Winners and losers in housing market collapse, by gimleteye

In a quarterly conference call yesterday reported by The New York Times, JP Morgan CEO Jamie Dimon referred to the current business climate as “a relatively benign point in the credit cycle.”

The market judged the company differently, sending share prices 3 percent lower by the end of the trading day.

Market jitters and JP Morgan’s comments are relative to the subprime mortgage meltdown.

In recent weeks, Wall Street's biggest players have all stuck to the same pitch: that the subprime mortgage mess is “contained”.

It is about as contained as inflation. You remember inflation? That's the index that omits food and energy prices because American consumers don't drive cars or eat.

Who would omit the price of food or energy from a core index? Clearly, someone or ones who want Americans to believe the cost of living is nothing compared to the benefits of democracy.

That's how the meaningful is turned to meaning-less.

Along the same lines, today Federal Reserve Chair Ben Bernanke told Congress in his mid-year economic report that he thought "the demand for housing would stabilize "soon".

Understand, though, that the charade that passes for current thinking on the economy in Senate or House subcommittee hearings is stage-managed by well-educated and well-compensated types who know perfectly well how poorly the broad stock market indexes have performed in relation to inflation.

And they read the papers and the blogs: consumer confidence is down, homebuilders confidence is plummeting, and public corporations, like Pulte Homes in yesterday's announcement, are hemorraging value.

Behind closed doors, including the doors of the Federal Reserve, one must infer that the dialogue is of a substantially different character. These knife-blade conversations do not show up in print.

Still, it is no secret: billions of dollars in Wall Street bonuses, over the past decade, and expectations for future wealth are tied to the creation of debt tied to mortgages, both commercial and residential. For every $1200/square foot apartment sold in Manhattan, there is at least one optimistic Wall Street banker in waiting.

That debt goes by as many different names as there are flowers in a garden. It is known, ubiquitously, as financial derivatives.

Leaving Manhattan aside, until housing markets in the nation's fast growing regions started to collapse, under the weight of the same liar loans, mortgage fraud, and adjustable rate, interest only mortgages (better known as toxic financial waste), holders of financial derivatives really didn’t have to worry much about informing their own investors about the value of the debt.

As long as real estate prices were rising, no one asked.

No one asked in Congress, which allowed government sponsored entities like Fannie Mae and Freddie Mac to engage in massive fiscal irregularities. No one asked in pension fund management, which assumed that the blue chip folks at places like JP Morgan would hold their interests at the highest level of fiduciary responsibility.

But now that dozens of subprime mortgage lenders have shut their doors and left paperwork in shambles in hastily closed offices, now that Bear Stearns’ funds have gone belly-up like crappie in a red tide, suddenly the rating agencies responsible for providing accurate values for financial derivatives as well as other credit have started to do what they should have done in the first place.

“Moody’s Investors Service says it is paying a high price for its tough stance on lax lending standards for commercial mortgage-backed securities”, reported the Wall Street Journal yesterday.

“On a recent CMBS (commercial mortgage back security) offering issued by Morgan Stanley, which included 225 fixed-rate loands on 268 multifamily, commercial, and manufactured housing community properties” Moody’s rivals got the ratings business.

“We used to rate 75% of the deals, but since our announcement (tightening credit quality standards for CMBS pools), we were not asked to rate 75% of them,” says Tad Philipp, a managing director for Moody’s. ‘Our market share has done a complete flip.’”

From one point of view, Moody’s is costing the big banks money, in rating the issuance of debt (and bonuses, of course) and so big banks are penalizing Moody’s.

The sharper point of view is that the big banks are suppressing facts about the vast excesses they have created in financial derivatives and the additions they make to the net worth of the nation's top financial executives.

And so, when one reads in the NY Times, JP Morgan CFO Michael J. Cavanaugh saying that “the bank’s decision to increase its credit loss provisions did not reflect a spillover of subprime lending problems into prime lending”, it is natural that the world financial markets begin to wonder, what the hell is going on?

In another Wall Street Journal article yesterday, concerning uncertainty in credit markets—not just subprime—Charles Gradante, co-founder of hedge-fund consultant Hennessee Group, said, “Right now things are starting to become unglued.”

What exactly does that mean?

For one, the ABX index which tracks the price of insuring losses in subprime bonds has fallen precipitously. According to the Journal, “the portion of the triple-A subprime debt issued last year has fallen about 5% in the past week. The portion of the index which tracks low-rated triple-B bonds is down more than 50% this year.”

Beyond falling indexes, beyond the matter of hedge funds, like the two disappeared from Bear Stearns’, is the question: how many dollars and how many hedge funds have to re-price their assets to reality?

That’s the essence of what Joshua Rosen, a managing director of Graham & Fisher, an investment firm, told the New York Times in a related story, “Bear Stearns says battered hedge funds are worth little.” Asks Rosen, “...’do the prime brokers and others who have extended lines of credit to the hedge funds really have a good handle’ on how those borrowings have been invested?”

The answer is, no.

The response of banking regulators is “to increase scrutiny”. (AP, July 17) Now Federal Reserve Chairman Ben Bernanke is offering lawmakers "fresh assurances that regulators are taking steps to better protect would-be homeowners from abusive mortgage practices.”

And this crew is going to protect America from inflation?

Putting the right price to inflation is as much anathema to the Federal Reserve, to Congress and the White House, as re-pricing synthetic financial derivatives to banks and hedge funds they loan and invest, sometimes on opposite sides of the same financial instrument: both are as substantial as smoke from a crack pipe.

And yet, reality has a way of forcing the air from whatever pipe dreams materialized from “the ownership society”: one of the biggest speculative financial booms in US economic history, next to the dot.com bust it was meant to absorb, and did for a while.

It may be Jamie Dimon’s point of view that this is a “relatively benign point in the credit cycle.” Try telling that to an American who has lost his or her home, or, to one of the 176,000 Americans who got foreclosure notices in May.

According to California based RealtyTrac, it is “the highest figure they have ever recorded in their monthly report and is 90 percent higher than the numbers from a year ago.”