what's the fuss about subprime crisis?

Subprime is just one of the things causing these problems. There are a number of other issues that aren't being explicitly called out. There's a bit of a domino effect and the financial markets are worried that things are beginning to unravel.

Anoop

I'm in Canada and I heard our central bank pumped billions of dollars into the banking system the other day. Now all Canadian banks have US exposure, and if it's not in the personal lending side like mortgages then it'll also be in the brokerage side as well. I dunno if the Canadian central bank pumped all this money to help us Canadians out or to help out the USA which is still considered our largest trading partner

Canada's housing market is still in boom mode. New, Resale, and recreational housing prices increases are slower than they were but they are still increasing to record highs. Real estate agents are camping out to be the first in line in some developments here in Toronto and our province is in the weakest position in Canada. Some cities in Canada had prices increase 30% last quarter. At the same time our national wages increased above national inflation the last 3 years

So again why did Canada's central bank pump billions into a money system because of a problem that has nothing to do with us? This problem shows no signs are coming here. Unfenced border and all.

My guess is there is no credit left in he USA and private equity firms can't make payments so American brokerages and Banks must go to foreign sources for immediate cash. American Brokerages and smaller banks are prolly not able to sell the debt and are stuck with it on balance sheets. Bigger banks have good cash flows so they can hide it a bit easier. Brokerages can't hid it as well and funds have to be frozen. When funds are frozen, cash is not so liquid.

I looked at two private equity deals that mean alot to me: Home depot's sale of HD supply and here in Ontario the Teachers Pension plan to buy Bell Canada Phone company. The HD supply deal might be breaking down and the private group want a lower sale price. Home Depot can get stuck with HD Supply if the price goes to low.

In both cases the private buyers are having trouble finding the money they promised. I bet if you look at other private equity deals the case will be true. If the subprime and maybe Alt-A markets collapse tying up vast sums of money and of coarse the profits that were supposed to be made (and reinvested into other loans), maybe that's how it affects global money supply.

It's a symptom that housing overvalued worldwide and the effects of a correction will be major. Although people go on the news and say "it's contained to subprime", in private they're busy covering their own behinds. E.g. CEO of Countrywide selling shares a day before announcing the mortgage market is the worse they've ever seen.

Any evidence to suggest it's overvalued worldwide? Real estate always has been a very localized market in my understanding.

And what about housing markets for years that were undervalued?? Another point: There is a global shortage of urban and suburban housing worldwide now and the condition will only get worse with over half the world's population living in cities.

The city beside me where I wanted to live in grew by 35 000 in 5 years (that's double it's 2001 city size) and the city I work in has tripled in size in 1991 census. The rural area I left in has been pretty stagnant (3 hours drive from here) since the early 1990's.

I always thought real estate was a local condition, that's all.

And the fun ain't over. ARM resetting peaks in 1st quarter of 2008 with more mortgages ($ value) resetting in one month than all this year so far.

What we are seeing is a general repricing of risk, especially in the credit markets. The spread between Treasuries and junk bonds is lower than it has been in years. That is a symptom of people chasing yield and ignoring the risk.

Beyond sub prime mortgages, much of the leveraged buy-out boom we have been seeing is driven by cheap risky debt. I'm told that the broker that handled the paper for the Chrysler buy-out has been unable to sell it, so they are having to carry it themselves.

There are strong analogies between this current party and the dot com bust of

2000. Then, the market underestimated the risk of the Internet stocks. Now, the market underestimated the risk of various debt instruments.

-- Doug

There seems to be three facets of this issue, first, the anomoly in rates, specifically, the short term rate dropping to record levels, 1%. Second, the surge in the high end home prices. Of course you can say that the rates drove the prices higher, as the same dollar bought far more mortgage at 3% than it did at 9%. Last, the no-doc mortgages, brokers filling in applications that were signed when still blank.

Underestimating risk was certainly part of both events, at least the houses have some value, even 70% is better that the dotcom's 10% or less.

JOE

Not if nobody wants to pay for its maintenance. Owning becomes a no-brainer only if the cost of mortgage + property tax + maintenance + HOA dues + Mello Roos is less than or equal to the cost of renting. We are still far from those prices, and at least where I live, prices would have to fall another 40% for that equation to hold true.

Anoop

Real estate is local in terms of "houses are $XYZ in this neighborhood in this area compared to ..." Most definitely at a micro-level, the local economy/population/demographics/geography/weather/etc all combines to produce specific values.

But when you zoom out, credit is the tide that floats all boats. There are some places like Michigan where the auto industry is so unstable, the boats have already sunk. But for the most part, easy credit has increased the relative value of housing compared to previous values pre-credit-flood. And now the credit tide is ebbing like a reverse tsunami. I don't want to sound all doomsday-ey but just brief perusals of housing and mortgage environments nationwide and worldwide leave a very bad impression. Considering how much the housing boom has propped up the economy since 2001, having that burst will be a noticeable negative impact both here and worldwide.

Consider the timeline. When NEW/LEND/etc blew up back in February, Bernanke was on TV saying "subprime only - it's contained". Now you have companies like AHM going belly-up and CFC/IndyMac in dire straights. These are the major alt-prime lenders. The talking heads on TV are saying with a straight face "it'll stop here -- prime is safe". Then the big stock dropoff on Thursday came after AIG's released report of how they're seeing defaults rise significantly on all credit bands -- subprime, alt-prime and prime. And of course, they immediately followed up with "but it should not be a cause for concern because of XYZ and ABC". Do you trust any of these assurances after they''ve been wrong several times already?

three words: worldwide credit crunch.

To the above you have to add closing costs for both the purchase and sale of the house.

In my case, I'm reasonably certain that I will be moving in two years. I can rent for those two years for less than it would cost for the interest and closing costs for a house of equivalent value (never mind the taxes, insurance, and PMI.)

[...]

Somewhere I got the impression that China in particular has a major role to play in this. Last I heard they hold some tremendous amount, hundreds of billions if not trillions, of U.S. currency.

Also, a recent web commentary I skimmed through mentioned that large investors may diversify their debt holdings by acquiring both high qualilty senior bonds and sub-prime bonds. But now they are having difficulties finding buyers for the latter, so they may have to sell more of the former than they wish to, if they have to sell at all.

Disclaimer: macro-economics is not a topic of expertise for me.

-Mark Bole

I think the paper itself, the entire portfolio of subprime will settle out a bit better than you imply. The totality of the underlying real estate is not likely to be worth 40% less that when the loans were written. There are tranches which, by design, will retain full value, and those that are worthless. The very convoluted way in which these securities were created is beyond any discussion here, but my oversimplification is this: imagine a mortgage is sliced up into 10 notes, the first of which represents the first 10% of the home's value, and the last, the highest 10%. When a house is foreclosed, and sold for $70K vs a mortgage of $100K, only the first 7 notes are paid, the last three are lost. A brief analogy. Not every last mortgage is going to fail, and not every one that fails will return zero on the loan JOE

Somebody bought 3/4ths trillion of bad mortgage paper (CDOs). Its not exactly sure who all these somebodies were: five hedge funds, a French bank, and German bank went belly-up recently. Could your favorite pension fund, bank or mutual fund have some of these? Seems like a global mystery game of "CLUE" at the moment.

At least one more is that between fancy computer modeling and ratings agencies that did not do their job, much of the paper got rated AAA when it should be C or less.

The computer modeling said something to the effect of "based on history, these mortgages will default at such-and-such a rate and will recover such-and-such a percent of the value in foreclosure." The ratings agencies said something to the effect of "the model means that the paper has such-and-such chance of loss, so the paper is AAA rated".

Bah. Elle could have told them that past performance does not guarantee future performance. Especially when the loans underlying the paper were far shakier than the loans made in the past.

-- Doug

An excellent explanation from the Associated Press on August

12:

The latest crisis in financial markets has once again served as a reminder of how vital and interconnected the health of the U.S. economy is to that of the rest of the world.

the past week by fears that Americans are failing to keep up with their mortgage payments and the ripple effects that could have on the global banking and financial system.

The fallout could further depress U.S. housing prices by making it harder to find buyers for a glut of foreclosed homes. That, coupled with a drop in the value of investments, could leave U.S. consumers feeling poorer and less likely to spend on domestic and imported goods.

''The sharp falls in global stock markets obviously affect consumer wealth, which again could dampen spending,'' said Howard Archer, chief British and European economist at Global Insight.

The most immediate effect for the half of all American households who own mutual funds and other individual investors worldwide is a decline in the value of their investments, which may or may not be short-lived.

Around the globe, small-time investors are taking a beating. Stock prices have slid in recent days as fears of the market crisis infected markets worldwide. Worried investors sold stocks but finding buyers was hard, which caused share prices to dip even lower.

The distress in the markets makes it harder and more expensive for businesses and consumers to get loans and cash, Archer said. If companies cannot get loans, they cannot expand and may have to cut expenses, typically through layoffs.

America faced a crisis similar to the current mortgage fiasco when hundreds of savings and loan companies went belly-up in the 1980s. Back then, the fallout did not spread dramatically to foreign shores because the U.S. government stepped in to bail out the banks and repay depositors.

But the past two decades have seen a quantum leap in globalization and outsourcing, crumbling trade barriers, and a revolution in financial markets have knit the world tightly together.

A steep sell-off in global markets on Thursday and Friday was triggered by distress signals from France's biggest bank, BNP Paribas, which had to freeze billions of dollars in assets in three mutual funds because of the falling value of securities linked to high-risk mortgages taken out by U.S. borrowers. ... More Americans are failing to keep up with their home mortgage payments, and there are concerns that this could ripple around the globe because much of the debt from mortgages has been packaged into securities sold to pension funds, banks and other investors who were hungry for high returns on investments.

The same mortgage securities in the U.S. that are crumbling in value are a part of bigger holdings that banks from Japan to Germany bought into because of low U.S. interest rates and a good returns. That is, until the mortgage holders started defaulting.

For rest, see

"Douglas Johnson" wrote > At least one more is that between fancy computer modeling and ratings agencies

No, I don't think this is the sort of sound bite that captures what was behind this correction/panic. Computer modelling evidently was different, but I do not exactly fault it.

The following seems a good explanation of some of this:

See the other link I posted here for the whole kitten kaboodle. I buy it. In short, too much credit to the unqualified masses and we get a panic. I do not think the panic is exactly justified. I do, however, welcome the correction.

I think it was a faction of the financial sector (investment banks, broker etc.) that knew they could offer loans to poorly qualified folks/businesses and either (1) make out like bandits for the long run, based on fairly rational expected rates of default (many industries use past behavior of consumers to justify expectations; I don't at all entirely fault the use of history when running a business); and or (2) make out like bandits for the short run, even if they destroyed the U.S. and world economies for a while.

See the S&L crisis of the 1980s.

I find it rather profound that a mass of such "little people" (with individual mortgages) defaulting on their ill-gained (for whatever reason) interest only, adjustable rate, blah blah, "ooh, we can have a house just like the Joneses, even it it's way cheaper to rent!" mortgages affected major hedge funds and so much more wealthy folks. Remember the mortgage debts, through some serious ;-) leger-de-main, eventually landed in such funds, luring investors with the promise of great income, for one. Said investors being as uh, ill-informed, as the "little people," but having way more money to throw away in one fell swoop.

It has become way too fashionable to trust what the masses in the U.S. do. Everyone seemed to be getting an ARM starting a few years ago, so it must be all right. How many times have I heard that idiot cliché about, "We only plan to be in this house a few years, so an ARM or interest only mortgage makes sense." No, given the few year timeframe, renting is far lower risk and made far more sense.

It's this misplaced trust that interest only and ARMs were "okay," rippling through the markets as described in the AP article I linked in this thread, that led to this correction.

And yet, it is a needed correction. It will tend to plant people's feet back on the ground. Well, the smart ones who learn and read more. Or it will throw out stock carcasses for vultures like me to hover over, then swoop down and pick on and so allow me to make a bit more profit than expected in the coming years.

ARMs are insane when the yield curve is as flat as it is. I just checked bankrate.com and it shows a 30yr fixed at 6.24% and a 5/1 ARM at 6.07%. The borrower is taking on a lot of risk and not getting paid very well for taking it.

More of the financial illiteracy we have discussed in the past.

-- Doug

Not that Elle needs me to come to her defense. But you realize you quoted her out of context. She was quoting the misguided thoughts of those who took the ARMs, so in effect, you are agreeing with her. Where were we all to point out the ARM insanity when the t-bill was at 1%, and had nowhere to go but up. That 5/1 ARM you cite may not be wise, but it's short of insane. JOE

No doubt. You know, an acquaintance and I each bought a house when t-bills were that low. He recommended getting an ARM. I thought he was crazy, why would I get an ARM when I could lock in 30 year rates that were REALLY low? His reply was that interest rates had been nothing but going down, so the ARM was a good bet. Indeed they had, but how much lower could rates go? Would the banks soon be paying me for taking a loan? He got an ARM, I got a 30-year fixed. And he's a professional economist in, get this, the credit industry. I wonder how he's liking his ARM now? It may not have adjusted yet (this occurred in 2003), so he may have already, or he might soon, refinance at a reasonable rate.

-Will