Subprime Ate My Homework

Early this morning a Bloomberg article proclaimed Subprime Defaults Blamed for Corporate America Earning Setbacks :

Railroads, chemical producers and insurance companies are blaming the worst U.S. housing slump in 16 years for their earnings woes.

Burlington Northern Santa Fe Corp., the second-biggest U.S. railroad, said lower shipments of housing products and lumber reduced second-quarter earnings. DuPont Co., the third-largest chemical maker, said slumping demand for kitchen and bathroom countertops was partly responsible for its profit drop. Genworth Financial Inc., the former insurance unit of General Electric Co., said earnings will be at the “lower end” of its forecast this year as mortgage-insurance claims increase.

“The subprime slime is oozing,” said Gary Shilling, president of A. Gary Shilling & Co. in Springfield, [New Jersey, who correctly predicted the recession in 2001. ``As home equity evaporates, that takes out the foundation of strong consumer spending growth, which has been the mainstay of the economy.''

Now while I believe that the 2007 subprime meltdown has caused all kinds of havoc with the economy, there are still other important things to consider.  For all the problems in subprime, there's a limit to what subprime can affect. 

On Monday, Paul Farrell of Marketwatch asked an interesting question:

How good are you at predicting big turning points? Remember how the assassination of a little-known Archduke triggered the First World War? Can you predict the Archduke "event" ... that pushes America over the edge and into a recession and bear market? Well, can you? After all, five years is a long bull market.

Farrell listed 20 potential "triggers" that could push America over the edge. While conceding that it'll probably be some combo of multiple triggers, a perfect storm, he asked readers to identify the "tipping point"  His list of possible triggers includes:

1.   War/military defense budget busting
2.   Real estate bubble raging
3.   Foreign trade imbalance, trillions new debt
4.   China's economy overheating
5.   Private-equity imploding
6.   'Homeland Insecurity' failures
7.   Hedge funds hurting retirement plans
8.   Oil rocketing toward $100 a barrel
9.   Weak U.S. dollar keeps sinking
10. Federal budget deficits
11. Social Security entitlements
12. Medicare's massive deficits
13. Health-care insurance deficit
14. Climate change fuels global wars
15. Personal savings shortfall
16. Consumer debt surging
17. Corporate pension defaults
18. Local government pension deficits
19. International credibility deficit
20. Washington politics in endless gridlock

Will another one of these possible factors be the "Archduke assassination" moment for stocks and the economy, or is subprime the villain that will be mentioned in future textbooks?  Are other factors of any significance- or do we blame it all on subprime? 

Why does this matter?

For one thing, it seems unlikely that all of Wall Street's woes [or the nation's] have been brought on by loans to subprime borrowers.  Will CEOs [as well as Americans and our government officials] be able to achieve plausible deniability and shirk responsibility by saying:

Darn subprime anyway.  It causes cavities, raises cholesterol, installs viruses on computers and , oh, it ate my homework- as well as messing up the corporate bottom line. [and the U.S. economy]

I think subprime is the trigger- but I don’t think it’s the assassin.  Let’s not get so consumed in blaming subprime that we forget there’s a few other teensy problems out there.

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7 Comments for this entry

  1. metroplexual says:
    August 1, 2007 at 5:18 AM

    Here is my 2 cents.

    http://www.nytimes.com/2007/08/01/business/01leonhardt.html?ref=business

    Resets still have a long way to go.

  2. John M. says:
    August 1, 2007 at 6:03 AM

    Agence France-Presse seems to think that subprime ate the carry trade and had the M&A bubble for desert. Looks like today’s results could provide a real purge and get everyone (especially the hedgies) focused firmly on reality.

    “World stocks in meltdown over US economy fears”, Ben Perry, AFP / France24, August 1, 2007.

    European and Asian stock markets plummeted Wednesday, mirroring heavy losses the previous day in New York, on mounting fears that weakness in the US housing sector could infect the world economy.

    In London, Frankfurt and Paris the main share indices were down almost 2.0 percent nearing the half-way stage.

    The yen meanwhile hit a four-month high against the dollar and oil traded close to an all-time peak in New York as investors exited risky investments and turned to safe-havens, dealers said.
    …

    Economists said there were growing jitters about the potential fallout from problems in US subprime lending sector, where mortgages are provided to people with questionable credit histories.
    …

    “The central issue that concerns the equity market is really the extent to which this whole subprime fallout will affect a general credit squeeze and reverse the expansion we have seen in the global economy,” said Mike Lenhoff, chief strategist at Brewin Dolphin Securities in London.

    “There is this worry now that the ease with which lending has taken place and the ease with which there has been access to borrowing to finance the global economy is being unwound.”

    No market was immune to plunging equities on Wednesday, as Hong Kong’s key Hang Seng Index closed down 3.15 percent, China share prices shed 3.81 percent and Indian’s main equity market plunged 3.96 percent.

  3. jan-martin feddersen says:
    August 1, 2007 at 6:56 AM

    Moin John,

    wonderful piece.

    What happened to the argument stocks need to climb

    “the wall of worry”

    that we have heard for almost 5 years from the bulls…… :-)

  4. John M. says:
    August 1, 2007 at 7:27 AM

    Jan-Martin -

    Looks like “The Wall of … What, me Worry?” is intact, at least for now. Dow up almost 60 points this morning.

  5. Tobby says:
    August 1, 2007 at 8:42 AM

    Many a prudent bear have been railing against the low risk premiums across ALL classes of debt securities on a global basis. Subprime mortgages are just the first to default and are currenlty causing the biggest ripples. There are quite a few public companies that are heavily leveraged with debt and are currently able to service that debt because of a relatively strong global economy. The real test will come when there is an economic slowdown.

  6. AustrianEconomist says:
    August 2, 2007 at 2:19 AM

    Suppose the Fed lowers interest rates next week because of “subdued inflationary pressures” (“officially” at least) and because of “declining credit availability to support future productivity growth” (read: subprime fallout).

    As a consequence the dollar would surely sink. All because of subprime and unpatriottic media such as housingdoom.com and Jim Cramer!

  7. twist says:
    August 2, 2007 at 8:38 AM

    AustrianEconomist-

    Hey- I’m opposed to lower interest rates for a couple of reasons.

    One, lower interest rates didn’t help Japan in their real estate crisis- it won’t help here.

    Two, Mr. Twist is an importer- if there’s one thing we hate around here, it’s a cheap dollar!

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