The L.A. Times issued a cover story regarding the New Century Debacle this Sunday. Yes, it was a smaller story on the bottom left hand side of the newspaper but it did make the cover. The story was well written and talked about top producing employees spending time at a castle in Ireland while the company collapses. Fiddling away as Nero burns Rome. Not only that, but the story parallels the weird black multistory building that New Century occupies in Irvine California next to a defunct savings and loan giant that no longer reigns. I guess Irvine is turning out to be a hub for high risk permabull empire building via wildly risky loans. If we want to take tabs, how much is at risk this year? Many believe that the sub-prime debacle will be contained in a silo and will not have an effect on the overall market. I disagree with this Pollyanna version and wishful thinking that will only add more fuel to the bubble while it takes its last breath during the 11th hour. Let us break down what is at stake:
Digging Deeper into the Numbers
Estimates coming out from the permabull camp state that 7.65% of sub-prime loans are at risk for default while only 1.25% of Alt-A loans are at risk. When looking deeper in Inside Mortgage Finance, an industry publication, we see that in terms of tracking data on sub-prime and Alt-A loans the data is vague. Considering that many loans are stated income I'm not sure how they arrived at their optimistic numbers. Stated income means made up; a recent study by the Los Angeles Times demonstrated that 80% of folks on stated income lied about their income. Of these folks, 60% overstated their income by 50%! Yet again, we realize how distorted the mainstream media is because no one wants to hear "hey, you now have to save up to buy a home!" Why is saving to buy a home important? It demonstrates two principle things of a prospective buyer. One, you are diligent enough to save for something you want (showing your ability to forgo credit for one or two years). And second, it demonstrates financial prudence. The last few years we have dropped kicked financial prudence through the uprights and have flooded the market with instant gratification liquidity. How can we be expected to save for a down payment when our savings rate is negative?
How Much Money is Now Lost Because of Sub-prime?
The general market hasn't felt the pain of the sub-prime implosion because mainly hedge funds have loaded up in these risky plays. However, mutual funds being rather safe from any collateral damage, will begin facing some pain when the rates start resetting and the larger players realize they will need to unload bad debt and overpriced McMansions in a market with no liquidity. Let us take a few top sub-prime operators and run the numbers to see how painful their kick to the groin was:
You notice the trend? Even though in terms of getting hammered IndyMac is still doing okay, they are the largest Alt-A player out there. But look how much market cap was lost by them simply being caught up in the sub-prime rage? Let us not forget the top dogs Freddie and Fannie Mae with a combined market cap of close to $100 billion. This crap will travel all the way to the top and New Century and Fremont are simply the first to get guillotined in this credit orgy we've been living through. Wall Street is rallying today but this is a dead cat rebound. Listen to the permabull housing heads at your own peril. Phoenix just hit a record inventory at 56,000. Some areas in Florida have dropped 20% year-over-year. Southern California is still in wonderland housing rehab but go ahead and jump into a Real Homes of Genius place at 600 square feet for $475,000. Your monthly payment will be approximately $4,000 since you can't go stated-income-suicide-negative-amortization for 1% but hey, you'll get one bedroom and one bath all to yourself. You don't need anything larger since your mortgage will fill up any empty space.