Friday, May 9, 2014

U.S. Subprime Loan Crisis: 2008 vs. 2014 – The Financial World Has A Short Memory

2008 – Subprime mortgage crisis
The U.S. subprime mortgage crisis was a nationwide banking emergency that triggered the recession of 2008, through subprime mortgage delinquencies and foreclosures, resulting in the devaluation of the attendant securities.
These mortgage-backed securities (MBS) and collateralized debt obligations (CDO) initially offered attractive rates of return due to the higher interest rates on the mortgages; however, the lower credit quality ultimately caused massive defaults.[1] While elements of the crisis first became more visible during 2007, several major financial institutions collapsed in September 2008, with significant disruption in the flow of credit to businesses and consumers and the onset of a severe global recession.[2]
There were many causes of the crisis, with commentators assigning different levels of blame to financial institutions, regulators, credit agencies, government housing policies, and consumers, among others.[3] A proximate cause was the rise in subprime lending. The percentage of lower-quality subprime mortgagesoriginated during a given year rose from the historical 8% or lower range to approximately 20% from 2004 to 2006, with much higher ratios in some parts of the U.S.[4][5] A high percentage of these subprime mortgages, over 90% in 2006 for example, were adjustable-rate mortgages.[2] These two changes were part of a broader trend of lowered lending standards and higher-risk mortgage products.[2][6] Further, U.S. households had become increasingly indebted, with the ratio of debt to disposable personal income rising from 77% in 1990 to 127% at the end of 2007, much of this increase mortgage-related.[7]
2014 – New US subprime boom – but this time it is for cars
According to the credit agency Experian, the total amount owed on car finance in the US had risen to $750 billion by late last year.
An estimated 36% of those loans have been made to subprime borrowers. So are the banks storing up serious trouble for the future – and maybe even another financial crisis?
American subprime lending is back on the road
A few short years ago, “subprime” was almost an expletive. During the financial crisis, mortgages linked to subprime borrowers – or those with poor credit history – caused devastating losses; so much so that many asset managers declared they would never touch subprime again.
But the financial world has a short memory, particularly when easy money and innovation collide. In recent months subprime lending has quietly staged a surprisingly powerful return, not in relation to real estate, but another American passion – cars. Some wonder how long it will be before this new boom causes another wave of casualties, not just among naive consumers, but investors too.
The Next Subprime ‘Time Bomb’ Is Ticking (Here’s How You Could Profit from It)
Driving Toward a New Economic Cliff
I became aware of this potential time bomb last year. A close friend was financially destroyed by the subprime mortgage crisis. He is an investor and was overleveraged on more than a dozen investment properties. He was finally forced to declare bankruptcy to get out from under the mountain of debt.
Within a week of the bankruptcy filing, he started getting letters from companies like Wells Fargo (WFC) and General Motors (GM). While my friend was used to getting nasty letters from banks and finance companies, these letters were very different. These were not demand letters challenging his bankruptcy, threatening lawsuits or anything the least bit negative. Believe it or not, these letters were pre-approval letters for auto credit!
In fact, one financial company actually sent my bankrupt friend a check for $30,000 to be used at any participating auto dealer for the car of his choice. He took the check and bought a used BMW.
Here They Go Again: Wall Street Is Offering Debt-On-Debt-On-Debt!
Here’s how the daisy chain of debt works— short form. LBO’s issue debt—loads of it. Leveraged buyouts are now being priced at typical top-of-the-bubble ratios of 10X cash flow (“adjusted EBITDA”). The portion of these LBO debt towers that consists of bank term loans and revolver facilities is sold to freshly minted financial conduits called CLOs (for Collateralized Loan Obligations) which are not real companies and which do not have any money!
No problem. What happens is that credit hedge funds and Wall Street trading desk hit a computer key, open a new spreadsheet window, wrap it in legal boilerplate, provide this newly minted CLO with a credit line and then start bidding for available LBO paper in the junk loan market. When they have accumulated enough offers, they slice and dice the resulting portfolio of LBO loans, and issue multiple tiers of debt– with these new slices being rated from AAA to junk against the loans listed on the spreadsheet.
So we now have a spreadsheet, a part-time “portfolio manager” and hundreds of millions of the latest CLO toxic waste. For 95 weeks running, there was no want of buyers for this CLO issued paper. In its infinite wisdom, the Fed drove interest rates on CDs and high quality paper to nearly zero—–so the scramble for “yield” was on. Soon Grandpa was being forced to buy a high yield mutual fund in order to pay the light bills….












 
Why We Are On The Verge Of Another Subprime Crisis 

 

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