It looks like a good argument on paper, but it only works if you ignore the following:
The U.S. has a larger “mortgage problem,” not just a subprime problem, which is something that many retail banks and mortgage lenders can attest to. In fact, there is even ample evidence that Alt-A, Prime HELOC and Prime ARMs could turn into a bigger problem than subprime. During the last round of quarterly reports many retail banks and mortgage lenders reported losses within their prime portfolios (HELOCs especially), alt-a lenders are experiencing the same problems the subprime lenders had in March, and 1 in 3 homeowners whose initial teaser rate on their ARMs was under 4% will probably go into foreclosure, a fact that crosses all types of borrowers. The U.S. has a mortgage problem, not a subprime mortgage problem. The subprime borrowers simply got into trouble first, due to being less financial stable than the prime borrowers. Anyone who just talks about “subprime” is only discussing a piece of the puzzle, not the whole puzzle.
Mortgage loans in the U.S. are often financed by institutional investors the world over, who invest in mortgage backed debt securities. Foreign and domestic insurance companies, hedge funds, retail banks, commercial lenders, pension funds, university endowments, etc., all invest in mortgage backed securities and provide the liquidity that fuels the U.S. mortgage market. As the mortgage problem deepens it becomes difficult to sell mortgage securities, which results in less liquidity for the U.S. mortgage lending market, and creates a wide spread problem whose impact extends far beyond subprime borrowers, and lenders. The mortgage problem with respect to the credit markets, is actually due to institutional investors in mortgage securities not only taking huge losses, but having used improperly valued debt securities as collateral for loans they then used for other investment activities. As a result, you have investors who not only have to deal with huge losses, but are faced with margin calls and liquidity problems as a result of their loan collateral decreasing in value. As a result of the one-two punch of the above, hundreds (if not thousands) of institutional investors world-wide are dealing with losses due to their subprime investments and mortgage investments in general. When the banking sector of a G-8 nation (Germany) and a continent (Europe) are dealing with investment losses, credit downgrades, margin calls, etc., due to mortgage securities, it’s quite obvious that the problem goes way beyond mortgage lenders and borrowers in default. Pension Funds and University Endowments have taken large losses due to subprime investments. Harvard lost $250 million dollars due to its investment in Sowood Capital Management, and the State of Massachusetts has lost approximately $80M so far this year. Now, these numbers are relatively small compared to Harvard’s $30 Billion endowment, and Massachusetts’ $50 billion pension fund, still, $250 million would put 1,300 people through four years of Harvard. Furthermore, if we consider the 10s of billions that university endowments and pension funds poured into hedge funds, which were then poured into mortgage debt securities, the losses that Harvard and Massachusetts suffered are probably just the tip of the iceberg. The U.S. consumer used the proceeds from HELOCs, and real estate speculation, for example, in order to fuel consumer spending. Now that housing is slowing, retail spending has stagnated as well, meaning that the housing slowdown will impact consumer spending significantly.
The U.S. mortgage market, is part of a larger ecosystem of institutional investors who provide the liquidity that make the whole system work. Any pain felt by borrowers and lenders, is also felt by the investors, and that investor pain contributed to the creation of a credit crisis. The European central bank didn’t add liquidity to the European mortgage market because someone in Iowa defaulted on a subprime loan, they added liquidity to the market because European banks are taking huge losses due their investments in debt securities backed by U.S. mortgages.
So, when you hear foolish analysts, pundits, or commentators, say that the subprime problem is “contained,”understand that these people either don’t see the big picture, don’t want to see the big picture or only understand part of the ecosystem.
