Tuesday, March 13, 2007

Sub-prime Submersion

As noted yesterday, dark clouds appeared over Wall Street in the form of defaulting sub-prime lenders, notably, New Century Financial (NEW), and sent the indices reeling on Tuesday.

New Century, which specialized in sub-prime mortgage loans, said on Monday that it may not be able to meet financial obligations of more than $8 billion. Trading on the shares were halted at 1.66 Monday, a loss of more than 96% from its high of 51.97, reached about a year ago. The stock briefly traded higher than 60 in December 2004. Trading continued to be suspended on the issue throughout Tuesday as the NYSE considered delisting and a criminal probe was initiated.

It was a truly horrible day to own stocks. The Dow, S&P, NASDAQ and NYSE Composite all opened lower and continued selling throughout the session, closing at or near the lows of the day.

Dow 12,075.96 -242.66; NASDAQ 2,350.57 -51.72; S&P 500 1,377.95 -28.65; NYSE Composite 8,926.28 -194.05

According to thestreet.com, shares of Bear Stearns (BSC), Lehman (LEH) and Morgan Stanley (MS) experienced losses of 6% or more on exposure to the bad debts of the beleaguered sub-prime market.

Apparently, the damage from mortgage defaults is more severe than those involved have been letting on. It's been suggested that as many as 25% of sub-prime mortgages initiated between 2003 and early 2006 - at the height of the real estate boom - may result in foreclosure and default.

The fault lies not only in the borrowers, whose desire to own an American home outstripped their ability to pay, but in the lenders, whose shady dealings and unethical practices put people who could scarcely afford them into homes with little or no down payment.

The terms of some of these loans are so onerous as to make normal lenders shriek with horror. Interest only loans with increasing principle were all the rage near the end of the boom. Another contributing factor was the rampant speculation on housing which pushed prices beyond normal affordability.

Real estate prices in some of the more overheated markets, such as Southern California, Washington, D.C., Boston and Florida, will take years to weed out the excesses. Homes that typically were selling in the range of 400,000-500,000 in 2005, today will fetch little more than half that amount, leaving many homeowners upside down - mortgage balances higher than the value of their homes. With unappetizing options of staying put and paying or selling at a loss, there are serious grumblings in suburbia.

Of course, with every loser there is a winner or two. Those homeowners who sold at the top of the market and downsized are likely ahead by tens of thousands of dollars. But there's little to no free cash floating around for investment in stocks, and that's crippling Wall Street today and will have a longer term affect as the housing bust deepens.

As this correction and mortgage blow-up extends, more days like this should be expected. Suburban middle and upper-middle class homeowners with little disposable income is not going to boost the economy. On the heels 4th quarter 2006 GDP growth of merely 2.2%, the 1st quarter of 2007 isn't shaping up to be much better. When economic indicators - like today's stalled retail numbers - begin to show little to no growth or outright declines, the other shoe shall have fallen.

Almost unnoticed amid the carnage was another decline in the price of oil, which lost 98 cents to close at $57.93, its lowest close in 3 weeks. Gold and silver continued their long, slow, clumsy, rangebound trade. Gold ended fixed at 649.40, -0.90. Silver ended the day at 12.96, a loss of 13 cents.

Declining issues outpaced advancing ones by a nearly 5-1 margin, while the measure of new highs to new lows flipped over, an ominous signal going forward. There were a combined 154 new highs to 225 new lows on the NYSE and NASDAQ.

New lows must reach a number beyond 350 before a bottom can even be considered close. We're not there yet. In fact, the Dow is still above the March 5 interim low of 12,039.11. There's more - probably much more - selling to come.

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