Sub-Prime? So Over! Part I

“Phew! That was close! For a moment there, it looked like the collapse of the subprime mortgage market was going to erase billions of dollars of financial earnings for years to come.

“Bad mortgage debts were piling up faster than trash bags in a landfill. At least, that’s how the credit markets saw the subprime meltdown in August. Two subprime hedge funds at Bear Stearns had gone bust in June; Ben Bernanke, head of the Federal Reserve, said in July that total subprime losses could total $100 billion; private-sector economists put the total nearer to $150 billion. Now MacroMavens in New York thinks we’re looking at $210 billion to $346 billion – ‘and that’s assuming the situation doesn’t get worse.’

“These billions in bad debt would seep into the broader economy, investors feared, and kill the market in new lending dead.

“But hey, panic over!”

Adrian Ash
October 23, 2007

And some more views from Short Fuse in Los Angeles…


Views from the Fuse:

It’s getting more and more expensive to be an American…

The dollar has fallen from its highest point in almost two weeks against the euro (EUR) this morning, settling around $1.4204 per euro.

Bloomberg reports:

“The dollar fell versus 12 of the 16 most-active currencies before the release of the Richmond Federal Reserve Bank’s factory index, which probably declined in October for the first time in four months, according to economists in a Bloomberg survey. An industry report tomorrow may show existing home sales dropped to an almost six-year low, according to another survey.”

“For their part, Countrywide Financial announced this morning a $16 billion subprime loan refinancing program. The nation’s biggest lender has targeted some 80,000 subprime borrowers who will most likely default when their rates are reset next year,” write Addison and Ian over at The 5 Min. Forecast.

“‘Countrywide believes that none of our subprime borrowers that have demonstrated the ability to make payments should lose their home to foreclosure solely as a result of a rate reset,’ said a statement from Countrywide President David Sambol.

“Of those 80,000 homeowners, the bank plans to move 52,000 into prime loans or guaranteed Federal Housing Administration loans. The 28,000 others, who have credit issues too severe to qualify, will have all sorts of rate reductions and modifications available that, to us, sound only marginally less sleazy than regular subprime loans.

“Countrywide announces earnings on Friday…heh. Brace yourself.”

Gold rebounded after falling 1% yesterday, back up around $758 an ounce, as people flock to the precious metal as a hedge against dollar weakness.

However, points out Kevin Kerr, writing for Outstanding Investments, there is an oft-overlooked industrial metal that can offer security from the falling dollar – and some pretty nice profits: tantalum.

“Tantalum’s big claim to fame in the metals world is that it’s used in the production of capacitors – important components in the manufacturing of mobile phones, laptops, PDAs, game devices, digital cameras and everything that makes the big world a little smaller.”

And in our world that is shrinking by the second, you can imagine how important this metal is.

“The growing demand for these products is why I believe the level of consumption of tantalum is going to exceed current industrial commodities like copper (construction, electronics), lead (car batteries), zinc (galvanized steel), etc.” continues Kevin.

“After all, many of those base metals have already had incredible increases in prices and are likely to continue to climb, just not as fast as things like tantalum, which is still fairly under the radar. Like all the industrial metals, tantalum may suffer a slump during an economic slowdown, but it is likely to snap back faster than any other, and supplies will be absorbed quickly.

“From a trading perspective, another positive for tantalum is that speculative demand is strongly tied to market fundamentals because it’s difficult for speculators to take large paper positions; hence, the speculation is done by traders taking physical positions, not financial institutions trading derivatives. It’s the real deal.”

Find out how to invest in ‘the real deal’ without owning a big block of tantalum…and how to make money during gold’s incredible rally. We know of a way that will let you capture 100% of the coming surge in gold prices.

The Dow paused at a rest stop yesterday. It was down about 4% from its recent all-time high and needed a break.

Why do we care about the Dow? We don’t really. Only a fool would buy the Dow at today’s levels. Still, there’s a fool on every corner…and they’re fun to watch.

Buying the Dow is a gamble on an entire asset class – large-cap stocks. Whether they will go up or down, we don’t know. But if we feel like gambling, we’ll go to a casino. There, at least, we’ll get drinks and pretty girls to look at too.

Investing in a particular stock is a different matter altogether. You can always find one or two decent stocks – even in an over-priced market. If you do your homework – the way Warren Buffett does, for instance – you’ll be making an investment. We leave it to others do that kind of heavy lifting. Here at The Daily Reckoning, we just point and laugh.

We laughed at the dotcom buyers in the frenzy of the late ’90s. Then, we laughed at the subprime buyers in the 2001-2006 house price bubble. We still laugh at anyone who ‘invests’ in a hedge fund. And we love laughing most at the ‘sophisticated’ institutions – including many hedge funds – that put money into derivative contracts composed of subprime mortgages. Investors in these funds must have had enough willing suspension of disbelief to hold up a bridge. They thought that, by some mysterious transubstantiation never explained, loans to people who couldn’t pay them off could be sliced and diced and turned into Triple A credits. What’s more, they were willing to give up 2% of their principal and 20% of their gains to the fellows who offered to let them in on the deal!


But you’ve got to hand it to the Goldman crowd. They gave investors what they wanted – good and hard. They securitized these dicey mortgages…sold them to their customers…and then, in order to protect themselves from the inevitable losses…sold them short!

And now Goldman (NYSE:GS) says that California residential property – the very stuff that provides the ‘security’ in their securitized credits – is overpriced by as much as 40%.

No, we’re not laughing at Goldman…we’re saluting. Any Humpty Dumpty investor dumb enough to sit on this wall deserves to be pushed. Goldman gave them all a shove – and made money doing it.

And the Humpty Dumpties are still climbing up, hoping to get something for nothing up there. A report from Minneapolis reminds us how hard it is to crush out this kind of optimism:

From the New York Times:

“MINNEAPOLIS, Oct. 21 – In a down real estate market, they came to buy. They came early, they came in numbers and they came with bank checks for $5,000.

“By 10 a.m. Saturday, more than 700 people filled a hall in the convention center here for what real estate agents say is the largest auction of foreclosed properties ever in Minnesota, with more than 300 houses or apartments for sale in two days. Opening bids ranged from $1,000 – for a three-bedroom house – to $729,000, for a five-bedroom house on 11.9 acres. The crowd was standing-room only, with more waiting to enter. Some were looking for homes, others for investments.”

Housing prices in the United States are falling nationwide; but in the minds of most house buyers, it is still a bull market. They have lived with rising prices for so long they now take it for granted that that is just the way things work. “House prices always go up in the long run,” they believe. But the run they are thinking of is only about 10 years long. Before that, prices rose – but only about as much as inflation. In some areas, of course, real prices rose with population and economic growth. In others, real prices fell. Overall, for the last century, there was little overall improvement in housing prices.

And why should there be? Housing is not an investment. It is a durable consumer good – one that needs maintenance, and one on which you have to pay property taxes. If it were a stock, it would be one with a negative dividend…you’d have to pay the company each year for the privilege of owning it. You can make money developing property. You can make money investing in property. You can make money building houses, too. But you can’t expect to make money buying houses.

Still, you would probably be wasting your breath trying to explain that to the crowd in Minnesota last weekend. They thought housing was the best way to make money ever invented. And they thought current market conditions offered an excellent opportunity to get in while the getting was good.

“The market’s really low right now, so you can get a good price,” said one buyer, a waitress who was not looking for a place to live, but a place she could fix up and sell. “Even if you can’t sell it right away, if you just sit on it and sit on it, it will go up.”

In Minneapolis, more than half the foreclosures this year involved houses that owners were sitting on, rather than living in. They were properties that were supposed to make the owners money, not provide them with a roof over their heads.

Whatever happened to those Humpties, we don’t know, but there are plenty more ready to take their places on the wall. One man at the auction bought a four-bedroom house at the auction for $145,000, without ever seeing it:

“I just looked at the picture and thought if we got it cheap enough, we could rent it for a year, then sell it when the market goes back up.”

“It won’t always be so low,” said another potential Dumpty.

No, it could be lower.

The property bubble seems to have exploded in the United States, but in many places, prices are still low and still going up.

Prices here in Argentina are about 30%-50% higher than when we bought two years ago. We’re still buying…cautiously. Not that we need any more property down here, but we’re not looking at it as an investment. Instead, sometime in the future, your editor is expecting to spend several months of the year in Argentina. It looks as though he’ll have grandchildren here. And he likes the place.

His apartment is spacious and very light. But it has a problem; it is on the widest avenue in the world – the 9 de Julio – and it is noisy. He doesn’t really want any more real estate, but he wouldn’t mind trading up, he told his agent.

If you are interested in overseas property, our old friends over at International Living are putting on what they call a “Global Wealth and Wisdom Summit” in Waterford, Ireland, in December. We will be there…along with the IL team…giving you what little we know about buying property abroad.

The sun was setting over the Andes. The air was still. The temperature was perfect. Francisco was coolly sipping mate. Jorge was nervously looking at your editor, wondering if he should call the police or the doctor.

We were wrapping up our visit to the ranch, still learning the cattle business. We felt like apologizing. But to whom? For what?

As near as we could tell, Jorge and Francisco were completely on the level. The numbers added up. And there was the hay…and there were the cattle. We studied their faces. We listened to their voices. These guys were not running for office, selling a hedge fund or directing the Fed. They were gauchos, ranchers…with no trace of mendacity, puffery or humbug about them. We made up our mind; they were men we could trust.

Everything was in order. The bills…the invoices…the inventories…the cows…

“It has been a terrible year,” Francisco summarized, “but even so, the cows are not as thin as you’d expect.”

We didn’t know what to expect. The only cows we have had much experience with are those in France; and they’re always fat and sassy. The grass is usually so thick that the cows barely have to move. The temperatures are moderate. The sun is never too hot…the nights are rarely too cold. A cow’s life in France is like a bull market; the only bad thing about it is the day it ends.

How the cows here, at the ranch in Argentina, would be jealous if they could see them! Out here, there is barely a single blade of grass for miles. They wander around the desert, eating whatever they can find – it looks like dried-up sagebrush to us. And when they get thirsty, they have to walk for miles to one of the tiny streams that cut through the ranch. The days are hot; the nights are cold.

In France, a cow is expected to have one calf per year. Few fail to do so. And each calf is welcomed like a royal heir, carefully monitored and sheltered until it is ready to be shipped off.

Out in the high desert, by contrast, only about half as many calves are born and survive. Many die from the harsh conditions. Some are killed by puma.

“Señor Bonner, we are on the edge of the world,” Jorge explained. We are the last outpost before you get to the salt flats [Dead Man Salt Flats]. Nothing can live out there. And even here, it is a struggle.”

“Still, we didn’t do badly,” Francisco added. “This year, we will still break even, even after buying all that hay. That is, we will break even if we can sell those ‘novillos.'”

“What are novillos?”

“Those are the cattle that the squatters give to us instead of paying rent. Up in the hills, people live there without any money. We think it is tough down here; but it is even tougher up there. They keep a few cattle, goats and sheep. Instead of paying us rent for the land, they pay us in kind…in animals. We’re trying to get them to shift to paying us in cash, but they don’t have any cash. So we take 5% of their animals each year. We call them ‘novillos’ because they are mostly males. And mostly castrated. But they are so thin. And they are a mixed breed…very hardy…but very tough. No one wants to buy them.”

“But if we can sell them, we’ll break even for the year,” Francisco continued. “Of course, I don’t know about next year.”

“You don’t expect another drought, do you?”

“No…I hope not.”

“Then, we should make a profit, because we won’t have to buy hay.”

“But because we had a drought this year…and conditions were so harsh – we also had one of the coldest winters ever – we didn’t get many calves. So we won’t have many to sell. I’m sorry, Don Bill…but next year we will probably lose money.”

Until tomorrow,

Bill Bonner
The Daily Reckoning