Thursday, May 28, 2009

Is Prime the New Subprime?


The Fed dodged a bullet today as the 7 year bond auction saw solid demand. Stocks breathed a big sigh of relief and moved higher on the news. I expect the equity markets to start trading off of the bond market and its treasury auction's over the near term. This could create a very volatile market because the bond market appears to be very nervous right now.

Santelli on CNBC said the next thing to focus on are the long end June 10 and 30 year auctions. It will be interesting to see what the demand is for longer dated bonds after watching the FCB's pile into shorter term treasuries. Lets not forget that the PPIP also launches around the same time.

This should set the stage for some serious market fireworks over the next month.

Is Prime the Next Subprime?

If you look at today's foreclosure data I would say the answer is easy: YES! Bloomberg reported today that there are now more prime foreclosures than subprime for the first time. They also reported that a stunning 9% of all loans are now delinquent:

"May 28 (Bloomberg) -- Mortgage delinquencies and foreclosures rose to records in the first quarter and home-loan rates jumped to the highest since March this week as the government’s effort to fix the housing slump lost momentum.

The U.S. delinquency rate jumped to a seasonally adjusted 9.12 percent from 7.88 percent, the biggest-ever increase, and the share of loans entering foreclosure rose to 1.37 percent, the Mortgage Bankers Association said today. Both figures are the highest in records going back to 1972. Fixed rates rose to 4.91 percent, Freddie Mac said, and an increase in bond yields earlier this week shows rates may continue rising.

Foreclosure Inventory

The inventory of new foreclosures and those already in the process of being foreclosed upon jumped to 3.85 percent, the MBA said. Half the loans now in foreclosure, adding the new and existing defaults, are held by prime borrowers, according to the trade group’s report. About 43 percent are subprime mortgages, and 7.1 percent are Federal Housing Administration loans. A year ago, subprime mortgages accounted for 54 percent of the U.S. foreclosure inventory. Prime fixed rate mortgages accounted for 19 percent of new foreclosures in the year earlier period."

My Take:

Folks, this is horrifying. Prime loans are never supposed to go bust. These borrowers are supposed to be "a lock" for the banks. They are the premier borrowers with the best credit scores. The fact that they are crumbling is extremely worrisome.

I mean hell, if a prime borrower isn't safe then who in the hell is?

Credit counseling companies are seeing a distinct change in callers as prime borrowers go belly up:

"Prime fixed-rate loans have finally leapfrogged those nasty sub primes to take the lead in the race to foreclosure. The foreclosure rate on primes has in fact doubled in the last year

"I got a call yesterday from Scott Scredon at the Consumer Credit Counseling Services in Atlanta. He says they’ve seen a distinct change in callers. “We’re getting calls from engineers and attorneys and post graduate students,” he says. “Many of these people run through their 401Ks and their savings and start living off credit cards and then they call a counseling agency for help. So it’s a new kind of person we’re seeing today, but it’s a sign of the times.”


This is nuts. Why are prime borrowers pissing away their retirements in an attempt to keep a bloated overvalued McMansion? These people are nuts! Walk away from the damn house! Why destroy yourself financially for the rest of your life in order to continue to live in one of these crapboxes?

Its not like your ever going to ever pay the loan off. I mean Christ: If you are behind on payments after just 3 years, How in the hell do you think you can continue to make the same payments for the next 27 years.

Your retirement is your nest egg. Don't piss it away by paying back a bunch of greedy bankers that fraudulently put you in a house that's worth half of what you actually paid.

How did this Happen???

Folks its simple, the prime borrower made the same mistake that the subprime borrower did only on a larger scale: They bought a house they couldn't afford!!!

Everyone that got involved in the housing bubble turned into debt whores. It didn't matter if you made $30,000 a month or $3,000 a month. The $30,000/month "prime" buyer bought a house for $1.8 million when they really could only afford $1 million while the subrime borrower paid $300,000 for a house when they could only afford $150,000.

Either way it doesn't make a difference. Neither one can afford the darn house.

How out of control did this mania and our debt loads get? Let's take a look at where we sit historically:

As you can see above, our debt loads are just flat out ridiculous. There is no other way to describe it. Housing and stock wealth have plummeted at a time where the average person holds more debt by far than any other time in our countries history. Meanwhile wages only mildly rose in comparison to the soaring debt loads over the same period. Umm...Can you say DEBT BUBBLE?

How on earth is anyone going to ever pay this debt back? Where is the money going to come from? Mars?

Answer: It won't be paid back. The problem we have here is our economy cannot grow until all of this debt is either paid off or defaulted on. Our consumer led economy simply cannot grow when the consumer doesn't have the ability to spend.

Bottom Line:

This will not end pretty. Whenever bubblevision talks about all of the "cash on the sidelines " come back here and take a look at this chart. Cash is on "the sidelines" because its being used to payoff record debt levels.

The now 9% deliquincy rate on mortgage payments combined with massive foreclosures, record invetories, and higher interest rates will only mean one thing: THE DEATH OF THE HOUSING MARKET AND OUR ECONOMY.

Every week all I hear about on CNBC is how they are signs of recovery. Housing supposedly is stabilizing and the banks balance sheets our now supposed to now be strong.

Gimme a break! How can they say this with a straight face?

If prime mortgages foreclosures continue this trend(and there is no reason to believe they won't) the banks are going to get slaughtered as their loan books become filled with millions of bad loans resulting in billions if not trillions of more $$$ in losses.

Green shoots? All I see is one giant housing weed.


CT-Hilltopper said...

I used to get so annoyed at my parents when they would preach at me about money.

You know the talks. Do you want it or do you need it (the item you want to buy)? Never spend more than you earn, that was another one.

My father never had a credit card, ever. He paid cash for everything he wanted, even big ticket items.

Now I am thankful for that upbringing, and I am passing it on to my children.

Thanks Mom and Dad. I wish I had said it more while you were with us, when it would have been more appreciated, but this will have to suffice.

Yes. Jeff, Prime is the new Subprime in this new Depression. Unemployment will be a leading indicator instead of a lagging one.

That's why all the economists are waling around with their pants around their ankles. The markets are being manipulated to the point where nothing makes sense anymore. Up is down, leading is lagging, and everything is backwards. Nobody knows how to call it.

Anonymous said...

"Meanwhile wages only mildly rose in comparison to the soaring debt loads over the same period."

---Wages decreased.

Jeff said...


So true

Nothing in the market seems to make sense anymore.

I am just glad I am mainly on the sidelines despite a few smaller trading plays plus picking up some metals and shorting treasuries.

When the market starts making sense perhaps I will dabble some more.

Until then I guess we all just have to sit here and watch the insanity.

Crazy times for sure

Jeff said...


I just meant the trend has slowly risen since the '80's

You are right wages are now dropping. Bad combination!

snood said...

Not only did the Primes over spend on houses, but they over spent on cars, vacations, vacation homes, etc.

There was a huge false wealth effect at play.

Jeff said...



The housing ATM was emptied with a spending binge on Hummers and flatscreen TV's!

The fact that 9% of all mortgages are deliquent is unbelievable!

Anonymous said...

my weekly check-in on potential sources of gold and silver purchases...anything ye\t?
also, what are your gold stocks of preference?

Peter said...

I have been a firm believer that the continued reference to unemployment as a lagging indicator is another backward looking myth in this new depression. To me seeing these stats just makes me believe in the theory a little more.

Americans are broke, it's as simple as that. We have saved nothing over the past two decades, actually we have negative savings as most Americans are up to their eye balls in debt. Every newly unemployed individual is just one more car/credit card/mortgage note that is going to default within 90 days.

As long as unemployment keeps growing the economy will continue to worsen. These prime defaults are just further proof that there is no salvation in sight.

Jeff said...


If you don't want physical buy some of the gold ETF GLD. I bought a fair amount on Friday.

John Paulson who is the smartest hedge fund manager out there just bought $3 billion of it.

I figure this as safe a place as any if he is willing to commit that kinda capital in there.

I also bought some silver via ticker SLV.

I will focus on the physical a little further down the road.

BAM said...

Another awesome post. I really like how you summarize all the major issues that takes within the day. I find that I don't have read dozen different website anymore. You capture all the important issues. Thanks again.

One question on "FAZ". When the market crashes how high do you think the price will jump to? I bought few hundred shares at ~$8.50 and it's down to about $5.00. Do you think it can reach $30 or even break $50? Cheers!

Jeff said...


Thats exactly how I read it too.

This is a death spiral that appears to be impossible to break out of.

Further job losses exacerbate housing defaults which exacerbates bank losses etc etc etc.

I don't see how we break this cycle without a full blown depression where the economy resets.

Jeff said...


Thanks. I am glad you are enjoying THTB!

FAZ....Thats a tough one. These derivative based leveraged ETF's are tough to read.

I really have no idea. The street thinks the government has backstopped everything financially related so I wouldn't expect much out of FAZ in the short term.

If the foreclosure continue and this pace and the banks look like they are about to roll over again you could see FAZ take a moonshot.

You are in pretty cheap so I would just sit on them and forget about em.

FAZ will have its day in the sun again. I can't tell you if it ever gets back to its old highs.


theART said...

OMG 9%?! Lawl, isn't there total of $32Tril in mortgages?

I bet banks will be able to hide their losses for a while because of new "revenue" reporting rules.

Jeff said...


Its such a joke isn't it?

I loved the report around the banks earning $7 billion dollars in the first quarter.

Whoopty doo when you have a trillion in losses on your balance sheet!

You gotta love the suspension of mark to market. Enron accounting in its finest form!

snood said...

9%? The banks must be snowed under in foreclosures. They were never set up to process that many.

The longer it takes for them to work through the foreclosures, the longer it will take to reach a bottom.

Jeff said...



The whole thing is a total mess. You gotta wonder how many foreclosures there are that aren't reported on purpose too because as they try to hide the huge inventories that they have.

Throw in higher lending rates and it turns into a tota sh*tstorm.

Anyone in a house that has a jumbo loan is so royally screwed its not even funny.

Jeff said...

Blah blah day from a price action standpoint.

Metals are soaring!

Lets see how we close this afternoon.

Avl Guy said...

Hey Jeff, I’m glad to see some of you are examining the possibility of the latest (?) 'Black Swan' to upset orthodox Economists, policymakers, and Talking heads: How Unemployment flipped from being a Lagging Indicator to a Leading Indicator. John Mauldin, The Big Picture blog, was the 1st I read to overtly articulate this and why: consumers now rely on income, rather then debt (credit) to drive that 70% of GDP. Furloughed or hours cut or wage give-backs AND no access to EZ credit? Then less spending. No jobs, no EZ access to EZ money? Then no spending. Quite simple.

I rephrase this as: We're now on Planet DeLeverage, please adjust all economic formulas and equations to reflect the New Natural Laws of Physics (Economics) while Deleveraging is in Dominance, including recognizing that Unemployment is a Leading Indicator.

Jeff said...

Avl Guy

Great to here from you!

Haven't seen you in awhile. Great points. I love Mauldin. His research is top notch.

We definately live in a new world. The consumer much less access to money as you so accurately described.

Eventually the media pundits will catch up with this. Until then the market will pretend that this is just a normal recession thinking that happy days are right around the corner.