Subprime Mortgage Problem Contained? Give Me a Break

I think that some heads are going to roll when Fed Chairman Ben Bernanke and Treasury Secretary Henry Paulson are forced to admit that the subprime mortgage problem is not contained. In my previous professional life, I worked as a sales person for a software company. We sales people were often referred to as “feet on the street.” In addition to our sales responsibilities, we were responsible for gathering competitive information, surveying the landscape, detecting trends and most importantly feeding this data back to headquarters. Through formal as well as informal channels, the “feet on the street” ensured that the executives always had the most current field data. Since the executives were constantly speaking to Wall Street or in Industry forums, inaccurate data could be very costly in many ways.

Obviously there is no such thing as “feet in the street” in the Government. If it were so, Paulson never would have made the following statement:

Damage to the American economy from the housing market downturn and subprime mortgage foreclosures appears to be contained…

Five days after his remarks, Buffalo, N.Y. based regional bank M&T Bank Corp (MTB) released a statement annoucing that it is having trouble selling some of its loans. Prices dropped more than anticipated in its recent auction of some of its Alt-A loans – loans that fall between subprime and prime.

Headlines on that same day were:

U.S. mortgage woes could hit regional banks (Reuters)

Mortgage Woes Spread Up Credit Ladder (Associated Press)

That doesn’t sound like a problem that is contained. Maybe Paulson’s people should be put on the street. Bernanke’s cadre of PhDs is no better. One would think that a PhD would be an expert in simple deductive reasoning like if A =B and B = C then A = C.

A - Tighter lending standards due to the subprime fiasco translates into a significant reduction in marginal buyers.

B - This leads to a reduction in demand for housing.

C - Imagine if no one showed up for your open house week after week. Common sense suggests to lower price to stimulate interest. Lowering your price affects all homes in surrounding area whether for sale or not.

In other words, the subprime fiasco adds to the existing inventory glut in housing and adversely affects all housing prices. A simple Google search would highlight the importance of housing prices to the economy. The following commentary from Comstock Partners helps connect the dots:

In addition it has been well demonstrated that mortgage equity withdrawals [MEW] have been a cash cow providing home owners with hundreds of billions of dollars that have gone into consumer spending. On an annualized basis MEW soared from about $100 billion in 2000 to $780 billion at the peak in the 3rd quarter of 2005. From that point it has already dropped by about 55% to $350 billion in the 3rd quarter of this year. Estimates as to how much of this went into consumer spending vary between 40 and 60%. This so-called “wealth effect” has been an extremely important prop to consumer spending as real consumption growth has far outpaced real income growth in recent years. With MEW no longer providing households with a substantial amount of extra cash and jobs not rising as fast, consumer spending growth is likely to slow significantly.

The housing “wealth effect” has driven tremendous lifestyle changes. Companies that catered to these changes profited handsomely. Harley Davidson (HOG) was one of the benefactors. Its stock price outperformed the S&P 500 by 130% from 2000-2006.

Doug Kass stated in an 3/28/07 article:

“Even motorcycle (loans) are hitting potholes! Indeed, it appears growing credit losses and delinquencies are beginning to render Harley-Davidson’s motorcycle loans, well, increasingly like hogs.

Thirty-day delinquencies (and loss trends) in Harley-Davidson’s receivables book offer a clear picture that credit-quality issues are broadening as HOG’s receivables experience has begun to trace a pattern of deterioration that we first began to see in subprime mortgage loans during the first half of 2006.”

Vanishing “wealth effect”; Alt-A loan issues; I haven’t bothered mentioning the massive layoffs by the bankrupt and the scaled-down mortgage companies. Maybe Paulson and Bernanke are using an abstract technical definition of “contained.”

Disclosure: None