Monday, August 06, 2007
What Happens in Sub-prime…Gets to Spain Really Quickly
“How does this happen?” somebody asked me this weekend.
That somebody was my wife, and she was wondering out loud how a financial institution such as Bear Stearns could get caught in a sub-prime debt crisis that pretty much everybody in America, including my dog Lucy, knew was coming.
It’s a great question.
On the one hand, it’s inexplicable. How could grownups decide that buying paper written by unscrupulous mortgage brokers with no documentary evidence that income or assets or creditworthiness are as stated would be a good way to invest their client's money?
What makes a well educated veteran who lived through the Long Term Capital melt-down ten years ago think nothing of leveraging forty-to-one a portfolio of sub-prime paper backed by overpriced houses next to Interstate 80 in Sacramento?
How does a wise-guy bond maven—who as recently as April 12th got a fawning article (“Prospering in an Implosion; Subprime Market's Fall Plays to the Strengths Of a Bold Contrarian”) and a photo of himself, his wife, his children and his yacht, in the New York Times—hit the wall in June, freezing investor redemptions and putting the yacht up for sale?
The complex answer involves newer age MBA-type concepts such as alpha and beta coefficients and bond strategies beyond my comprehension, along with older-fashioned realities such as leverage and margin calls.
The simpler answer, however, is the fact that these markets of ours vacillate—over seconds and minutes and hours and days and weeks and months and years and decades—from greed to fear and back to greed again
When markets get fearful, no news headline is positive: wars are bad for consumer confidence, Fed rate cuts are proof-positive that the next Great Depression is at hand, and all corporate earnings reports, no matter how strong, seem not quite good enough.
When markets get greedy, however, the opposite holds true. Every headline is positive: wars stimulate the economy; Fed rate cuts feed the liquidity machine; while all earnings reports, no matter how poor their quality, become excuses to bid up the underlying stock.
When greed takes hold, investors become inured to risk and simply make up whatever they want to make up that helps them justify the risks they’re taking.
Lest you think I exagerrate that last point, recall that six brief months ago, when the domestic housing market had frozen solid and the counter on the ticking time bomb that was the sub-prime mortgage mess was fast approaching “zero,” the solace of highly levered bond market players in this particular cycle was a catchy phrase stolen from the Las Vegas advertising slogan, “What Happens in Vegas Stays in Vegas.”
Now, whatever you might think of an entire U.S. city marketing itself as a haven for adulterers, “What Happens in Vegas Stays in Vegas” is one terrific slogan, packing as it does the entire Rat-Pack lifestyle into seven words—not one of which actually refers to smoking, drinking, gambling and, yes, whoring, but which together imply all those activities and more.
And from those seven words came the rather hopeful catchphrase of the market wise-guys whose 40-to-1 leveraged portfolios depended entirely on the continued inflation of the housing bubble in order to bail out all the unqualified buyers whose paper they owned in one form or another:
“What Happens in Sub-Prime Stays in Sub-Prime.”
We heard it on CNBC and read it in bond briefs from Wall Street’s Finest. Hey, it was catchy!
Thus, with a brief, memorable and entirely false sentence did an entire world of bond mavens dismiss the fact that what they owned was upwards of a trillion dollars of garbage that had only temporarily been transformed into something better than garbage by the magic of Wall Street paper-shuffling and the waving of Moody’s Magic Ratings Wand.
Imagine their surprise, then, when National City Corp stopped making stated-income “liar” loans long after the liars had stopped asking for a loan; when IndyMac began charging higher rates on mortgage loans despite lower Treasury bond yields; and American Home Mortgage simply shut down.
But it should have come as no surprise.
The shift from greed to fear had been underway for months, and had already crossed the Atlantic to Spain earlier this spring—around the time John Devaney got his 15 minutes of fame as the “Bold Contrarian” in the New York Times, a mere two months before he would freeze investor withdrawals and three months before he would begin peddling his yacht, called “Positive Carry” but more aptly named “Carried Out,” for needed cash.
Indeed, anybody listening in on the recent General Cable Corporation earnings call—and the company’s previous call in early May—would have heard that what was happening in sub-prime was absolutely not staying in sub-prime.
General Cable (ticker BGC) makes copper cable—about as basic a thing as basic gets. And what General Cable was seeing was that what was happening in sub-prime was, in fact, spreading around the world pretty quickly.
But don’t take my word for it. Hear it straight from the mouth of General Cable’s seasoned, extremely able CEO, Greg Kenny. For the record, I once worked for General Cable’s former parent company.
Greg Kenny – General Cable Corporation President, CEO
As discussed in our last conference call, we have seen some weaker housing in Spain and Oceania directly impact the sale of some products used in new construction. In addition, we have seen a secondary impact in cables used to connect houses to the grid, such as electrical and telecommunications distribution cables in the United States.
Kenny noted positive offsets to the weakness in housing from the United States to Spain and Oceana (Asia Pacific):
We're also happy to report that cabling for wind farms continues to be quite strong. In Europe demand for medium and high voltage cable is very high due to the continuing rebuild of the electric utility distribution infrastructure and increasing investments throughout Europe in wind farm electricity generation. Extra high voltage underground systems continue to be in demand and lead times and now extending out beyond one year. Demand for cabling solutions in the oil, gas and petrochemical markets, particularly offshore exploration and production platforms, remains high and lead times are also extending.
He also described a firming in telecommunications demand:
At the same time, the submarine fiber-optic market appears ready to improve after years of declines....
Unfortunately for General Cable, and bond mavens everywhere, the positives are not enough to offset—in the near-term—the negatives:
The construction market in Spain is slowing after more than a decade of strong growth, and will create some headwind as we move into the next few quarters. As you may remember from our last conference call, cable for housing applications is about 7% of our worldwide revenues. Housing demand also has some impact on small gauge electrical and telecommunications distribution cables.
Kenny expressed hopes that what started in sub-prime will eventually stop spreading:
I would hope that we see the Spanish thing correct. We're watching the government as it begins to try to perhaps come in and build housing for all of the immigrant communities, etc. So we're watching government policy as they try to go through a soft landing there.
He's not the only one. After all, what happens in Spain eventually gets back to Vegas.
I Am Not Making This Up
© 2007 NotMakingThisUp, LLC
The content contained in this blog represents the opinions of Mr. Matthews. Mr. Matthews also acts as an advisor and clients advised by Mr. Matthews may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Matthews' recommendations. This commentary in no way constitutes a solicitation of business or investment advice. It is intended solely for the entertainment of the reader, and the author.
Posted by Jeff Matthews at 7:13 AM