Wednesday, August 1, 2007

The Weight of the Subprime Mess Is Huge

While I have been fairy neutral to slightly optimistic about the current market situation, I am formally admitting I am now bearish. Simply put, the weight of the hedge fund problem is too large for this market to overcome right now. By my count, we have seen 10 funds hit the skids: three at Bear Stearns, Sowood Capital, three funds in Australia and three in France. According to this site the total is now 18. I wasn't aware of the other 8, so I can't comment on the veracity of that sites claims. When these problems originally started hitting the news wires, I though we would see 3-5 funds die. We're already at twice that number in a month's time.

The news is coming at a faster pace right now. Two news organizations -- the Street.com and CBS.Marketwatch -- have commented on the rumors about funds that are flying on the street. My guess is there are some bid lists going around that have got some people concerned which is what is leading to the rumors.

Add to this mess the fact that banks can't sell loans right now. M&A has been a primary reason for this rally. For the last 3-4 months, we've seen entire sectors rally on the news of one takeover as traders bet on the next target. Banks ability to sell these loans made to finance these deals is now gone -- or at minimum severely limited. Lenders are asking for stricter loans terms which borrowers are balking at. All of this means the market for M&A is effectively gone for now.

And then there are the huge problems in the mortgage market right now. American Home Century's announcement that it was for all practical purposes insolvent should spook everybody. As the Kingsland Report noted:

So we go from the west coast blow ups of subprime names like New Century to a big fish on the east coast which specialize in near prime (Alt-A) and prime lending. AHM was not a fly by night company, it was a top-10 mortgage company with a Q1 book value of over $20 bln. It is based in Melville, NY (Long Island) where a variety of money center banks have back office operations. It had over 7,000 employees, nearly 1,500 in Melville.


According to the Implode-o-meter, we've seen 105 mortgage companies/lenders etc... close their doors, or experience a seriously big financial problem. That indicates how broad the far reaching the problem is.

In short -- this news indicates there are problems happening right up there in the food chain.

The point of all this is it looks as though we are moving closer and closer to the edge of the cliff.

Right now the only way to reverse this situation is for the negative news to stop for an extended period of time. Off the top of my head, I would guess at least a month, but a few weeks at bare minimum. This would allow the markets to take a breather from the news and reassess the situation. But so long as this pace of news keeps coming, we've got serious problems. There is only so much stress a financial system can take. And my guess is we're pretty close to the limit for now.