Search Our Site

Custom Search

August 4, 2008


Actually, it’s been a year and a half

CNBC was running a story on Friday about how it is one year later since the mortgage backed asset market froze forcing the Fed to directly start injecting money into the economy and soon after, lower rates. CNBC believes that the credit crisis started last August when Jim Cramer had his famous meltdown on CNBC. In fact, the real start date of the credit crisis was March 8, 2007.

On March 8, 2007, New Century Financial, the first lender (subprime lender) to have problems, announced that it would stop originating any new mortgages. The company declared bankruptcy within a month and has since been under federal investigation for improper lending practices. The only question at the time was whether or not the pending crisis in the subprime market would move into the broader credit markets.

We now know that it did.

Last August, a number of ‘safer’ mortgages began to experience an increase in defaults and foreclosures. Now, let’s take a step back to what the mortgage markets had turned into during the housing boom. The original lender (the bank that writes the mortgage) would issue your mortgage for repayment (same as always).

However, investment banks wanted to get in on the housing boom, so they created something called mortgage backed assets. Essentially, these were paper that were being backed by the physical mortgage. In the event of a foreclosure, the originating bank and the investment bank were to split the asset.

Unfortunately, when foreclosures started to rise, originating banks either refused to pay investment banks to liquidate their portion of the mortgage, or due to the lack of a buyer on the market, they simply could not sell the homes and they just sat on the market. The result by August was that investment banks were holding billions in foreclosed mortgaged back assets, and they could not find a buyer.

Then, the Federal Reserve stepped in. The Fed bought billions in distressed mortgage backed assets to keep the entire investment banking system from freezing up. I also heard a rumor that a federal judge found that an investment bank could not collect, even if the distressed property had been sold, but this could not be confirmed nor denied.

Now, onto Jim Cramer. I know many people believe that Cramer was the “white knight” that rode in and saved the investment banking industry with his famous rant, but this is simply not true. Investment banks, up to the time of the Cramer rant, were not properly communicating with the Federal Reserve. The Fed felt that since they were not hearing of major problems, there was not much of an issue. The investment bankers figured that the Fed knew what was going on. The only thing the Cramer rant did was get one party on the phone with the other party and gauge the severity of the situation.
I used to have a great deal of respect for Jim Cramer, and I still do when it comes to picking individual stocks. I do not trust, nor do I believe that his opinion should be solicited for advice on the stock market as a whole, or any other economic analysis for that matter. Use the above videos to make your best judgment.


No comments:

Popular This Month