Monday, March 31, 2008

Subprime Housing Leads to Subprime Financial Institutions

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. In addition to the term helicopter economics, we have also coined the term, helicopternomics, to describe the current monetary and fiscal policies of the U.S. government and to update the old-fashioned term wheelbarrow economics.

The housing reports released in October 2007 which indicated the state of the market in September were even more dismal than those of the prior month. Nationally, foreclosures had doubled year over year and they had gone up as much as 500% to a 1000% in the worst hit bubble areas of the housing market. Existing Home Sales were down 23% nationally. Although also down substantially, New Home Sales were nevertheless reported as increasing (huh?).

The September 2007 New Home Sales report was a classic example of how the financial media frequently reports bad news as good and hopes people only read the headlines and not the fine print. The New Home Sales report originally indicated that there had been 795,000 houses sold in August. The report then indicated 770,000 houses sold in September. This drop of 25,000 was heralded by the media as a increase of 4.8%. This happened because the sales figures for August were revised downward to 735,000 (by almost 8%, an incredible error for a statistical report) and the September figure was above this number, so this indicated that sales were going up! The first thought of any rational person should of course have been, 'if the numbers for August were actually much lower, why shouldn't the ones for September be much lower as well?' Even a casual look inside the September report lent substantial support that this was indeed the case. Sales in the West, probably the worst hit housing area in the U.S., were supposedly up 38% - a completely absurd number and an indication that the September numbers were being overstated just as the August numbers had been.

Despite the complete devastation in housing sales., median house prices were reported up 2.5%. The statistical tricks that led to this impossible outcome were discussed previously in this blog in the posting, "Housing Market Collapses, but the Statistics Hold Up".

House sales were falling off a cliff because mortgage money was disappearing. By October 2007, 183 mortgage lenders had already closed their doors since the previous December. One that didn't was Countrywide, the largest mortgage lender in the United States and therefore presumably too big to fail. What kept Countrywide afloat was a $2 billion capital infusion in August from Bank of America. Barron's reported that there were rumors that this bailout had been secretly arranged by the U.S. federal government. If so, it would only be the first of many bailouts that the Feds would have to arrange to prop up failing American financial institutions. Shortly thereafter, one of the major British mortgage lenders, Northern Rock, experienced a run on the bank - the first in England since the 19th century. Northern Rock had been known for it 125% mortgages and when word got out that it needed an emergency loan from the Bank of England, depositors queued up for blocks desperate to get their money out. While the Bank of England directly provided capital to keep Northern Rock going, this approach would prove to be no more successful than the more circumspect American one. Both Countrywide and Northern Rock would barely survive into 2008.

Next: What Banks and Enron Had Common

Daryl Montgomery
Organizer, New York Investing meetup

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1 comment:


The subprime blowup is the greatest financial event since the crash of 1929.