Two things that are being missed in this discussion (at least I missed them) are that the reason New Century and others like them are having problems is largely because they cannot find investors. These outfits prepackage and lend out money that has been provided for them to loan. When Citigroup, and other similar investors withdraw the funds, the sub-prime is basically out of business. It could be just a case of good management on the part of the investor no longer willing to invest. However, the housing stock, at some value, still backs up that investment.
Steve, what you are missing is that the pledge to pay back a loan with interest and fees is essentially no good for subprime loans. Also, the asset that backs the pledge has a value that is not known. It is, after all, a changing real estate market from when the subprime loan was made and values are either flat or falling in more than half of the markets since that time.
Lenders and their source of funds (investment bankers and investors) are in the business of loaning out money with the expectation of being paid back. They are not in the collection business on dead beat borrowers nor are they wanting to make money available to mortgage entities that would loan to them.
For the remaining lenders willing to deal in the subprime lending, they are refusing to make 100% LTV loans and they have tighten their underwriting standards, which eliminates a large segment of past borrowers.
The second thing that seems to be missed here is the power of derivatives... both to increase profits and risk. What you wanna bet that someone in the derivatives market takes a real bath before its over (if they haven't already).
Where have you been Steve? Go look at the ABX trading. Look at the articles on CDOs (collateralized debt obligation) and hedge funds. I posted an article of how the accounting works on CDOs; they are not marked to market, their current value has to be reported on a rating agency's downgrade of that particular CDO bond issuance. Moodys, Fitch, S&P, all have something to loose if and when they downgrade those CDO bonds. What is that? They rated them when they were issued. Might that have a negative consequence to their business?
When the CDO bond rating falls below BBB- (investment grade), pension funds, hedge funds, insurance companies, any public institution has to sell them because by law they cannot invest in anything that is rated below investment grade. That will cause a disruption in the liquidity of that market. Prices will free fall like New Century stock for the same reason; mutual funds and hedge funds are dumping their holdings.
I heard an article this morning where short term potential problems for the economy were rated. Terrorism was #1. Too much individual debt was #2. Housing, specifically, was not on the list... but, it is a component of #2. It's not just a housing bubble problem, the problem is that Americans have borrowed too much money.
Debt is only a problem when it is not paid on time or not paid at all.
What you should be worried about Steve, is that the losses in the subprime debt market will not be contained. Those losses may spread to other markets. The key is the housing market and its ability to absorb the shock. Credit for housing has been reduced. That certainly will affect demand for housing. The cash out refinance that was adding to the consumer spending is reduced. You need a rising house price market to sustain that free equity gain to borrow against and to make good the bad loans on them.
As the housing market spirals down in both volume and price, it will cause more losses to the economy as a whole and those losses will spread into other markets, other countries. Asset diversification is loosing its uncorrelated classes.
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