|
Today's Market WrapUp 08.06.2007 Mon Tue Wed Thu Fri Allison Archive Sub Prime Blues The stock markets were rocked with further volatility last week, spurred primarily by the sub-prime credit situation. The markets appear to be concerned that sub-prime problems are spreading to other areas of the credit markets and a “re-pricing” of risk is underway. In the meantime, the sub-prime lenders are not helping bolster the confidence of Wall Street. Sub-prime lenders have been going out of business at an alarming rate, nearly 50 this year alone. Last week it was American Home Mortgage’s turn to implode, losing over 50% of its value on Friday alone and 93% for the week. The “coup de grace” was administered today as AHM filed for bankruptcy protection, and finished the day down 37% at 44 cents. AHM was a $22 stock in late June, and as high as $36 in the last year. Freefalling Off a Cliff This is a vivid example of how quickly things can go from stable, to concerned, to freefalling off a cliff. Does anyone doubt there are many other financing companies traversing the cliff without knowing it? Most of AHM’s 7,000 employees were suddenly laid off last week. The Wall Street bankers that lent AMH money have stopped lending. The mortgage loans that act as collateral for AMH’s credit lines have sunk in value. In addition AHM was having trouble selling its new mortgages. American Home Mortgage was once ranked as the 10th largest mortgage lender in the country. “Seizing up” is a term we may hear more and more with regard to the credit markets. Financial Sense Online has long written about the perils of excessive central bank money printing, massive global liquidity, and the inefficiencies and imbalances that have resulted. We have also heard from Wall Street about how the real estate downturn had run its course in 2006, and this year how the sub-prime meltdown in February was an “isolated” incident and would not spread to other credit markets. It seems Wall Street may be a tad premature on both counts. Leverage Cuts Both Ways “Wait and see” remains the catch phrase now, as trillions of dollars of hedge fund money and mind-bendingly complex financial derivatives have yet to be “marked to market.” This is quite a different situation than previously, where a “mark to model” system was used, wherein the sellers of the derivatives set their own prices based on their murky black box models. There is much that is still unknown about the sub-prime mess, but the spreading contagion to other areas of the credit market certainly appears to be underway. The extent of the damage is far from clear, but fear and uncertainty are rising. The problem today is that institutions, other than the Fed, have been able to add leverage to the system. This was not the case in 1998. Leverage is great when credit is cheap and risk is low, but as risk and rates rise, the outcome of massive global leverage grows ever more ominous. Bear Stearns Woes Continue Bear Stearns continued to have trouble after the rapid demise of two of its hedge funds last month. On a Friday, August 3rd conference call, CFO Sam Molinaro said the credit market was “about as bad as I’ve seen it in 22 years.” After this refreshing spate of honesty, the market sold off and finished down 281 points on the day, capping a wild week of ups and downs. Earlier in the day, Standard & Poor’s cut its credit rating outlook on Bear Stearns to negative from stable. As the rating agencies are normally reactive rather than proactive, one could infer that things are already negative. One market theme of late has been uncertainty, another theme, swift and violent re-pricing. When the market senses that a financing entity is in serious trouble, the market fortunes of that company are not of the “wait and see” variety in today’s environment. It’s more of a “sell first and ask questions later” situation. The sub-prime blues is looking more like a flu pandemic. The markets anxiously await the next victim. Will the Federal Reserve Step In? We are now hearing impassioned calls for the Federal Reserve to step in and make the problem go away with another massive injection of liquidity. The irony of course is that’s how we got in this mess in the first place. It’s an oft-used analogy, but the market is like the drug addict asking for another fix to make him feel better. And of course each fix, be it drugs or liquidity, just makes the situation worse. It certainly appears that a lack of liquidity is not the problem. The problem is too much liquidity, and too many risky investments that have not been appropriately priced. The credit market needs to cleanse itself, and if left alone would likely do so. The banking system needs to write off the bad loans and bite the bullet. But the process could be ugly, politically and economically, and the government may have a hard time restraining itself as we near presidential election season. If the Fed in its wisdom does decide to cut rates later this year, the prospects for the dollar and precious metals will likely be heading south and north, respectively. Teaser Rates May End in Tears Real estate officials have used the word “staggering” to characterize the number of ARM loans whose teaser rates are due to reset soon. According to the Mortgage Bankers Association, $1.5 trillion in loans will reset in 2007. Since most of the teaser rates were three years, 2008 looks to be at least as bad, given that 2005 was the peak of the real estate mania. Manias tend to end in tears, and it appears many more will be shed before the real estate market reverts to traditional levels. Is the credit bubble finally unwinding, as the tech bubble did in 2000? No one knows at this point, but risk and volatility have re-entered the market. Before it is over, risk and re-pricing may travel all the way to the Treasury bond market. No investment instrument is without risk, even those that for that last 20 years have been thought of as risk-free. Lack of transparency in the sub-prime and derivatives sectors make the outlook murky, which only makes the markets more nervous. At some point, prudent selling and running for cover may become a self-fulfilling cause of more damage, and the effect a cascading disaster. One can only hope that both transparency and cooler heads will prevail. Today’s Markets The Dow Jones Industrial Average rebounded from early weakness to gain 287 points to end at 13,468.78. The financial shares led the way, bouncing back from Friday’s big down day. The S&P 500 Index gained 35 points to 1,467.67, while the Nasdaq Composite rose 36 points to close at 2547.33. Sub-prime lender American Home Mortgage filed for bankruptcy protection Monday. Michael Strauss, the CEO of American Home Mortgage issued a statement today, signaling the end for AHM investors. "It is unfortunate that American Home Mortgage, a company that we built into a highly successful business, experienced this sudden reversal of its fortunes due to the unanticipated and rather sudden deteriorations in the secondary and national real-estate markets." The company has terminated its mortgage-originations business. It said it is "highly unlikely" that the value of its assets will be enough to fully pay off its creditors. Therefore, "it is realistic to conclude that ultimately there will be no shareholder equity value remaining," according to American Home Mortgage. Crude oil futures came under severe pressure, with the front-month crude contract falling $3.42, or nearly 5%, to close at $72.06 a barrel. Traders are worried that a slowing U.S. economy will result in lower energy demand. The dollar traded mixed against both the euro and the Japanese yen, coming off earlier lows as investors awaited the Federal Reserve's decision on U.S. interest rates Tuesday. Wishing you a good evening, Tony Allison Copyright © 2007 All rights reserved.
|
