Sam Sez

Date: Friday, June 18, 2010

Question: "Is Subprime: The New Normal?"

Answer: Apparently yes.

The trend accelerated circa 2005. Mortgages, credit cards, car loans and other extensions of credit ramped up for those less and even in cases least likely to pay. While much has been written about housing and a main assumption in many models was flat to rising prices to offset and delinquencies or defaults a more troubling factor was the change in bankruptcy law. It effectively enabled lenders to pursue impaired borrowers despite filing for bankruptcy. It essentially legalized predatory lending into everyday practices and business procedures. One simple validation of this point is the surge in pre-enactment filings. Savvy lawyers and understanding bankrupts knew it would be better to file before than after. Since then the data bear it out.

Over the past few years there has been a risk transfer from private financial institutions to the taxpayer and the balance sheet of the Federal Reserve. Types of paper that have been purchased with “priced to maturity” as a guiding criterion have been mortgage backed securities as well as other “asset” backed securities.

Rhetoric about subprime mortgages, containment, $50 to 100 billion etcetera has proven to be hollow much like the impaired assets/loans/securities. Unless the Fed or one of its proxies continues to purchase overvalued paper the securitization market is paralyzed. It is not a matter of behavioral economics, smiley faces, public perceptions, managing expectations and the like. In this matter it centers on the big players, the major financial institutions and they are not playing or participating in any meaningful way because they know what is floating around not only on their books but on the books of others. Despite the opacity, this can be perceived by evaluating true bank-to-bank lending, CDS pricings, and the relative values between Fed member borrowing rates versus Treasury borrowing rates. The approach can be applied to various treasuries and central banks as well. An interesting question is who can borrow cheaper? Would it be favored Fed members or the Treasury, starting with short-terms and then going on a “rolling basis”? Of course, the typical consumer or prudent saver is on the bottom of this situation. The general population does not benefit from ZIRP especially in all their borrowing needs and requirements. Coincidentally, there has been an increase in the conversion of fixed rate to floating or variable rate credit cards with large spreads to benchmarks. Given the present ZIRP environment it may not look very bad for favored customers and their rates but a bump up in rates will damage account serviceability.

Finally, the economy is becoming more subprime than not and in ways that go way beyond the early forms of subprime mortgages and payday loans. Solutions for these multiple problems must come from sound and thoughtful people. The total number of employed people has declined over the past several years. Moreover, the situation is masked by blending part-time with full-time jobs. To pay an increasing debt load you need more free cash, more free income. Part-time work does not cut it for full-time debt.







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