The problems triggered by the housing bust and the deterioration of subprime loans are spreading and will not disappear within days or weeks as many hope. This is not just another scare that will pass quietly into the night. Much like a slow leak, new aspects of the situation pop up daily. Since our comment last week more evidence has come forth, and we have only touched the tip of the iceberg. The following is just a small sampling of items reported during the week.
According to Realitytrac foreclosures for the first six months were up 58% from a year earlier and 30% from the previous six months. That amounts to one filing for every 134 U.S. households. Moody’s Economy.com predicts that 2.5 million mortgages will default this year and expects delinquencies to peak in the summer of 2008 at 3.6% of all outstanding mortgage debt.
The Case-Shiller home price index for May was down 3.4% from year-earlier and 0.29% from the previous month, the 18th consecutive monthly decline. They stated ".declines in annual home price are showing no signs of a slowdown or turnaround.15 of the 20 metro areas are now reporting negative annual price returns."
Moody’s described some Alt-A mortgages as no better than subprime loans. This is no longer a surprise since Countrywide last week reported a big rise in prime quality delinquencies as well. American Home Mortgage stock plunged 85% in one day after it said it doesn’t have the cash to fund new loans. The company is closing its doors tomorrow (Friday) and is suspending redemptions. It is noteworthy that American Home focused on borrowers considered good credit risks, but made many loans to people without documentation of income or assets. This was typical of an Alt-A loan.
Bear Stearns is facing a major loss in yet a third fund with $900 million in mortgage investments and stopped all withdrawals. Significantly, the fund had almost no exposure to subprime loans, but was faced with a combination of markdowns on a broad range of mortgages and refund requests.
There is much more. Earnings at IndyMac, one of the largest independent home lenders dropped 57% as bad loans more than quadrupled. Hedge fund Sowood Capital Management lost more than 50% in July and will wind down is two funds. Assets were about $3 billion before the decline. The Harvard endowment lost about $300 million in the fund. American Home Lenders said its survival is in doubt and that bankruptcy is possible. Other funds reporting big losses included Old Hill Partners, Wharton Asset Management, United Capital and Braddock Financial.
The fallout from the subprime debacle has been evident overseas as well. London-based Caliber Global Investment lost 53% on U.S. subprime .loans, and is shutting down. Oddo & Cie, a French money manager, is closing three funds totaling $1.37 billion, citing the crisis in U.S. asset backed securities.
Australia’s Macquarie Bank announced that its two highly-leveraged high-yield Fortress Investments Funds could lose up to 25% of its investors’ money. Significantly, the funds weren’t directly exposed to U.S. subprime investments, but were impacted by the plunging values of riskier investments in the credit markets. The funds were invested in senior secured corporate loans, which are mainly the leveraged debt used in LBOs. According to the fund’s management these assets were sound. However, as the securitized value of the funds’ investments fell, Fortress had to sell some of its assets in order to meet its borrowing covenants. The funds face possible margin calls from their lenders if they aren’t able to sell enough assets to reduce leverage. The lesson here is that once risky assets start plunging, leveraged funds are forced to sell to meet margin calls at a time when buyers are demanding big discounts. This is a perfect example of liquidity disappearing when it is needed most.
In our view the liquidity alarm bells have only started to ring and there is much more to come. The subprime problem has spread to all mortgages and to risky investments of any kind. Globally there are hundreds of billions of dollars or more of securiities that have suffered major declines in value, but have not been yet marked to market. When the margin clerks call for more money the good stuff gets dumped on the market since the bad stuff can’t be sold. We will be seeing a lot more of this in the period ahead. There has never been a period of wild speculation that didn’t end badly, and we don’t think that this time will be an exception.
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