Saturday, March 3, 2007

Banking Regulators Wake Up and Slam On The Brakes

Unless something bigger pops up this weekend, the bullet point that's likely to burn into the minds of many on Wall Street come Monday morning in column 2 of the Wall Street Journal is what's up on their website this morning:

BANK REGULATORS PLAN to crack down on loose lending standards on subprime mortgages. New Century said it is the subject of a criminal inquiry.

The Journal story summarizes both the ultra-woes of New Century (NEW) and the exit stage left of Freemont (FMT) from subprime lending via FDIC cease and desist order. These are breathtaking corporate developments in and of themselves.
But the decision by banking regulators to stop the banking industry from making bad home loans (gee, what a concept) is going to have severe reprecussions. The effective overnight end of easy interest only 2/28, no-doc, 100% LTV, 3-2-1 and 1-0 buydowns, GPM's, etc will erase close to 20% of the potential buyers from the real estate market effective TODAY if the last few years of subprime and alt-a loan stats are good data to work from. Holy (insert your word of choice here)! The regulatory shutdown doesn't even count that distress that showing up in higher FICO score customers who are starting to have trouble paying their second mortgages, according to Countrywide (CFC). The real estate market is crashing (he said with a monotone expression). Of course, crashing something that's spread out across the country and worth trillions doesn't happen overnight and will take months play out, but the subprime locomotives that have resulted in unsustainable excess are going off the cliff one by one.
By the way, with respect to New Century which will more than likely go out of business, the problems there have been known for years. Did you know that on a conference call in 2005 NEW management admitted that they borrowed $1 bln for a-single-day each quarter to beef up their balance sheet? Did you know that NEW management admitted that they sold mortgages back to themselves? Aaron Crowne over at uncovered this and has linked up to it. It's worth going over there to check this stuff out. Aaron also draws attention to the absolute travesty of the Bear Stearns (BSC) buy recommendation on NEW shares earlier this week. In covering the analysts shenanigans for so many years, I've gotten so used to it that I haven't said much about it since it happens all too often, but the conflict of interest in the Bear Stearns call are unusually astounding. Aaron's count of subprime lenders that have gone kaput is up to 30! By the time it's over, I believe there will NO independent subprime company left standing.
All of this brings me back to my own deep thoughts: The regulators were asleep at the switch until late Friday. Surely if a blogger in 2005 can pick up on the shenanigans at a place like NEW, regulators had to know but let it go. Who gave the regulators (a variety of agencies) orders to OD on the Ambien until now?
These developments will surely have a dark impact on the market come Monday morning since the finger prints of the biggest names in banking and Wall Street are all over the subprime debacle and the implication of a crashing housing market is elimination of the 'wealth effect' which will stymie the consumer and send the outlook for earnings and the economy into a tailspin.
We found out this past week that the markets can actually become non-complacent (who woulda thunk it!). Will we see a selling climax next week that leads to a rebound? Or a selling climax that leads to an extended bear? It's all hard to say. With M2 and M3 through the roof via central banks around the globe it might be tempting to go with the easy, short lived correction theory. But in spite of all the liquidity creation by the "money changers", the early stages of a credit crunch are in the making here in the States. That's got to be bad for stocks. I will post more about that later this weekend.


Jason said...

Hi Jim, thanks for the great info! Any updates on your Trading Biases?


Gary S said...

Although junk bonds were down last week, I was impressed with how well they withstood the carnage in stocks. I was even more impressed with how well the closed end junk funds performed. And it was real easy, almost too easy, exiting junk on Tuesday's close with but the smallest of losses for the trading day. I can't think of anything more positive for stocks than junk bonds (the open end funds) reverting back to its pattern of making historic highs on an almost daily basis. Still, I think last week was some type of top for junk and the direction of this most trend persistent asset class will now be down. I hope I am wrong.

Gary S said...

Sorry, correction to above comment, meant to say it was easy, almost too easy, exiting junk bonds on Wednesday's close with but the smallest of losses, not Tuesday's close.

Jim K said...

Jason, thanks for reminding me. I hadn't updated that section in a number of weeks.

Gary S.. Yes, there are mixed signals. I think we're good for a 10% correction in many indexes which could be an easy shot in the first few days of next week, but still sifting through a lot of data to decide whether to call for something sharper.

Lauriston said...

Jim K

Stuff about NEW is simply unbelievable. Absolutely unbelievable. This area of subprime could turn out to be the next Enron, and this time the biggies are involved (GS BSC MER MS etc.). God help us all...

Jim K said...

Lauriston, as Lincoln once said, 'What is to be, will be, and no prayers of ours can arrest the decree.' Should be an interesting week next week.

IgorD said...


The banking regulators are pulling the plug because it is time. The subprime sales network is getting liquidated, MBS investors taking losses, Freddie and Fanny distancing themselves from subprime lending while Wall Street brokers pocketed record commissions last year.

There is also probably political pressure for public hanging of the "bad" guys.

Commerial MBS indexes (CMBX) are also showing signs of stress. Are the commercial lenders next?

The market bear would be very logical at this point. The Fed must lower interest rates to save the day and flood the system with cheap money again. It is not often you hear Alan Greenspan to say R-word on the Asian tour.

The Gold took a hit last week for the benefit of the US Bonds, but the fundamentals remain strong to support investment interest going forward. Next week should be really interesting.

Jim K said...

Jason, it's been a while since we've have an intra-meeting increase. that would be interesting. What's interesting about the rate elixir is that perhaps it won't work this time? Maybe things are a bit too far gone already and will have to run their course as part of the downward slope of the business cycle.