Last year on this very day, Bear Stearns traded at $100 per share, Stan O’Neal was still the CEO of Merrill Lynch and Wall Street had just finished underwriting $73 billion of subprime loans in the second quarter of 2007, albeit down from $135 billion in Q2 2006. Everything look pretty darn look.
In short, less than one year ago, America was caught up in a circle of vice that was being pumped up by the forces of greed, i.e., Adam Smith’s famous invisible hand acting through unregulated markets.
If you doubt that greed was the driver of the real estate bubble considered the amount of fees embedded in a subprime mortgage. Each layers of the pyramid got its cut : mortgage broker, bank, investment bank, rating agency and State goverment, before these Triple A junk bonds were sold to clueless investors. Conservatively subprime mortgages involved transaction costs, i.e., fees, taxes and legal expenses, in excess of 10%. One thing that I have learned during my career in the financial field is that when total transaction costs exceed 5% you are looking at a Ponzi scheme or just plain old fraud.
The good news is that, last year at this time, the credit crunch was just around the corner. By mid-August, as the money markets locked up, because investors were sensing that something was wrong, the bad behavior would rapidly come to an end. I predict that the news from the Treasury and the banks will be very bad for the next two months — July and August — and then miraculously take a turn for the better, until by February 2009 the year on year comparisons will look downright good. That is because the volume of subprime loans declined to near zero from August 2007 to December 2007 — and there is always a year lag in the way Wall Street digests statistics.
So for those punters who like to bet on that $40 trillion dollar track called the stock market, it is time to load up on cheap financial stocks — be sure to pick the companies that won’t go under between now and year end. Next summer you will be able to brag at the pool that you called the bottom and got money for nothing.