After bubbling beneath the surface since last February, the absolute rot that is sub-prime lending reared its ugly head again last week. But this time it wasn’t just the stories of failing lenders like New Century and others that roiled the markets, it was much further up the ladder. The contagion is spreading after all.
A margin call by Merrill Lynch on mortgage-related collateral owned by Bear Stearns called CDOs (collateral debt obligations) and the attempted fire sale that followed partially revealed one of the Street’s darkest secrets–the true worth of these sub-prime-laden securities.
Unfortunately for the Street, the secret that these forced sales managed to reveal was that the overall worth of these securities is considerably less than what it were made out to be when they were booked as assets using only the pricing models that valued them.
The theoretical values generated by those pricing models, in other words, had met the marketplace and come up short. Their uncovered "true" value, as it turns out, was less than the models said it was. Go figure.
That only set off further fears that the rest of these illiquid securities would also be "marked to market" in the future, a prospect that could only set off more margin calls and financial crises within the banking sector in the months to come.
Merrill’s attempt to unload these securities, after all, drew only a tepid response to say the least, proving that the demand for these securities is thin and severely limited in price.
The highest rated of these CDO tranches, those rated A or better, only drew a few bids of 85 cents on the dollar, while the lowest rated tranches, the so called "toxic waste," drew no bids at all, causing Merrill to abruptly end its fire sale.
Adding more fuel to the fire was that JP Morgan also decided that it would try to dump some of Bear Stearns’s assets, in an attempt to front-run Merrill.
A further disaster was only averted when Bear Stearns decided to put up 1.6 billion dollars of its own to bail out the two failing hedge funds that were responsible for the mess. But the damage had already been done.
The problem now is that since all of these securities have presumably been sold at a big discount (Merrill hasn’t released the details of the sale yet), the losses that they incurred will eventually be passed along to all of the rest. The others will be "market to market," too, devaluing their worth as assets.
That can only mean one thing: more margin calls.
How this all ends, of course, is anybody’s guess. The big boys may indeed be able to unwind these positions in an orderly manner. Or they may not. We shall see.
Either way, the end of the crisis last week really did nothing more than add a few shovels of dirt to the problem. It takes a lot more than that to bury an elephant.
Meanwhile, last week’s housing data continued to disappoint. Spring has come and gone and with it all of those bullish hopes of finding a bottom.
Here’s what we learned last week:
Demand continues to fall: New house sales dropped in May to a seasonally adjusted annual rate of 915,000, from 930,000 in April. Compared to the same period last year, sales volume fell by almost 16%.
Existing house sales, for their part, also plummeted to a rate of 5.99 million, the lowest level since June 2003. That was down more than 10% from the same month in 2006.
It is worth noting that it was last year’s dismal spring selling season that really started it all and this year was by all accounts considerably worse.
Supply continues to grow: On the other side of the equation, the latest figures show that the number of homes on the market continues to swell.
The number of new houses for sale did dip slightly, to 536,000, but is was to no avail. The monthly supply of houses grew instead to 7.1 months. That was up from a seven-month supply in April and a dramatic increase over last year, when the supply stood only at 6.2 months by the end of spring.
For existing house sales, the news was even worse. The supply of existing houses for sale surged more than 23% from a year ago. According to the data, there are now 4.431 million single-family houses, condos, and co-ops on the market. That’s the most in U.S. history!
That makes for an 8.9-month supply of used houses at the current sales pace, up from 8.4 in April and the worst reading since June 1992.
Prices also fell: According to the data, the median price of a new house fell 0.9% from a year ago to $236,100, while the median price of an existing house dropped 2.1% to $223,700.
A separate index compiled by S&P/Case-Shiller showed price declines in 14 out of 20 major metropolitan areas, with the biggest declines in Detroit (-9.35%), San Diego (-6.7%), and Washington D.C. (-5.7%). House prices, by the way, have fallen now for ten straight months.
Taken together, this means the hoped-for rebound in housing is that much further away.
That’s the tough reality that Wall Street and Main Street are both going to have to deal with now and in the future.
By the Way. . . . On February 2, 2007, I informed my readers about the dangers of investing in beaten-down building stocks in a press release entitled "Buyer Beware: Homebuilding Stocks on the Brink."
It was released at a time when Jim Cramer was still falling all over himself trying to pump these same stocks up. Boy, was he wrong.
Since then the major homebuilding stocks have plunged an average of 38%.
Hovnanian (HOV) fell from $35.17 to $15.63 a loss of 55%.
Lennar (LEN) fell from $54.82 to $35.21 a loss of 36%.
Centex (CTX)-fell from $ $53.67 to $40.05 a loss of 25%.
Pulte (PHM) fell from $33.82 to $22.37 a los of 34%.
DR Horton (DHI) fell from $29.70 to $19.73 a loss of 34%.
Beazer Homes (BZH) fell from $43.42 to $23.44 a loss of 46%.
Citigroup, by the way, cut Hovnanian on Monday from a buy to a hold. Great timing fellas.
The bottom in housing is nowhere in sight.
Wishing you happiness, health, and wealth,
Steve Christ, Editor