Kass: Subprime's Siren Call

This column by Doug Kass was originally published on March 12 at 9:12 a.m. EDT on Street Insight. It's being republished as a bonus for TheStreet.com and RealMoney.com readers. For more information about subscribing to Street Insight, please click here.

Maybe Jim "El Capitan" Cramer is right when he writes, Get Over Subprime's Collapse and in his view that the brokerage companies will be relatively immune from the subprime carnage.

But I doubt it.

It is far too easy and convenient to dismiss the subprime woes based on the notion that because it is on the cover of The New York Times or on the tongue of many market commentators, it is either discounted or not as bad as it seems. Rather than listen to the comments of others on the Street and in the media, I prefer to deal in facts as opposed to simple and glib sound bites.

Here is a tidbit from Page 132 (yes, I do read every page in these filings!) of Goldman Sachs'(GS) 10-K dated Nov. 24, 2006.

Securitization Activities

The firm securitizes commercial and residential mortgages, home equity and auto loans, government and corporate bonds and other types of financial assets. The firm acts as underwriter of the beneficial interests that are sold to investors. The firm derecognizes financial assets transferred in securitizations provided it has relinquished control over such assets. Transferred assets are accounted for at fair value prior to securitization. Net revenues related to these underwriting activities are recognized in connection with the sales of the underlying beneficial interests to investors.

The firm may retain interests in securitized financial assets, primarily in the form of senior or subordinated securities, including residual interests. Retained interests are accounted for at fair value and are included in "Total financial instruments owned, at fair value" in the consolidated statements of financial condition.

During the years ended November 2006 and November 2005, the firm securitized $103.92 billion and $92.00 billion, respectively, of financial assets, including $67.73 billion and $65.18 billion, respectively, of residential mortgage loans and securities. Cash flows received on retained interests were approximately $801 million and $908 million for the years ended November 2006 and November 2005, respectively. As of November 2006 and November 2005, the firm held $7.08 billion and $6.07 billion of retained interests, respectively, including $5.18 billion and $5.62 billion, respectively, held in QSPEs.

Note to Cramer: El Capitan: I am officially ordering a Code Red!

The Subprime Fungus

"I guess we are a bit surprised at how fast this (subprime) has unraveled." -- Tom Zimmerman, head of Asset-Backed Securities research at UBS, in a recent conference call for institutional investors.

The fungus of subprime credits has grown in scope and in economic consequence over the last three months. We are now beginning to experience a full-blown bursting of the latest asset bubble, which could prove even more devastating than the piercing of the Nasdaqstock bubble in 2000. The impact of the subprime collapse on the availability of mortgage credit -- and, in turn, consumer spending -- is the primary reason why I believe the U.S. economy and corporate profits will materially disappoint most observers, and why the equity markets remain vulnerable.