Winners and Losers from the Mortgage Mess

Includes: AXP, COF, DFS
by: Frank Rong

It's very hard to find winners from the mortgage mess that we are currently in. Losers are well known - they are:

1. Mortgage lenders, e.g. Indymac (IMB), Countrywide (CFC). Majority of them are gone.

2. Homebuilders, who started to go under.

3. Regional banks who made a large quantity of loans to homebuilders and land developers. They cut their losses and exited the business.

4. Investment banks who specialized in securitization of mortgages, e.g. Bear Stearns (NYSE:BSC), Merrill Lynch (MER) and Citigroup (NYSE:C). They need constant life support in the form of equity infusion or buyouts.

5. Mortgage insurers: Ambac (ABK), Radian (NYSE:RDN) and MBIA (NYSE:MBI) etc. Business model broken, many of them teetering on gone.

6. Many industries that have direct exposure to the housing industry, from Home Depot (NYSE:HD) and Lowes (NYSE:LOW) to furniture sellers, etc.

The winners are hard to find at this moment. Who do I think will likely emerge as a winner? I think it will be the credit card issuers. Let me explain.

Card issuers were the losers during the housing bubble. As home prices skyrocketed from 2002-2006, it reduced the need of borrowing from credit cards. Many homeowners tapped their home equity line of credit to pay off credit card balances. Card issuers had to choose either maintaining their credit standards and risk their managed loans dropping year on year (MBNA and Discover (NYSE:DFS)), or easing up lending standards to grow their loan portfolios, (AmEx (NYSE:AXP), and Capital One (NYSE:COF)). The result was not much fun, as overall industry loans barely grew from 2001 to 2006, with the growth rate was below nominal rate of GDP. The primary reason that MBNA had to sell itself in 2005 was the fact it saw its loan portfolio decreased year over year in both 2004 and 2005.

Simply put, during the bubble year card-issuers faced new forms of competition called home equity lines of credit. They lost some of their best customers to home equity. Now the housing bubble has started to unwind and getting a home equity loan will be increasingly more difficult and expensive, and sometimes downright impossible. As mortgage lenders disappear, competitive pressures are easing; therefore card issuers can charge higher rates and fees. Less competition is good thing in this case.

The bursting of the housing bubble should not be construed to be entirely negative - it has plenty of positives that the media does not even bother to report:

1. Property taxes and insurance are lowered since property value drops, thus more discretionary spending power.

2. New home buyers don't have to pay exorbitant prices, thus lower monthly mortgage payments and more consumer spending on other things.

3. American consumers are still in good shape. Many of those people who bought homes at the peak never put down any money. They did not lose that much either.

Despite all the drawbacks, free market capitalism works. Recession is healthy and essential. It cleans up the system, takes out the cyclical white elephants. The bursting of the housing bubble will make homes much more affordable. That's a very positive thing. During the 80's, oil prices crashed, 9 out of top 10 banks in Texas either went under or got bought. The U.S. economy survived and thrived afterwards. The money American consumers saved from oil was spent on other things.

It's not much different this time, home prices will continue drop; therefore, American consumers will spend much less money on housing than they did during the bubble years. The money they saved from lower housing will get spent on something else. The beauty of American capitalism is that the Free Market has this self-correct mechanism.

If you are still not convinced, just answer this question: are lower energy prices good or bad for the American economy? If your answer is yes, then the next question will have to be yes too: Are lower costs associated with owning a home a good or bad thing?

Sure some banks and some people might get hurt because of some price drops, but lowering the cost of things (including homes) will eventually be a very positive thing for American consumers and the overall economy.

Disclosure: I am long DFS and the U.S. market in general.