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Blood From a Stone

Back in 2002-2007, terms like prime, subprime, Alt-A, option ARMs, jumbo prime and second liens became part of the mainstream verbiage as middle class citizens started flipping houses like degenerate gamblers. 2008 was not a pretty picture for the hot real estate money and speculators started singing a different tune as the entire financial system teetered on the edge of the abyss. More Mortgage Meltdown by Whitney Tilson and Glenn Tongue explains the build-up, implosion and future scenarios of the domestic housing situation along with the ramifications on the economy as a whole. The book is divided into two parts, the first half covering the housing bubble and the second half a series of case studies on different companies and how to evaluate them for investing purposes through the eyes of a value investor.

Tilson and Tongue demonstrate that although subprime loans were the brunt of much populist anger after the housing bubble burst, they only accounted for 20% of all mortgages issued at the peak of the bubble, and it is the other 80% of mortgages we really have to worry about now. The height of the real estate frenzy was in 2006 and since subprime loans reset after 2 years, they were the catalyst for the collapse in 2008. However, the equally toxic Alt-A and option ARMs reset after five years so in 2010, we will begin to feel the effects of another round of defaulting mortgages and these defaults will continue until 2012. In essence, we are in the eye of the hurricane right now, the calm before the storm.

More Mortgage Meltdown was published in May of 2009, three months after the market lows reached in March and although the authors didn't predict the current surge in security prices, they do acknowledge that stock prices are cheap at the time of publication: "Based on data from Yale economist Robert Shiller, U.S. stocks on March 3, 2009, were trading at a cyclical price-earnings (P/E) ratio of 12.3, their lowest level since 1986 and well below their historical average dating back to 1870, of 16.3. (The cyclical P/E compares stock prices to average earnings over the past ten years in an attempt to smooth out booms and busts.)". Well, that was in May and now it's December and Barron's reports that the P/E for the S&P 500 is 85 after a 9 month run up. We are in nose bleed territory where valuations are concerned and this market is ready to roll over like Beethoven. In fact, at the time of printing Tilson and Tongue argue that "the cyclical P/E ratio, while below its historical average, is well above previous bear market lows of 6 - meaning stocks could almost get cut in half again.".

I have been reading Whitney Tilson's column he writes with John Heins in Kiplinger's for a couple of years now and have always enjoyed his long-term value investing perspective in a market where traders live in the moment. I also enjoyed it in this book, but all in all, I was disappointed in More Mortgage Meltdown. Granted, the first half of the book was brimming with valuable statistics and insights on the housing crisis, but the second half of the book wasn't up to par. The last 150 pages of the book is filled with case studies on individual stocks to both the long and the short side and I thought that these studies were too technical for the beginning investor. For the experienced investor, the case studies were not that interesting and tended to get tedious which bogged down a potentially good book.