Smart Borrower Blog

Market Indicators Foretold Credit Woes


Aug 19th, 2007 @ 5:20 PM by Alden Smith


James Melcher, founder of Balestra Capital, is a man to watch. Over a year ago, he saw the market as dangerous, and worried about the trade and budget deficits, the housing boom, and high credit card debt. With $100 million in assets at his hedge fund, Balestra Capital, he was in a position to do something about it. He hedged his bets, foreseeing the troubles in the housing market, and today is on top of his game.

What were his indicators?

Quoting an article in the New York Times: ” As far back as 2001, advocates for low-income homeowners had argued that mortgage providers were making loans to borrowers without regard to their ability to repay. Many could not even scrape together the money for a down payment and were being approved with little or no documentation of their income or assets.” Melcher paid attention. This week, he left with his wife for a vacation in Paris.

The signs were there

In December of 2006, first sub-prime lenders started failing as more borrowers began falling behind on payments, often shortly after they received the loans. In February, HSBC Holdings P.L.C., a large British bank, set aside 1.76 billion dollars because of its concern about the American sub-prime market. The credit analysts in research saw this coming also. Their warnings went unheeded because the managers felt it was only a tempest in a teapot, and therefore not of much concern. Jack Malvey, the chief global fixed income strategist for Lehman Brothers, reports that “This has really been progressing for quite some time.”

Were these indicators overlooked, or just ignored?

Goldman Sachs, Wall Street’s most dominant firm, have provided little detail into how one of their hedge funds lost 30 percent of its value in just weeks. Byron R. Wien, a 40-year veteran of Wall Street who is now chief investment strategist at Pequot Capital, said that “Now the big question is: Will this spill over into the broader economy?” The general consensus is a “wait and see” attitude. No one can surely predict where this will take the market.  Because I am no market analyst, I quote the New York Times: “The answer to that question will be revealed over the coming months. But the cast of characters who missed signals like the rise of delinquencies and foreclosures is becoming easier to identify. They include investment banks happy to sell risky but lucrative mortgage debt to hedge funds hungry for high interest payments, bond rating agencies willing to hope for the best in the housing market and provide sterling credit appraisals to debt issuers, and sub-prime mortgage brokers addicted to high sales volumes.”

What went wrong?

It is believed many investors did not know what they were buying. This is understandable when you consider that these loans are packaged and repackaged and sold off to the market place. It would take considerable digging to find the rotten apples.  Many feel that these investor did not understand the risk of these mortgages they were buying in packages.  For whatever reason, it has made a real stir in the market place.

Where will this go?

No one can predict how this mess will bail itself out.  It would be nice to say that it will be worked out to everyone’s advantage.  What worries me is that the fund managers looking for a high yield portfolio will fall into another state of denial.  And maybe the Feds and central banks will get tired of bailing them out.  Enjoy Paris, Mr. Melcher!

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