Cramer's Meltdown Spills Into Print

There's a school of thought that Jim Cramer just plays a screaming nutcase on TV, that in reality he's actually quite smart and knows his onions.

On the other hand, he's also capable of using his column in New York magazine to write something like this:

This spring, as many homeowners stopped paying, the mortgage bonds—for the first time—starting losing value. Hundreds of billions in bonds that were thought to be worth more or less the price they were sold at, it turns out, are worthless.

Bonds are almost never worthless. Even in cases of enormous and outright fraud, like WorldCom, bonds aren't worthless. Cuba stopped paying its debt decades ago, and its bonds aren't worthless. And mortgage-backed bonds, of course, are backed by mortgages, which in turn are backed by houses. The minimum recovery value on a defaulted mortgage is about 50%.

And this isn't some kind of Cramer slip. He repeats himself later on, and even says that he's smarter than Bear Stearns' Warren Spector:

Spector, maybe one of the best minds in the bond business, genuinely believed that these mortgage-backed bonds still had substantial value. If someone as savvy as Spector thought these bonds were still good when they were actually worthless, that tells you that thousands of other managers are simply dreaming if they think their portfolios are worth anything near what they claim they’re worth.

The thing is, Spector was right when he saw a certain amount of value in mortgage-backed bonds. If Cramer really thinks that mortgage-backed bonds are worthless, he should be shorting them all like crazy right now. But I don't think he is. The AAA-rated tranche of the ABX subprime index has already started to rally in price – it's now back up to 92.5, from a low just below 90.

Now to be charitable to Cramer, it's possible for a mortgage-backed bond to be worthless even if the underlying mortgage still has value. The first-loss tranches in a waterfall structure can be wiped out entirely, leaving the value for the holders of the higher-rated bonds. Although it's worth noting that even the lowest, BBB- tranche of the ABX index is still trading in the high 30s: a long way yet from zero.

In any case, most of the losses at subprime-exposed hedge funds have not been due to holding low-rated tranches which might be wiped out; instead, they've been due to leveraged exposure to high-rated tranches which have merely dropped in value.

There are some very nasty things going on in the mortgage-backed market right now, so there's really no need for this kind of hyperbole. Cramer's meltdown has been something of a hit on YouTube, so maybe he's just trying to milk the last drops out of it. But he's wrong about housing, and he's wrong about the value of mortgage-backed bonds, as well.

Comments

[Woodrebel:]

Jim can't short, buy call or put options as part of his contract with CNBC. He can only own one stock personally, Thestreet.com.

Everything else is in his charitable trust and in that fund his hands are restricted. He can't buy anything he has talked about for 5 days and he has to hold everything in his portfolio for at least 30 days.

2007 Aug 15 10:09 AM

[Malkiel:]

Your headline was intriguing but you apparently had no point behind it, since your minute technical distinction is no more valid than Cramer's dismissive rhetoric. Various articles in other sources, particularly the WSJ, have pointed out recently that mortgage-backed securities are essentially illiquid, always have been, and lack a good model for valuation, making your point no more factual than his. It would have been more to your point to discuss Cramer's truly off-the-wall rhetoric about why people should be selling their houses and walking away from upside-down mortgages, which I would think should have caused more public consternation from industry people than they have and justified a comment prefaced by your headline...

2007 Aug 15 10:28 AM

[Eric Balkan:]

I recall seeing a news article some weeks ago about a mortgage broker in distress selling their loan portfolio for 6 cents on the dollar. As Malkiel points out above, these loans and their derivatives are illiquid. So even though they will likely be worth more someday, if you need the money now, today, to stay in business, and you can't find a buyer, the value might as well be zero.

The very first share of stock I bought, as a teenager, was the Pennsylvania Railroad. Great balance sheet -- they were one of the largest landowners in the U.S. But when they needed cash to keep running, they couldn't get it, and so went bust. Turned out there wasn't much of a market for plots of land 10 miles long and 15 ft wide.

2007 Aug 15 11:29 AM

[WHYME:]

Only one comment-> What a stock [or index] trades for is rarely an accurate indication of its' true value.. Let us revisit this subject in August of 2008!

2007 Aug 15 12:44 PM

[Malkiel:]

Eric, I always used to be able to get cash for the Pennsylvania RR in Monopoly... :)

2007 Aug 15 12:59 PM

[Dana Eisenberg:]

the reason many of the bonds are worthless is that many CDOs/MBSs are synthetic, the equity tranches have been squeezed to death.

2007 Aug 15 01:20 PM

[Allen Jones:]

No he's probably right if he is referring to the first loss tranches of the secutitzations. They absorb the losses from the foreclosures first before the A and higher rated tranches see any loss of principal or interest. I suppose as the trusts wind down as the losses are realized and or the mortgages pay off that they might have a recovery value based on the foreclosures but since many of the securitizations were based on foreclosure rates far lower than we are now seeing, many of them will become worthless. many smart folks are short these bonds through the ABX indices.

2007 Aug 16 12:32 AM

[plumber2:]

Billions $$$ still evaporated because of greed and stupidity of both bankers and Congress.

Go ahead please Hillary and Pelosi, continue to give nothing down mortgages to third generation welfare puppies, single mommies, and irresponsible kids and dead beat dads. Some one needs to tell these folks that is why banks used to require 20% down. To prevent people from just walking away.

And our schools need to educate students about responsibilities and priorities in life.

Pay attention now. 1) Pay your rent or mortgage first ( to protect your credit and keep a roof over your head). 2) Put food on the the table for you and your children. 3) put clothes on your family. 4) save 10% for a rainy day (lifes stoorms). 5) Then buy discretionary items last.

Note: Most of the people walking away from their mortgages have new cars, cell phones, big screen TV's
and a netflix account but they do not have the responsiblity to pay their rent or mortgage first.

As they say: If you think education is expensive, try the cost of stupid it will sink your ship faster.

What is wrong is to expect the American taxpayers to bail out the grrdy and stupid.

2007 Aug 16 09:40 AM

[Eric Balkan:]

Most sub-prime mortages are refinances of prior mortgages, many to people who needed the money to make credit card payments. The top 4 reasons for continual credit card debt are hospital bills, home repair, car repair, and job loss. See responsiblelending.org

The current problem has a lot to do with mortgage lending being based on the profit motive, a.k.a greed. The more loans the broker makes, regardless of quality, the more money he makes. The Fed used to regulate this -- which is why we didn't have this big a problem before -- but this is an anti-regulation era so the Fed doesn't do that any more.

ibrakefortrees.wordpre...

2007 Aug 18 07:34 PM