Mortgage Crisis: Shark With an Appetite

I was in New York earlier in the week for the Value Investing Congress. Among the more valuable presentations were those of Sean Dobson at Amherst Securities and Whitney Tilson and Glenn Tongue of T2 Partners.

They were valuable because they helped frame where we are in the mortgage crisis, which has been the main shark in the water over the past couple of years. You should know where that shark is and whether or not it is hungry. The chart below shows you the ferocious fish may still have an appetite.

Mortgage Loan Resets

It shows you that we are past the viscous subprime crisis, when that shark chewed through the balance sheets of a number of banks and financial institutions, in some cases devouring them whole. However, it is not yet safe to get back in the water:

There are these other slices of mortgages that are not quite as risky as subprime that reset in the next couple of years. Years 2010 and 2011 face big resets in so-called Alt-A and Option ARM loans. What this means is more write-downs and more losses for banks and others who hold these mortgages.

Making all this worse is the fact that the housing has not yet recovered. The T2 duo made the case that the current “stabilization” of the housing market is a head fake. Mostly, it’s due to huge government support of the housing market. But there is still a large inventory of homes out there. And with these resets coming due, we’ve still got a large amount of foreclosures on the horizon.

All the while, the unemployment numbers are still poor. The T2 duo calls the unemployment situation the “most severe since the Great Depression.” The US economy has shed over 8 million jobs in this recession and unemployment – officially – is nearly 10%.

Plus, it’s not like the average US consumer is in a good position to sail through this crisis. Household liabilities are still high, as this next chart shows:

Disposable Income

US consumers need to save and rebuild their financial strength. This is why the savings rate is on the rise. This is why, for the first time since the 1950s, household credit debt declined.

As investors, it seems clear that any idea that depends on discretionary consumer spending – say, buying trendy new sweaters or watches or expensive shoes – faces some big head winds. Better to the stick with the necessities, I say.

Also, it looks like the bounce in the stock prices of overleveraged banks and financial institutions is premature. Most bank stocks should be sold, not bought. The bounce in home building stocks looks ridiculous in light of what they have to look forward to. The T2 duo actually recommended shorting the home building stocks through the iShares Dow Jones US Home Construction ETF (ITB). By shorting it, you make money when the stock prices of the home builders go down.

They made a compelling case, of which I will highlight a few things. Exhibit A would be the fact that the average new home has been on the market for 12.9 months. Exhibit B is that we have about 2-3 years of existing home sales just to absorb the vacancies that exist. According to T2, about 6% of all homes built this decade are vacant.

Exhibit C is that the home builders themselves have too much debt and too much inventory relative to their thin equity cushions. The home builders are in the position of trying to hold up a bowling ball with a sheet of paper…in the rain.

Lastly, the home builder stocks are almost universally expensive on a price-to-book basis, as this chart shows:

Overpriced Housing Stocks

Stocks with lots of debt, too much inventory and an awful market don’t deserve premiums over book value. Discounts are more like it.

So there you go. I like the idea of shorting the home builders. At the very least, I wouldn’t buy one. I’d also stay away from banks and financial institutions that hold mortgage assets. American real estate is not worth zero, as Dobson said, but it can be worth a lot less than today’s price.

I recommend staying with the sorts of companies that own essential assets and/or sell essential items. As I like to say, stick with what keeps civilization a going concern. And avoid any stock that is dependent on regular access to the credit markets. As we saw in 2008, a mortgage crisis can shut down the credit markets. We don’t want to be held hostage by lenders in that situation, so stick with excellent financial conditions.


Chris Mayer
for Markets and Money

Chris Mayer
Chris Mayer is a veteran of the banking industry, specifically in the area of corporate lending. A financial writer since 1998, Mr. Mayer's essays have appeared in a wide variety of publications, from the Daily Article series to here in Markets and Money. He is the editor of Mayer's Special Situations and Capital and Crisis - formerly the Fleet Street Letter.

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10 Comments on "Mortgage Crisis: Shark With an Appetite"

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Oh wow, that first chart is scary!! The masses love to go out and watch horror movies saying that “you will be on the edge of your seat and gripped by fear” If they love being into all that horrible negative stuff, well, they won’t have to pay any more, this stuff is more scary than any Hollywood director could ever dish out

The impact of the option ARMs will be determined in part by the interest rates which the US experiences now and during 2010/2011 when they reset, plus the willingness of anybody to go in and buy up the surplus housing (will the US allow foreign investment in this regard?). While still hard to quantify, it will still be big and people will once again be returning their keys to the bank and walking off to Walmart to buy a Chinese made family tent ( ). By 2012, we’ll all be at the definitive side of it all, and as… Read more »
Dan M
A small quibble – I don’t think the US savings rate is increasing at all. Americans are not really saving, they are paying down debt, which is not nearly the same thing. Savings might be spent later. Paying off debt never results in money that can be spent later. Paid off debt is money that disappears from the economy, and only makes deflation worse. I’m not arguing that debt should be perpetuated, rather that I’d be happier to just see it defaulted on and get it over with. It’s a crazy world when something that should be good (increased saving)… Read more »
Much as i’d like to see Sydney house prices fall i do not think what happens in the USA will have much impact on prices here (or even in Canada as another example) the reason is simple when things turn to doo-doo in large economies like the USA and Europe, many of those with money run away – to places like Australia it only takes a small proportion of people running from a larger economy to have a substantial impact here so i expect house prices to rise across the board Australia has always dealt with economic threats by upping… Read more »
Murray, you are bang on!! I have read the daily reckoning for the last 2-3 years and have listened to ‘expert’ opinion on how Australia’s house prices are unaffordable and unsustainable and over valued and so on and so forth. The bubbgle is about to burst and reality is about to set in and greed will be punished. It sounds wonderful in theory but i am now 29 my wife and i have 56k deposit and a DINK scenrario bringing in 112,000pa, we cannot afford to even buy a one bedroom unit in a 15 stroy block 12km out of… Read more »

…an unmanageable pace and scale of immigration is the mortgage bankers’ wet dream…

Coffee Addict


What would you suppose the unit which sold for $358,000 will sell for if interst rates were touching say 12%?

While 12% may be a bit far fetched at the moment, what will happen when the when central banks finally let go of their free money policy? In your shoes I wouldn’t dispair. Rudd has less control than he thinks he does.


For the record by the end of next year I will own my place in Melbourne and will probably move back there from up north. Hearing that prices have gone so crazy down there does not make me the least bit happy as it obviously prices out the young and struggling from having much chance at having their own place or if they do they will be up to their ears in debt for most of their life. I agree with your assessment CA but I suspect that the government will just boost the first home owners grant and tweak… Read more »
Ned S

DR seems to pander to people’s deep underlying wish that central banks did not exist and that the world was a fair and reasonable place. But central banks do exist and the world is not inhabited (by and large) by fair and reasonable people – Just self interested ones. Such is Life – With the challenge being to learn to laugh at it – And at oneself. :)


Hooray! Ozzies build and buy the biggest houses on earth!(SMH 30/11/09)C’mon, we need 12 million more people living here to fill them. I sneezed and “heritage” fibro two-bedders in western Sydney flew past 400k (for KDRB into McMansions)That is the “genius of the market” at work, ain’t it? (An old leftie has sneaked into your blog)

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