The subprime lending crisis is worse than consumers think and the news media is reporting, warned James Cramer, co-founder of TheStreet.com. In fact, it could "crush financial and real estate markets for years,” he cautioned.
In his recent article in New York Magazine, Cramer, a former hedge fund manager who now hosts CNBC’s Mad Money pointed the finger of blame at former Fed Chairman Alan Greenspan "who wanted to boost an economy reeling from 9/11 and create a legacy of homeownership for all, including those who could not document steady income or, for that matter, citizenship.”
[Editor's Note:The Mother of All Financial Disasters]
He went on to write that, "We think of him as Saint Alan now, but in a few years he will be known as the reckless Fed chairman who encouraged the creation and use of exotic mortgages that required you to put down very little money, odd creations like the "2 and 28,” an adjustable mortgage with low interest payments the first two years that explode into gargantuan fees for the next 28. Don’t have the money to pay for the 2 before the 28? Go "piggybacking”. Take out a home-equity loan against your new house to meet those minimal payments.”
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Referring to the fictional character in John Steinbeck’s Grapes of Wrath, Cramer continued, "The housing markets were so hot the lenders barely had time to check if their buyers were deadbeats, cheats, speculators, or actual honest-to-Betsy hardworking people who wanted nothing more than what Tom Joad wanted 70 years ago.
"Oh, and the buyers didn’t have time to check out the terms, either; the value of the houses was going up too fast. Gotta close now! Nor did the regulators tap the brakes — whoops, there were no regulators. If something went wrong, who cares? The buyers could always sell their ever-appreciating home to the next guy on the reservation list or the ten after him. The builders, brokers, and bankers then shipped these mortgages east to the big Wall Street firms, which bundled them together and merchandised them as high-yielding bonds often backed up by nothing more than the full faith and credit of, well, no one.”
Cramer opined that Greenspan applauded these "fabulous financial breakthroughs that gave everyone a chance at the American Dream.”
But that’s not how it worked out.
[Editor's Note:Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.]
"The same guy who prescribed the mortgage elixir for all Americans then laced it with 17 straight interest-rate increases, increases that brought rates to levels so high that legions of people who bought a home with a teaser rate couldn’t afford the payments.”
According to Cramer, between 2004 and 2006, just as interest rates started spiking, 14 million families bought homes, many taking advantage of low teaser rates and piggybacks.
"Given that the average home went for about $250,000, that’s hundreds of billions in loans that cost a lot more per month than when they were taken. Now these people are stuck. They can’t refinance because the rates are too high, and they can’t sell their homes to repay their mortgage, either,” he observed.
All this stands to affect consumers and financial markets more than people think, stated Cramer. Why?
"Because the people who ultimately bought the bonds backed by what now look to be billions in bogus mortgages are those who run most of the big pension-, hedge-, and stock-and-bond market mutual funds in this country…Some manager, however, borrowed huge sums to buy tons of these mortgages to turbocharge their results. And the most aggressive managers bought billions in mortgages given to less creditworthy individuals, the so-called subprime loans you keep hearing about,” he wrote.
None of this mattered though until June 2007, stated Cramer because of what is known in the trade as the "marks” — the value of a stock or bond as it’s "marked” by a firm. Many of the mortgage bonds were priced too high, he explained, because nobody thought that large numbers of borrowers would ever elect to walk away from their homes instead of pay the interest that backed the bonds.
"Now all hell’s broken loose on Wall Street because of those mismarks…Hundreds of billions in bonds that were thought to be worth more or less the price they were sold at, it turns out, are worthless,” wrote Cramer.
What’s more, the firms such as Bear Stearns that bought the bogus loans, don’t have the money to pay up.
"These funds, which were supposed to be brimming with cash — the "liquidity” — turn out to have not much at all, and there are virtually no buyers anywhere for these mortgage-backed bonds,” Cramer stated.
That’s why all Americans are losing money.
Moreover, it’s not just that the lending crisis is causing interest rates to rise, "it’s that the value of your home is endangered because of the high Wall Street — the industry, if not the stock market — is set to take.”
According to Cramer, the hedge fund business is liable to be cut in half by the chain of mismarking and redemptions.
Cramer predicts the Fed will cut interest rates sooner than it otherwise would have.
Still, he cautioned, "this Fed has been famously inflation-wary, and it may be reluctant to loosen rates too much, lest it overheat the economy, especially since the Fed seems to believe that the nonfinancial economy, the part not connected with home building or lending, is thriving…If Bernanke’s right, and the rest of the conomy is as solid as he seems to think it is, it’s possible the lending crisis could be contained to only those who work in and around the credit business.
"But that’s a big if,” he continued. " If the lending debacle keeps spreading, or the rest of the economy heads south, the Fed may find itself too far behind the curve to do much good.”
Cramer advises consumers not to expect President Bush to get involved and help the situation by pressuring Fannie Mae to issue emergency loans to alleviate the credit squeeze.
"This administration seems to be either totally clueless or totally heartless, or both, and doesn’t want to goad Fannie Mae into helping. Maybe they hate that quasi-governmental institution set up by bleeding-heart Democrats to help struggling home buyers of a different, more liberal and compassionate, era. Or maybe they just think that anything short of an FDR-era Agricultural Adjustment Act for homes, where we bulldoze whole housing projects instead of cornfields to get price stability, just won’t work.”
Cramer anticipates the "pain and contractions” in the housing and credit markets could result in as many as 7 million homeowners who bought houses in the past few years to either foreclose or default on their mortgages.
He also admitted that he feels helpless in the situation "because I don’t see anyone doing a whole hell of a lot about it.”
Editor's note:
Sir John Templeton first warned of market, housing crash – Read More Here
The Mother of All Financial Disasters
Will the Liquidity Crisis Sink Your Stocks? 12 Ways to Profit.
