal to 7% of total debt. Such a credit contraction could produce a large recession, if it happened in a short period such as a year, or a long period of sluggish growth — say, over two to four years, he adds.

Hatzius admits this assumes all else being equal (as would any card-carrying economist), including the rest of the economy, and that markets carry on with business as usual, a heroic assumption. He adds that Goldman already assumes knock-on effects beyond residential construction on consumer spending in its forecast for relatively subdued growth. And he says that regulators may persuade strong banks to keep credit flowing despite their losses, though he doubts how long they would be willing to keep that up. Finally, foreign investors may pump capital into affected institutions, as with China’s Citic Securities acquiring a 9.9% stake in Bear Stearns.

The bottom line is that mortgage credit losses, although highly uncertain, pose a bigger threat to the economy than generally is acknowledged, Hatzius concludes."

Hence, its the mere size of sub-prime foreclosures are merely the starting point of analyzing this issue — and derivatives are only the second point. Add in the leverage, and you have a real substantial economic threat  that even Ben Stein can understand . . .



The Goldy Standard
Barron’s, NOVEMBER 19, 2007

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  1. Philippe commented on Nov 17

    Amazing rhetoric and logic when it serves its purpose Golman states that its level 3 assets are a mere 7 Pct of its total assets when begging for lower interest rate they recognise the level 3 as a proportion of capital.
    No need to drink hard Alcohol just read Wall Street

  2. justin commented on Nov 17

    Slowly the curtain is being pulled away from the Wizard of Oz, known as the Financials. It has been snowing poppies in their worlds for too long! Two trillion is going to have a gigantic affect. Are we counting all the credit card defaults that are coming down the pipe? Oh! I’m sorry they’re using the pipe to smoke the poppies…so how would they know?

  3. Ross commented on Nov 17

    No disrespect to Ben Stein but his papa was a moron. I lived through the stagflation 70’s when his dad was Nixon and Fords economic council chairman. Truely this guy was clueless. Ask Kudlow if he ever wore a WIN button. What did WIN stand for? Anyone? Anyone?
    As far as I can tell, inflation is MUCH worse than in the 70’s. We haven’t got to the hoarding stage yet but it too will come.
    “Better buy now instead of tomorrow, when things will cost more, you’ll find to your sorrow.”

  4. John commented on Nov 17

    Stein doesn’t understand very much either deliberately or because he really is as obtuse as he appears. I suspect it’s the former. He’s basically a Republican shill, a bit like Kudlow, who makes his living peddling justifications to the faithful. He had some beauties in the NYT last Sunday. For example. The failure of big institutions like Citi and Merrill to properly monitor the performance of management was because their boards were stacked with university professors. Someone made money out of all this mess so everything’s ok. Bob Rubin was principally responsible for the tech bubble. I’m not kidding read the piece. Just as good as anything Malpass, Moore or Kudlow could come up with.

  5. Jim Richards commented on Nov 17

    Although Hatzuis’s analysis seems
    quite plausible, we should not forget that Blankfein mentioned on Wednesday that Goldman is net short the mortgage sector. Are they ‘talking their book?’

  6. Florida commented on Nov 17

    Stein also tried to hedge that position a little bit with a column last week in the NY Times, in which he argued that the sub-prime problem was created by political correctness. He never fully explained the causality behind the claim, but it was certainly one of the stupidest business columns I have ever read in my life.

  7. lurker commented on Nov 17

    Stein is a perfect example of my meme that just because you get published doesn’t mean you know anything…financial journalism is often an oxymoron. And when a hedge fund guy writes a column or starts a blog (present host excluded, of course) hold on to your wallet and think for yourself.

  8. stu commented on Nov 17

    Is it possible that the foreclosure rate is elevated right now because the speculators are getting flushed out, but the owner occupied rate is still low, so the situation looks worse now than it really is? I just heard this argument and it makes sense, but I wasn’t able to find any data.

  9. Bucky Katt commented on Nov 17

    Benny boy should stick to teen movies, IE: Bueller? Bueller?

    And yet, he has a voice in the media as some sort of economic guru.

    I figure real inflation at 13.6%

    What happened to WIN?

  10. Bob_in_MA commented on Nov 17

    Ben Stein’s column last week hit a new high, on the fatuous commentary scale. He basically implied that people who used easy credit to buy homes at the peak of the market were the winners–the ones who could make their payments, of course.

    He reasoned that they were able to buy a more expansive house due to the lower borrowing costs. The fact that the lower borrowing costs only allowed the buyers to pay inflated prices seems to have slipped by him.

    There are a lot of bad business writers (check out the article at Baron’s about theprospects for Japan’s stock market, but fails to mention th eimpact of a slowdown in the U.S.), but Ben Stein is such an ass he makes me angry…

  11. Philippe commented on Nov 17

    Are they ‘talking their book?’

    No Recession in Sight by Paul Kasriel

    No the economist (undertaking his usual beggar plea before Fed meeting) is inferring that lower interest rate is the panacea , should it be, it would shore up the real estates and make all short position uncomfortable.
    The economist seems to ignore that solvency is the real problem.
    May be a consultation to this site would help l No Recession in Sight by Paul Kasriel 10-15-2007.htm
    PS Banks like Goldman should issue new shares capital increase? their profits are high enough to offset the market fears their stock price is at its best, its chairman is not seing threat at any level 2/3, its equities representative is seing the SP at 1600 at year end. All is for the best in the best of the possible world.

  12. Groty commented on Nov 17

    Bloomberg interviewed Gregory Peters from Morgan Stanley this week who made a similarly dire warning about a systemic financial system shock, placing the probability at greater than 50%.

    I’m sure Bernanke will return Blankfein and John Mack’s calls. They could express their concerns privately. So is the point of coming public with these scenarios to generate pressure outside of Goldman and Morgan Stanley for more and deeper rate cuts?

  13. Brian B. commented on Nov 17

    I like Ben Stein, but he has consistantly taken this issue. I never understood why he doesnt see the big picture. The housing market is a big ladder. If you take out the bottom 3 rungs no one gets to move up. Also he has never talked about the ‘wealth effect’… consumers are going to spend less… and these 2 issues will affect the economy. Finally some one has taken him to task. In the long run he will probably be proven correct but why wait for 5-8 years and all that pain… cash out and re-enter

  14. Winston Munn commented on Nov 17

    What Mr. Stein fails to recognize is the subprime is not the problem but only a symptom of a much larger problem – the cough that won’t go away that signifies lung cancer.

    Behind this mess is the unbridled greed that accompanies bubbles – and it was everywhere, from residential real estate to commercial real estate to credit cards to leveraged buyouts to bank SIVs – all overextended and overleveraged based on a misguided assumption of a continuation of higher demand and higher prices.

    What we are observing now is a validation of how dependent is the U.S. economy on the availability of credit. The first pinch hit subprime residential customers; next, leveraged buyouts were nullified; the next shoe to drop will be commercial real estate, as demand expectations grossly exceeded estimates; credit cards will most likely be the last area affected, as consumers can make minimum payments and delay default. It is a daisy chain effect and will take many months to play out.

    What we are seeing now is that companies who don’t need to borrow have free access to credit, but those who depend on credit are having trouble finding it at any price. As with any severe economic slowdown or recession, those companies strongly positioned financially will be O.K., while those dependent on credit will be squeezed – some out of existence.

  15. ken commented on Nov 17

    There are two sides to every argument. The two sides here seem to be:

    One side is saying sub prime fallout will be worse than what EVERYONE thinks.

    The other side is saying sub prime fallout will be better than what EVERYONE thinks.

    The two sides seem equally divided. So where exactly is this EVERYONE they keep talking about?

  16. Robert commented on Nov 17

    Ben Stein is an idiot. I have never read anything he wrote that made much sense to me because they all left OUT large portions of whatever the topic du jour was. He NEVER examines the Big Picture (heh) from an objective standpoint. No serious, well informed investor, analyst, or economist ever takes anything he says seriously. Ever. I hope. I know someone who, after reading one of Stein’s perma-bull goldilocks articles on housing, bought into WM at around $38, along with quite a few other stocks, and nearly all of them have been hit hard. I tried to lay things out for the guy, and all I needed were two charts, but I guess Ben Stein’s overly simplistic (and utterly retarded) “analysis” of the situation took the foreground in his mind. Needless to say, he’s regretting that now. Indeed, Stein should return to making movies and commercials and STOP producing faux financial commentary that ends up with the little guy getting hurt.

  17. pjfny commented on Nov 17

    winston munn ( see above) said it right!
    Subprime (or its derivatives) is not the problem, just the first (weakest) symptom).

    When you go from an overleveraged credit boom to riskaversion and de-leveraging (especially in a recession), it will affect all assets (negatively), while you liabilities stay the same, impairing you balance sheet (especially financial services). Banks and other financial companies are going to need capital, right at the moment when the mkt is reluctant to give it to them. All assets are at risk, including commercial real estate, credit card, private equity etc etc
    My guess is that this cycle is not over until one or more major financial services (including banks) have gone under!

  18. Ben Stein the Hack commented on Nov 17

    Ben Stein’s larger agenda appears to be to cheerlead the economy, and I suspect this is part of his larger agenda to show just how “good” the Bush economy (read: massive tax cuts) have been.

    Of course, he’s lining it up to claim that the next President (or perhaps this Congress) is actually to blame for the economic mayhem that is coming down the pipeline.

    The reality of the Bush “ownership” society is that it’s been, on both a macro and micro level, all about borrowing to “own” stuff. The easy credit from early in the Bush administration, the high budget deficits incurred by his massive (supply-side) tax cuts, the huge current account deficits, etc. etc. etc. have all had the purpose and/or effect of encouraging rational actors to borrow heavily to fuel GDP growth.

    The collateral damage from the subprime crisis will be huge. First, you’ll see a massive tightening of the credit markets (already occuring), as all investors pull out of residential mortgage-backed securities (and their derivatives such as CDOs), and as foreign investors pull out of US debt markets completely. This will tighten consumer and business spending in the US, proving (again) that supply side incentives don’t lead to business investment in the absence of demand.

    Second, you will potentially see an avalanche of foreclosures that won’t just be limited to subprimes. As subprimes start defaulting and then being foreclosed upon in the next 6-9 months en masse, you’ll see a large decline in property values, which may lead to a sudden and severe decline in homebuying. The glut of supply vs. demand is likely to be sticky, and stagnant/declining home prices could last into 2010-11, when a wave of prime ARMs (5 yr, 7 yr, largely taken out by yuppies) start resetting. These homeowners will be better positioned to survive their ARM resets, but some of them will most definitely default.

    And let’s not forget the devaluation of the dollar vis-a-vis other currencies. Inflation appears to be just around the corner, which will exacerbate the enormous loss of household wealth already being suffered by Americans. This, coupled with far tighter credit, should lead to large declines in consumer spending.

    Finally, if foreign investors decide that the US economy is no longer where they want to be, and start divesting or stop investing in US assets and USD denominated assets, this could get really ugly. Foreign banks have essentially been subsidizing US debt (both private and public) for some time now. If they decide to stop doing that, you’ll start seeing some pretty rough interest rate spikes, and stagflation is a real possibility.

    Which is all to say that Republican economic policies may just have ruined this country of ours.

  19. scorpio commented on Nov 17

    agree with all negative portrayals above re BS the politico-economic-market sage. but in his defense may i recommend a small title he wrote back in the ’70s called “Ludes” (as in the drug of choice at that time) about a real estate macher’s rise and fall in booming SoCal. it was really a wonderful Gatsbyesque little work. he got that little picture right. but he’s a flak on the big picture.

  20. alexd commented on Nov 17

    I have to agree with most of what has been said on inflation. I also think there seem to be many Pollyanna types out there who seem to make their judgments and calls more as a sign of political support rather than thinking the situation through and making an apolitical conclusion.

    It’s like the goldilocks scenario. We all know the goldilocks scenario. Well let’s say the fairy tale is true. What do we know of the girl’s past? We do know she breaks into people’s (da bears) homes and eats their food and sleeps in their beds (notice nothing is said of whether she even took her shoes off and whether she remade the beds she slept in. No her only criteria is whether she found something comfortable for her as an individual. Sounds like the neocon approach of “as long as I got mine”. What it does not tell us is whether Goldilocks was subsequently tracked down by the bear family and dismembered and eaten, or if the bear family sued her and a lien was taken out against her. I suspect the possibility that Miss Goldilocks might have become an unwed mother who is addicted to crack cocaine or even worse an economist.

    This morning I saw on CNN a blipvert / mini program on how to reduce your grocery costs. If ever there was a warning call for inflation this is it. By the time it is on CNN it is in full swing.

    There are some interesting etfs based on the commodity investment indexes that Jim Rodgers set up.

    There is a song by the late Warren Zevon that was made in the Era of Gerald Ford being president. It is called Mohamed’s Radio.

    “Everybody’s desperate trying to make ends meet
    Work all day, still can’t pay the price of gasoline and meat
    Alas, their lives are incomplete

    Don’t it make you want to rock and roll
    All night long Mohammed’s Radio
    I heard somebody singing sweet and soulful
    On the radio, Mohammed’s Radio

    You’ve been up all night listening for his drum
    Hoping that the righteous might just might just might just come
    I heard the General whisper to his aide-de-camp
    “Be watchful for Mohammed’s lamp”

    Don’t it make you want to rock and roll
    All night long Mohammed’s Radio

    I threw in the lyrics after the part that deals with inflation cause I just want to encourage people to check out his work

  21. ron commented on Nov 17

    Feldstein during his speech at Jackson Hole in Sept noted these items:

    40% of mortgage holders in 2005 did a home refi

    Subprime by the media has been focused on 1st time buyers but only 15% of subprime went to 1st time buyers the rest was used by the refi crowd How many went to 100% cash out or 125% of value we don’t know but during this time many converted their fixed rate mortgage into ARM or IO to max their leverage. So I don’t think its out of the question to assume that a significant portion of the mortgage holders today are unside down their mortgage relative to its market value since a large # of refi’s have taken place since 2002. Feldstein also noted that 9 trillion dollars of MEW withdrawl between 1997 and 2005.
    When BB during the Q&A during his congressional visit carried the idea forward that the GSE’s should raise their lending caps this is a clear indication by the FED that the problem is beyond just lower interest rates and Congress can’t look to the FED for answers or hope.

  22. a guy called john commented on Nov 17

    How 4% of Mortgages Have Brought Down the Entire Market

    If the parameters in the Pareto distribution are suitably chosen, then one would have not only 80% of effects coming from 20% of causes, but also 80% of that top 80% of effects coming from 20% of that top 20% of causes, and so on (80% of 80% is 64%; 20% of 20% is 4%, so this implies a “64-4 law”).

  23. Stuart commented on Nov 17

    The only comments uttered from B. Stein that I have ever found myself applauding were those he voiced when he was expressing his disdain and disgust for the creation of the M-LEC super SIV. He called it square at that time. Yet, except for those comments, everything else I’ve heard or read from him, seems to view dynamics and machinations of the market risks in an extremely simplistic and naive fashion. He doesn’t get it. Still he did get the SIV scam, and I at least give him some kudos for that.

  24. Greg0658 commented on Nov 17

    it seems we live in a sports arena and not the symphony hall

    maybe the murder of “Dull Care”

  25. Estragon commented on Nov 17

    The tumor analogy limits the analysis to the body politic of the US. A better analogy might be that of a virus, which has clearly not been contained to the US. We’ve already seen significant writedowns and liquidity issues show up in Canada, Britain, etc.

    Stein could argue (quite properly) that the subprime problem should be viewed not only as a small fraction of the US economy, but as an even smaller fraction of the larger world economy. In so doing though, he would be planting the seeds of his arguments’ destruction.

    * While the US fed has a dual mandate and can probably be relied upon to employ the proverbial helicopter, there is no such assurance in the rest of the world. Central banks charged solely with price stability may not be so compliant.

    * We’re all well aware of the extent of the residential real estate issues in the US, but on many measures the issues are even more serious in other countries. Britain, Ireland, Spain, China, and others are also at various stages of foaminess, if not bubbles.

    * We have a reasonably good idea of the capacity of the US financial system to sustain losses, but others (notably China’s) are far clear. There’s a growing risk that as the tide goes out, we may see some more foreign banks have been swimming naked.

    * Non-US members of the defacto USD block have serious and visible inflation problems, and US easing is likely to make matters worse.

    * Countries outside the defacto USD block are showing growing signs of stress in terms of trade. Europe is relatively less vulnerable than some, but not immune. Canada is showing definite signs of slowing. A big part of the bull case assumes rising exports with a weak dollar, but that assumes non-USD destinations aren’t adversely affected by the weak USD.

    * If the US slows even moderately, expect protectionist sentiment and the treat of retaliation to grow, particularly as we go into political silly season.

    In other words, we not only have the domestic leverage effects magnifying the impact of subprime, we have a lot of channels of infection lined up in the world economy. If world trade and financial flows were relatively well balanced, we might reasonably expect to get through this relatively unscathed. That isn’t the real world though, and the virus threatens to become an epidemic.

  26. D. commented on Nov 17

    Since our markets are based on growth, we can’t tolerate a credit contraction at all no matter how small it is!

  27. donna commented on Nov 17

    Winston is right except that even the greed is merely a symptom. In a properly run economic system there are limits placed on greed. In our system the checks and balances have been eaten away, and the government policies contribute to the problem by catering to the greedy.

    Instead of building an economy, we’ve built an unstable Ponzi scheme that has floated all wealth to the top. Now, we get to watch it fall over. There’s nobody left for the rich to suck money from.

  28. John Thompson commented on Nov 17

    Here here Donna I feel the sucking from the rich.

    Although, if our economy was sucked dry already, I doubt some much effort would go into chasing retiree dollars. 3 trillion in pension funds at risk. The “$6.5 trillion of securitized mortgage debt was outstanding at the end of 2006.” These guys got to wake up. Our economy is toast. (at least maybe good for environment eventually)

    Ben Stein in a supply sider. He’s a fun guy and a smart guy sometimes. So I wonder why he goes simplistic on real estates’ impact.

  29. KirkH commented on Nov 17

    I know I know. Roubini is a bear, an accurate bear. But he has now either gone off the deep end or we’re in for one hell of a ride.

    I now see the risk of a severe and worsening liquidity and credit crunch leading to a generalized meltdown of the financial system of a severity and magnitude like we have never observed before. In this extreme scenario whose likelihood is increasing we could see a generalized run on some banks; and runs on a couple of weaker (non-bank) broker dealers that may go bankrupt with severe and systemic ripple effects on a mass of highly leveraged derivative instruments that will lead to a seizure of the derivatives markets (think of LTCM to the power of three); a collapse of the ABCP market and a disorderly collapse of the SIVs and conduits; massive losses on money market funds with a run on both those sponsored by banks and those not sponsored by banks (with the latter at even more severe risk as the recent effective bailout of the formers’ losses by theirs sponsoring banks is not available to those not being backed by banks); ever growing defaults and losses ($500 billion plus) in subprime, near prime and prime mortgages with severe known-on effect on the RMBS and CDOs market; massive losses in consumer credit (auto loans, credit cards); severe problems and losses in commercial real estate and related CMBS; the drying up of liquidity and credit in a variety of asset backed securities putting the entire model of securitization at risk; runs on hedge funds and other financial institutions that do not have access to the Fed’s lender of last resort support; a sharp increase in corporate defaults and credit spreads; and a massive process of re-intermediation into the banking system of activities that were until now altogether securitized.

  30. David commented on Nov 17

    The volatile derivatives market and the size of coming sub-prime foreclosures will change the political landscape. Maybe Al Gore is right about global warming getting serious and the only true solution is military force “Energy Conservation”, both here at home and abroad.

  31. pjfny commented on Nov 17

    Here is one more alarming fact:

    The CDS (credit default market), a multi trillion dollar mkt, which many many financial services companies are relying on to hedge their credit risk…..only works if the credit default seller can perform!!!!

  32. Schunder commented on Nov 17

    1) Ben Stein is awesome. He doggedly reminds people to cheer for the women and men in Iraq and Afghanistan. Hardly anyone else uses their public status to stick-up for America’s finest.

    2) Ben is an idiot? So far he is right, and the bears are wrong. If the bears predictions come true, then ‘idiot’ might be applicable. Until then, all those bears who have called for a recession that has yet to appear are the idiots.

    3) If you lost money in some home builder, or Bears Stern or Citigroup, them maybe YOU are the idiot. So far, unemployment is pretty darn low and GDP growth is decent. We are not in a recession – so far Ben is correct.

    4) If you want to believe that you can tell the future and thus *know* recession is coming and Ben is wrong, well, I’ll consider you the idiot. Anyone who claims to know the future is a madman.

  33. aled commented on Nov 17


    You want the future? One day within the next 100 years you and I will die. Call me mad.

    An economy based on an unrestrained geometric progression of borrowing to acheive growth will collapse onto itself when the debt proves to be unmanagable.

    There is no global warming he said as he watched the body of the drowned polar bear float past him. The point when people notice large scale change is usually when it affects them directly.


    That parrot isn’t dead, it’s only stunned!”

    Monty Python

  34. halbhh commented on Nov 17

    Let’s play Is-This-Logically-Consistent-?

    “After all, the losses in all mortgages — subprime, alt-A, prime and jumbo — come to about $400 billion. That would be equal to about 2.5% of the capitalization of the U.S. stock market, “equivalent, in other words, to one bad day in the market,” Hatzius writes.

    What’s different about mortgages is, in a word, leverage, he continues. Most stocks are owned by traditional investors, such as individuals, mutual funds, pension funds and insurance companies, who don’t use margin and don’t short. In contrast, most owners of mortgages are highly leveraged, including banks, savings and loans, broker-dealers and government-sponsored enterprises such as Fannie Mae and Freddie Mac, according to Fed data, which don’t count hedge funds.

    This distinction makes a huge difference. If, say, these leveraged players account for $200 billion of mortgage-related credit losses, and they lever up 10 times, that hit results in a $2 trillion reduction in credit, Hatzius theorizes.”

  35. Mike Alexander commented on Nov 17

    I don’t think the margin argument is valid. Heavily-leveraged stock investments had a role in the Great Depression. In this case leverage could result in an amplification effect because speculative stocks can lose a large fraction of their value following bubble periods because they have a very low intrinsic. Cash buyers of the Nasdaq 100 (QQQQ) at its peak of 120 are still, 7+ years later, more than 50% in the red and 2-3 years out saw 70-80% losses with no leverage at all. Since stocks can fall so much all on their own, if say %15 trillion of stocks falls 50% (as happened in 2000-2) then you see a contraction of ~$7 trillion. A huge loss that produced a rather mild recession.

    Real estate, on the other hand, does not fall much in price. A cash buyer of housing at the peak of the recent bubble will probably be able to offload his investment at even money within a few years. It’s only leveraged players that are at risk.

    But leverage doesn’t create loses where there are none. It simply lets one hold a great deal more of the losses (or gains). If the total losses from bad mortgages os $400 billion, then its $400 billion, just as the total stock loss in the last bear market was $7 trillion. Leverage doesn’t magnify this loss. It simply makes the impact fall more heavily on the leveraged players.

    So why the concern? The concern is that those leveraged players may well hold different classes of assets that don’t have the high intrinsic value of real estate.

    To meet margin calls of losing real estate investments the players may have to liquidate many times this value of investments that don’t have high intrinsic values like junk bonds. A bank might be forced to sell junk bonds or other corporate debt in order to meet margin requirements of fall mortgage securities. This will cause the price of these other assets to fall and might spook others into selling our of fear that their might be a problem with their paper.

    This is how financial panics get started. In the old days, it meant loans became unavailable for even creditworthy borrowers. This doesn’t happen anymore because the Fed ensures that credit is always available for creditworthy borrowers (they essentially cannot “run out of money”).

    Thus panics do not happen. A big contraction can cause a recession perhaps but this subprime mortgage things simply doesn’t seem big enough.

  36. Robert commented on Nov 17


    I am not the idiot in question here – I have stayed far, far away from anything even remotely CLOSE to housing and banking since March of this year, for reasons which are only marginally more complicated than Stein’s financial commentary. And, as noted above, I only really need two charts to make the bulk of my case. One is the Shiller Used Home Price Index:

    Here’s an updated version:

    The other is the Credit Suisse ARM reset chart:

    I think the first one is pretty self explanatory. In terms of real home value, what goes up, historically speaking, must come down, and I don’t think it has come down nearly far enough.

    The second chart shows when the ARMs reset, but it takes at least four months for a foreclosure to happen (90 days of no payments, 30 days to foreclose), and that’s assuming the best case, fastest scenario. The reality is that these ARM resets will take much longer than four months for the effects to trickle down into the broader economy. We are just now hitting the top of the ARM reset peak, which means that statistically, it’s a near certainty that foreclosures will continue to rise for AT LEAST the next four months, which, obviously, means continued losses for banks and home builders. 5% of our economy is (or was) employed in the housing industry. The current GDP growth rate is.. what – 2%? 3%? If the number of employees in housing is cut in half (which seems conservative to me), say bye bye to that growth.

    Don’t forget that even if an ARM borrower doesn’t foreclose on his or her home, those resets are going to cut into their discretionary spending, and the effects of that shift in spending, I believe, will be much more pervasive and long lasting than many analysts believe.

    The only thing that could possibly stabilize this economy, in my opinion, is a direct result of a weaker dollar – Increased exports. This very well may be what the FED is counting on, and it very well may happen.

    Maybe idiot was not the right word. Ben Stein is certainly an intelligent person (and until I saw his financial commentary, I liked him), but it confounds me that anyone with access to the above information would be calling a bottom right now. This information is easily available, and it only points to one thing – More problems. Anyone with any sway in the media who calls for a bottom immediately rouses my suspicion that they either A) are too inexperienced or haven’t done enough research to merit their position of influence, B) are a shill for someone else who wants the economy to appear in better in shape than it really is, or C) trying to get some attention. I haven’t read of Ben Stein’s support for the troops, but if he’s actually doing something which supports them instead of cheerleading for never-ending increases in ‘defense’ spending, then I applaud him for that. Otherwise, he can suck it on that point too.

    I don’t *know* a recession is coming, but I think that a recession is highly likely to occur absent a major bailout of both lenders and borrowers. The FED may continue to devalue the dollar in order to avert a recession, but which is more important to them remains to be seen. Interesting times lay ahead, to say the least…

  37. Peter Principle commented on Nov 17

    “If, say, these leveraged players account for $200 billion of mortgage-related credit losses, and they lever up 10 times, that hit results in a $2 trillion reduction in credit”

    Ten times? Try 40 to 60 times, once you account for the multiple layers of leverage — A hedge fund leveraging to invest in a CDO, which leverages to invest in mortgage tranches, etc.

    This whole pyramid could (note I said could) prove to be what the infamous holding companies were in ’29 — the financial accelerator that makes it impossible to stop the dominoes from falling.

  38. halbhh commented on Nov 18

    If there are, for example, $401B in losses, then there are $401B in losses, not $4T or $2T, etc., but …. yes, $401B. If a group used leverage to purchase more mortgage backed securities on margin, then they simply amplify their own return. They don’t change the total net return in the market.

  39. halbhh commented on Nov 18

    Another way to read the speculation about the “$2T” is to presume an unlikely thing: that the “leveraged players” were buying widely into all sorts of securities for all sorts of loans, and not mostly mortgage loans. Do we know that?

  40. halbhh commented on Nov 18

    Let me spell it out what I mean above: if some “players” lose in the mortgage CDO (etc) market, why presume this is only a small part of all their held securities? Instead of them having 90% of their securities in other non-mortgage types of loans, it’s more likely they had on whole, for example, $30B in capital, leveraged, and took for instance $150B in losses, wiping them out of course, and causing banks to contribute, etc., etc. Instead of a $2T reduction in securities from these players dissappearing, you’d have a $150B reduction. Just abritary numbers to illustrate the presumptions not laid out, and totally necessary.

  41. Subliminal Trader commented on Nov 18

    Swami Watch!

    Swami Syndrome: A proclivity for predicting the future coupled with a blinding disconnect to the fact that a coin toss (or the proverbial monkey) would be more accurate than your lame prognostications.
    There are lots of Pseudo Swamis out t…

  42. andy commented on Nov 18

    “WIN” stood for “Whip Inflation Now.”

    I’m 39 years old and lived just outside Washington, D.C. as a child. I remember that pin button quite vividly.

  43. XON commented on Nov 19

    I never said much about this, because it seemed to still be in the ‘unlikely’ category, but the more I watch things unfold, I thought I might offer this:

    There is a principle in contract law called Reasonable Assurances. Broadly, it states that if one party in a contract has evidence that the other party will not perform, it has the right to request reasonable assurances. This will primarily be in a more liquid form that rationalizes the risk/capital ratios, e.g., If I loan you money at 3%, but your property begins to act like a 9% risk (i.e., declines in market value), I can ask for 6% of the principal in cash as reasonable assurances.

    Almost every mortgage I’ve ever seen has a clause like this buried in the middle somewhere. It usually says something to the effect that if the value of your home declines below the principal value in the mortgage, the lender can demand the difference in cash, usually due in 15-30 days.

    This might have been the ‘nuclear option’ in the past; and therefore almost never used and NEVER talked about. If, however, the holders of these over-leveraged mortgages are facing insolvency, what countervaling influence is there to prevent them from going after a nice 3-10%-of-loans-outstanding chunk of cash to stave that off? As long as “I got mine”. . .

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