Will Subprime Fallout Lead to a Depression?

Roger Nusbaum submits: One of my favorite SNL bits of all time was a game show parody called What's The Best Way with Adam Sandler, Glenn Close and Phil Hartman. It was about driving directions in Boston, with the accents in full-on mode.

I had the You Cahn't Get There From Here thought (think thick Yankee accent) as a I read a very gloomy post from Bill Cara that a reader pointed out to me.

Bill sees a depression coming to the U.S. Based on how I read the post, he lays a lot of the cause at the feet of the subprime market. He has a zillion charts and tables to help make the case.

I tend to view this sort of thing in terms of probability. Any outcome could be possible I suppose, but what is the realistic probability of any particular outcome?

One thing I don't think I saw in Bill's post was how many people are impacted by all of the loans made that are part of the problem. What I mean is (making numbers up here to make a point) if 50% of every loan written last year was subprime, and half of those sub prime loans default, how many people are impacted? If 1000 loans were made, and 250 of them default, who cares? Obviously more than 1000 loans were written, but does this issue effect even 1% of homeowners? I really don't know, but the number of people facing default is either significant or it is not, and per the post by Bill we don't know the number.

Bill is worried about rates going up, causing adjustable mortgages to reset, causing people to lose their homes. Again how many families does this effect? Are there 3 million of these loans out there (1% of the U.S. population)? How many of those 3 million (or whatever the real figure is) are impacted? One chart shows that in 3Q 2006, 4.8% of subprime mortgages are 90 days or more delinquent.

Five percent of 3 million (again a number I made up) is 150,000. Is this enough for a depression?

He could be right, but I don't agree with him. His discussion is not complete with out knowing how many people are impacted. He cited that 20% of 2006 originations were subprime, but again how many people is that?

To me, the bigger threat is subprime as one small-ish piece of global liquidity constraint.

I am not saying that real estate and lending are not facing some problems, but I do question that a depression has as high a probability as Bill gives it.

Comments

[irondoor91]

Re: the posts on Bill Cara's site:

Does anyone out there remember Howard Ruff, the author of Ruff Times? Howard made a major killing offering seminars, books and products for survival in the "inflation-depres... of the 70's. He also sold dried food and advised people to move to the countryside and be prepared to defend themselves from the folks who would be leaving the big city housing projects when the depression hit. Better get those 1,000 gallon tanks of fuel in the ground. Shotguns, generators, etc.

Get a life, folks. If Bill really belived in his own cool-aid, he would be giving specific investment advice on what stocks to short. But no, all he can do is tell you why no matter what you do, nothing is going to save your precious retirement other than to buy physical gold. Try taking your gold down to the local grocery store and convert it into food. How about buying some gasoline? Paying your insurance premium? But, why think about that when you're going to be up in the mountains living in a cave anyway. No need for insurance up there.

You know who is going to make out in the sub-prime crisis? Mortgage brokers who will re-finance the same people who took out these loans in the first place. Look for the good old Federal Reserve to come to the rescue.

[Josh Stern]

I'm in the Twin Cities MN area and I recently heard that permits for new construction were running 44% below last year (when the overall housing market here was already slumping). For me, the economic story is about how far we have yet to go in the unwinding of the whole residential home market including, but not limited to, construction, materials, mortgage financing, home furnishings, real estate sales, etc., etc. Making it harder for whoever was getting those sub-prime loans to buy more houses is probably a bigger impact on the economy than those defaults.

[randythurman]

sub-prime is only a part of the problem. the basic problem itself is the huge credit/debt bubble. fast and easy money for everybody. from the guy that bought the house he new he could'nt afford to the big investment banks funding,buying and insuring this debt(mbs/cds). that big pile of money laying on the table is mighty tempting, especially when you don't have to put anything down to cover. better yet, when you're using other peoples money. you would think common sense would come into play here but i guess thats one commodity we really are short of. i think the chances of a depression are pretty slim, but a good old ass-kicking 20% correction is almost a sure thing. jmo cbw hbb.

[lee smith]

Bill Cara is a gold bug and professional alarmist who spends much of his blog time backpedaling. The real estate and loan bust is a reversion to mean phenomenon and nothing more.

[AndrewHorowitz]

Wow! The subprime market is going to cause an outright depression, That is like saying that an ingrown toenail is going to cause a shutdown of the entire coronary system. While there may be an infection that is spawned, that can be treated and before it gets life threatening, you (or your doctors) will take preventative action unless you are a total idiot. That brings us right to the point of who we are looking to, to help us avert a major catastrophe caused by mindless runs on the banks in an effort to ensure that money, well... safe.

The unfortunate fact that most seem to forget is that unlike decades ago, the banks are a part of the entire financial market, not the entire market. More funds have been distributed into brokerages, hedge funds, mutuals, annuities and other non bank instruments. The fact that a few greedy lenders have done a poor job at qualifying their clients and that there has been a significant housing bubble brewing does cause a bit of concern.

If the subprime lenders go out, remember there still is a healthy cash flow that will be returned as people are forced to pay something for the place that they live in. I mean, really, does anyone actually think that all of the people who borrowed money are going to stop paying, chance eviction? If so, the properties are the collateral and even in a fire sale situation, they can be sold. So think about the worst case:

All loans are in default, cash flow has stopped, eviction precedings are implemented... First there will be a government intervention, then if it gets to it, some other smart company in the business (Bank fo America, Citi?) will scoop up the discounted assets and possibly ingest the subprime companies (LEND) and the prices that we see on these stocks today after the free fall will be laughable.

Someone has to get sense knocked into them. This is getting ridiculous. The worst fears have now been factored in. Okay, they have been punished, let's not go voerboard with hysterics.

Andrew Horowitz, CFP
www.thedisciplinedinve...

[RogerNusbaum]

great comments everyone, thank you

[Malkiel]

Whenever I think of Bill and the gold bugs I think of Robert Lichello's description of his experiences in occupied Japan, where nobody would buy gold because essentials were in such short supply--soap, cigarettes, alcohol and chocolate were the currencies that worked in that economy. I imagine guys in the Catskills trying to sell warehouses of gold for a truckload of cigarettes when the big flood comes, and not finding any takers...

The open structure of the world economy today should head off any true "depression"... but the extent to which American workers have come to rely on unlimited credit (the average household has negative savings) could still cause a recession if the credit dries up. This mortgage problem is tied to that given how much borrowing against equity to service credit card debt has been going on. I'm surprised the ball has been in the air even this long...

[lee smith]

"This mortgage problem is tied to that given how much borrowing against equity to service credit card debt has been going on"

What equity? The people who take on these fancy interest only and no down payment mortgage loans have no equity in their houses.