Smart Borrower Blog

The Trouble With The Market Today


Aug 18th, 2007 @ 8:44 AM by Alden Smith


Because it is my job to report the news on the blog, I have spent the day culling the resources I have to find something a bit positive to put in place today. It has been interesting sorting through all the mess that the sub-prime lenders have gotten the market into, and a real revelation besides. It has become very understandable to me why we are now in this market position.

Thoughts From the Front Line

I am certainly not a financial wizard. You surely don’t want to throw money at anything I say! I have a lot of interest in the market because to me it is an indicator of how things are going in this great country of ours. One of the things I like to use as a barometer is the weekly newsletter by John Maudlin, of Investorinsight.com. I subscribed to this newsletter a while back when swing trading, as it keeps a good finger on the pulse of the market with no self-promoting and sugar coated information.

His newsletter came today, and I found it timely. I have spent the morning going through some things of great interest, and have found I have a better handle on why the market is in the position it currently is. My thoughts are based on John’s newsletter.

The Panic of 1907

This year marks the 100th anniversary of the Panic of 1907. During that time period, J.P. Morgan stepped in and aided the market to provide liquidity. Others, notably Rockefeller, followed suit, and the panic was quelled. Now, we have the central banks going to the aid of the beleaguered mortgage companies.

What has caused this current panic?

My own personal opinion is this – greed has placed the market in a precarious position. Sub-prime lending, always a tricky situation, has finally turned around to bite where it hurts. In the sub-prime market we have seen bad mortgage underwriting practices, bad rating agency practices, excessive leverage and the need for yield. Greed and complacency have been the watch words of this market. Now that this leverage has been withdrawn, the market is in trouble.

Where it begin

In the early 90’s investment banks created a new type of security called an Asset Backed Security (ABS). These banks would take thousands of mortgages or loans and package them into a security. These different types of securities – Residential Mortgage Back Security (RMBS), Commercial Mortgage Backed Security (CMBS), Collateralized Loan Obligation (CLO) and Collateralized Debt Obligation (CDO)- were turned in to tranches and given a rating by rating agencies such as Moody’s, S&P or Fitch. Because the risk became diluted, many of these securities became a worthwhile investment.

The winds of change

In 2004, loan practices begin to change. By 2006, about 80% of sub-prime mortgages were adjustable rate mortgages. Mortgage brokers were so interested in making a loan that they did not carefully review the application or request the proper documentation on income and jobs. These loans became known as “liar’s loans” because of this practice. A recent report by the Mortgage Asset Research Institute reported that 60% of these new buyers had overstated income by over half. The market set itself up for a fall.

Where it will go

Maudlin feels that the distressed debt hedge funds will eventually bail out the market. He feels that these hedge fund managers will go in, take a look at these loans, and buy them up. There will of course be loss. Many CLO’s are put together in such a way that they can absorb these losses, reinvesting payments received and making them worthwhile. Once again, it is a matter of time until the market can re-invent itself.

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