March 14, 2007

Panic in the markets!

So the Dow fell more than 240 points today. However, the world did not come to an end. The economy, while not good, is still decent as is the job market. Granted, nothing is a strong as it could be, but it's not the end of the world.

Everyone is nervous about the mortgage industry, specifically the sub-prime sector. Some of the companies are going to go bankrupt, adding to the ones who have already filed. It's the kind of the thing that happens every 8-9 years and it's completely healthy as it shakes out the weaker lenders who underreserve for losses and have ridiculously lax underwriting guidelines. They were the ones who made life difficult even for those of us in the A paper market. Fuck New Century. I'm glad the bitches are gone.

This brings up a great point on liquidity. Countrywide's CEO says the overall industry is entering a kind of liquidity crisis. While I think there are some issues, I don't think it can be classed as a crises. What the investment banks are doing is squeezing the folks with the weakest balance sheets. By forcing them to buy back bad loans while at the same time freezing their access to new capital, they are effectively shutting them down. This will work with a company like New Century, but it more than likely won't with someone like Novastar (on the smaller end of the business) or GMAC (on the larger end).

Sellers are in charge of the market right now and are creating, as they always do, terrific buying opportunities. The bottom line, especially in the mortgage business, is that the players who aren't forced under are the ones who will end up being hugely profitable as time goes on. Bottom line is that the reaction in the market (selling everything they can) is way overdone. As a great friend said to me almost a decade ago, "Be greedy when others are fearful; Be fearful when others are greedy."

Will the slowdown in housing and the collapse of many lenders cause a recession? Sure. That was already cooked into the market. The bigger problem is how much leeway the Fed has to drop rates. At this point, we need some real fiscal responsibility in Washington. Otherwise, what happens today to sub-prime lenders may be what happens tomorrow to the Federal government.

One last note, for those looking for how far things may go, keep in mind there is TWO TRILLION DOLLARS sitting on the side lines, accessible by hedge funds.

Eight of the top 10 LBOs in history have been inked since June; in 2006 alone some $420 billion in leveraged buyouts took place, a record. And yet private equity firms still wield as much as $2 trillion in combined buying power, enough to take out fully a 10th of the entire U.S. stock market.

The fuel for all the buying—low long-term interest rates—remains in the tank. In fact rates have been falling in the past few weeks and fell even more Tuesday, making the debt, or leverage, that private equity firms wield even cheaper. "The difference between cost of capital and return on equity is so enormous that if you're a leveraged player you just have to buy," says market watcher Jason D. Trennert of Strategas Research Partners. He goes so far as to suggest that the Standard & Poor's 500-stock index itself, if it could be packaged into a single entity, would be a screaming LBO candidate. Hence what veteran market strategist Edward E. Yardeni has taken to calling the "private equity put"—for put option, a floor price under a security. In this case it's under the whole market.

If you have stocks, hold 'em. If you have cash, buy. Then don't look at things for at least six months.

Posted by mcblogger at March 14, 2007 12:25 AM

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