August 16th, 2007
Subprime Opportunity
There has been chatter about the subprime lending market and how it’s ultimately affecting the entire global economy, but I haven’t been listening… until today. I’m not a day trader by any means but I do have some stocks listed on a dashboard widget and I couldn’t help but notice the entire list was red. I don’t remember seeing this before, a variety of securities and all of them were down 1-4%. I don’t normally pay attention to macro economic machinations, usually the discussion and posturing tends to be somewhat hyperbolic. However after some light research I began to see how closely this relates to me.
The “Subprime Meltdown“
The housing bubble ended around 2005, in other words across the U.S. prices on existing housing stopped ascending and in many markets like Phoenix, Arizona they began to sharply decline. No big deal right? Home loans are typically 30 years long and a house is not an investment for many people, it’s a home. In classic American style borrowers, home buyers, were willing to buy more than they could afford. With adjustable rate mortgages, ARMs, people could get approved with great rates even with poor credit. However those rates typically adjust after 2 years, as is the case with a 2/28 ARM. After two years rate adjust some ridiculously high level, usually set by contract. For example in 2005 your ARM may have started at 8% (decent for a subprime loan of the time) but then adjust to a contractual minimum of 11% or much more. Of course you can refinance, if you home has appreciated enough to provide the value necessary and therein lies the problem, the real estate market is generally not appreciating. It’s now 2007, 2 years since the real estate market cooled, and a large percentage of homeowners with subprime loans are not able to refinance nor can they afford the higher rates forcing them into foreclosure.
I was a subprime borrower. FHA loans have high requirements for approval and I could have gone with a mainstream a-paper loan but the interest rate was relatively high, so to get a lower rate I went with an ARM. Had several bad things happened simultaneously, my house not appreciating and losing my job maybe debilitating accident, the interest rate hike I was facing could have put me in the same boat as many borrowers, on the verge of foreclosure. Fortunately for me that didn’t happen and I refinanced and saved a couple points on my loan, leaving me in great shape. The possibility however, was more real than I understood and I can see how many Americans could get into a negative equity situation.
Silver Lining
The subprime mortgage financial crisis has led to “major declines in stock markets worldwide, several multi-billion dollar hedge funds becoming worthless, record dollar devaluation, coordinated national bank interventions, contractions of retail profits, and bankruptcy among several different mortgage lenders.” Silver linings contrast greatly against the blackest skies. If you have liquidity there are many decent investments to be had in the stock market. Some are calling this the best securities market for buyers in 12 to 16 years. I tend to feel this is an exaggeration but I was compelled to make some moves of my own, however sophomoric. Texas Instruments has been on my watch list for a while now, DLP being one of their better known technologies, and they are down ~15% after the recent market storm. Much of the market seems to be getting some needed correction but some companies are getting hit for no apparent reason. It’s obvious why the market value of Country Wide is taking a hit, and Home Depot recently announced 15% decrease in sales, but why is the chicken company in Brazil down 25% ? These are opportunities.
Other Notes
Some lenders like First Magnus are having to completely halt lending because they can’t find investors to buy the loans from them. Many companies have a capacity limit on what they can afford to guarantee and they depend on reselling the loans to free up resources. There are some great articles like this one which discusses the specifics of the subprime market, why it’s necessary, how the government should react, Disaster Myopia, etc.
August 21st, 2007 at 10:10 am
Another interesting link on the subprime market as it related to hedge funds and the like. It seems the global debt market is worth 100trillion but the equity market is only worth 50trillion.
http://www.forbes.com/home/opinions/2007/08/20/croesus-chronicles-liquidity-oped-cz_rl_0820croesus.html
August 21st, 2007 at 1:59 pm
I too have found the recent housing woes troubling. Some of the major lenders have been in trouble and have missed their marks for earnings, meaning an increased level of defaults.
The important thing to note, and I heard this from Donald Trump, is that if you do get into trouble with your mortgage, based on the variable market rates, is don’t pack up the tent and default.
You see– the banks (seriously) don’t want your house. (They have enough already to resell due to foreclosure.) That’s more expense for them. It’s cheaper for them to get you in and negotiate again on the rate and try to bring your loan under control at this time. The banks are hemorhaging right now and need all the borrowers to keep paying in whatever capacity they can.
August 22nd, 2007 at 8:45 am
The big question is, of the financial stocks that took big hits on market valuation, which are good long term buys?