The Dow bounced right back – up 180 points Tuesday. Gold soared over US$721.
What do you think, dear reader? Both went up…but which is the surer bet? We have our opinion. What bothers us is that it is too obvious. Central banks and financial intermediaries have been flooding the world with cash and credit. As the quantity increases, it is only reasonable to expect the quality to go down. That’s why we have a problem in subprime debt…lenders stretched to earn more money by making loans to marginal borrowers and then selling the paper on to investors who didn’t ask too many questions. Now, the lenders…and the investors who bought the mortgages from them…are in trouble…and in turn, you could be too.
Countrywide (NYSE: CFC)…known as “Countryslide” in the New York Post…has seen its share price fall 60% this year. The stock fell 5% on Monday…following word that the firm needed a bailout pronto. The company’s president, Mozilo Angelo, said the business desperately needs cash to continue operations.
Fifty mortgage lenders have closed their doors so far…and more probably will before the correction is over.
We remember quoting Mr. Angelo a couple of years ago. What impressed us was that the CEO of the nation’s largest mortgage lender – the firm makes one in five mortgages in the United States – had no illusions. If we remember correctly, he saw the implosion coming. We wonder what happened? Was he powerless to protect the business? Was the lure of fast profits too much to resist? Did the crisis come sooner…or harder…than he expected?
We don’t know; but we take it as a warning. Even seeing the broad outlines of a problem shaping up doesn’t mean you’re going to be in the clear when it hits.
The geniuses who run hedge funds must see the traps, too. Still, many walk right in. Moody’s says the default rate on high-yield debt is likely to double. And yesterday’s news brings word that two more large funds have barred withdrawals. Investors are trapped in Pirate Capital and Y2K Finance. Pirate says that two of its Jolly Roger funds have lost 80% of their money in the past year. And Y2K, run by Wharton Asset Management, is down a similar amount.
“Neither a borrower nor a lender be…”
If only people had paid attention to Shakespeare. But who reads the classics anymore? And who can blame the moneylenders? They didn’t make any money unless they lent. And borrowers? Who doesn’t want to get in line when someone is handing out money? And now both lenders and borrowers are in trouble. Everyday brings more evidence – foreclosure rates, defaults, late payments.
Still, you wouldn’t know it by looking at consumer spending. Consumer credit rose 3.7% in July. That’s down from 5.9% in June, but still considerably higher than GDP growth. Credit from mortgage lines has become harder to get, so the lumpen borrower is switching to more expensive credit from credit cards. Our guess is that the real impact of the real estate slump hasn’t quite registered yet . So far, only about a third of the ARMs written in 2005 and 2006 have been reset. And, so far, the average house price has been barely affected. Jobs are plentiful. Credit cards are easy to come by.
Success is a hard thing to overcome, we keep saying. The American consumer has been so lucky for so long it will take him a long time to realise what a bind he’s gotten himself into.
Markets and Money