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| Adrian Mastracci, portfolio manager at KCM Wealth Management, says “There is an old saying that borrowing works really well until it doesn't." |
Vancouver, BC (August 20, 2007): By now, practically everyone has heard something about the US mortgage mess. Particularly sub-prime.
There is an old saying that borrowing works really well until it doesn't.
Adrian Mastracci, portfolio manager at KCM Wealth Management says, “A lot of facts and figures are flying by. Some will impact the markets broadly."
The US Fed made this observation in their surprise release of last Friday when they reduced the discount rate:
“Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward.”
This is strong language for the Fed. The markets are about confidence. Their comments raise some concerns about future prospects.
To understand today, look back at the past. We’ve had the tech meltdown, the Long Term Capital Management fiasco and the savings and loan bailout – just to name a few.
But there is opportunity in risk.
Keep perspective
Here is the mortgage big picture to keep in perspective:
- The US mortgage market was valued at approximately $2.5 trillion ($2,500 Billion) in 2006. Sub-prime was reported to be about 21%, up considerably from 2005, and still rising.
- Many mortgages granted in all categories were of the Adjustable Rate Mortgage (ARM) type. Typically, the ARM mortgage rate resets periodically, the payments may go up a lot even if rates don’t move and, in the end, borrowers may owe more money than they borrowed.
- Not a desirable picture for ARM borrowers. Hence, many may find themselves in a financial bind after the resets.
- Both 2007 and 2008 will be heavy years for ARM mortgage resets. September to November 2007 and the first part of 2008 will be intense periods for resets, many of which are sub-prime.
- Some months indicate mortgage resets approximating $50 billion. This will put pressure on family cashflow. More cash will have to be earmarked for mortgage payments or face foreclosure.
- Increasing foreclosure rates are expected to be one of the fallouts from these resets. California and Nevada are already hit quite hard.
- Borrowing against home equity has been the financial lifeline for many US consumers. It’s folly to count them out now. However, some spending slowdown could occur as borrowing terms tighten.
- Many of these mortgages have been sliced and diced into various packages. Then they are sold to investors, such as banks, mutual funds, hedge funds, pension funds and individuals.
- There is much apprehension among investors about the quality of these mortgage investments. Thus, it’s difficult to assess their true values unless at least a portion is resold to new investors.
- Today there are fewer buyers than ever before. The packages are harder to sell; even high quality ones. That is one reason that the Fed is concerned. It wants to restore market confidence.
- Lenders were happy lending to anyone. Now even quality covenants face borrowing obstacles. There is no painless answer.
It’s not that easy trying to figure out the size of the mortgage mess problem. No one has a complete handle on it, and may never have.
My read
Chaotic times are not new. History repeats itself. Today’s mortgage mess is the latest crisis du jour.
Don’t invest all the cash on hand. The carnage is not over yet. Opportunities will come along.
Revisit basic premises and focus on fundamentals. Be prepared for shakeouts in times ahead.
This mortgage mess too shall pass one day. We’re not quite there yet.
The Fed has this turmoil squarely on its radar screens. Somebody will incur financial pain.
Your comments are welcome.
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