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Sectors that may benefit from the Foreclosure crisis.

|Includes:Ambac Financial (AMBC), FAZ, RDN

For those who have been following my blog, I've been focusing more on opportunities that may arise from this foreclosure mess.  

Obviously, the first in line would be something like FAZ, the 3x ultra-bear ETF on the financials.   It's quick.. it's dirty, and it's focuses on the TBTF banks and the top financial companies per the Russell 1000 financial index:

However, it also includes some particular mortgage insurers, such as MBIA (symbol:MBI).   So if you're buying FAZ, you're also shorting MBIA, which I don't think is particularly smart given the prospects for significant commutations and put-backs on the banks that originated these fraudulent (and I think we can say that is becoming more evidently clear) mortgages to non-credit worthy borrowers.

Over the past weeks there has been increasing speculative interest regarding the Monoline insurers, under the belief that violations of "representations and warranties" may negate a large amount of their liabilities.  Significant commutations, put-backs, and settlements, would free up contingency reserves to be applied to new business.

But here's a take that I've not seen presented..   The loss for TBTF banks might actually prove to be a benefit to the smaller regional banks who did not engage in the securitization of their originated mortgages.   John Mauldin's most recent article quotes David Kotok.  Kotok describes what most of us already now, but he cuts the heart of the matter by revealing how Title Insurers are increasingly refusing to write coverage:

“Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it—that would have been nice, to see a shining knight in armor, riding on a white horse.

“But that’s not how America works nowadays.  “No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.
“In every sale, a title insurance company insures that the title is free –and clear —that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because—of course— they didn’t want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.

Now.. we know that it's estimated that about 60% of all outstanding mortgages are registered via MERS.   And since MERS was set up to handle securitization of mortgage notes, where the chain of title has likely become suspect, if not irreparably broken, we have to look at who holds the other 40%.   Presumably these note holders are the regional banks, most of whom did not engage in securitizing their notes, but held them on their balance sheets.

Thus, if we're facing the prospect where 60% of all mortgages are now unavailable to receive title insurance (for the time being), the available 40% of notes should  become more valuable.   Furthermore, if foreclosures are being held up because of this breaking of the chain of title, it will reduce the supply of available properties to be sold.   The only people who could manage to actually sell their houses are those holding clear title, or able to obtain title insurance.   And it's the regional banks and S&Ls that hold most of these mortgages (and titles).

So can we theoretically postulate that if 60% of American homes are not for sale, due to lack of title insurance, the other 40% may actually appreciate in value?  

Might this backlash against the TBTF banks might actually enhance the credibility of the smaller regionals?

The only problem with this is that the major regional banks are also part of the Russell 1000.   Thus, if you buy FAZ, you're shorting against the regionals.   But if true, a move from the TBTF banks to the smaller regionals may provide some egalitarian balance to the Russell 1000.

For that reason, I'm not sure I want to buy FAZ, or at least hold it very long.   But there are many folks who will look at the FAZ as the easiest proxy for shorting the TBTF banks, so the regionals, and some of the bigger monolines may become collateral damage.

For that reason, I have a speculative position in Ambac (Symbol:ABK).   It's been beaten to death..  And most importantly It not part of the Russell 1000, so it avoids any downward pressure from financial shorts.   I also hold a smaller position in Radian (Symbol: RDN), which is also not in the Russell 1000.

I like MBI, especially since Bruce Berkowitz filed that he owned 11% of the stock.   But that was back in July, so he may actually be distributed into the recent surge.

But ABK?   A VERY high risk, high reward, speculative play..   And if this week plays out like the short squeeze back in April, ABK could see appreciation of 200-400% over the very short term. 

Disclosure: Long ABK, RDN