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Construction Boom: Built-In Subprime Risk

Jim Cramer

The amount of disinformation about subprime loans is simply out of control. Without compromising my view of a Fed rate cut in May, which was buttressed by everything from FedEx's(FDX Quote) weak earnings to Darden's(DRI Quote) poor traffic in last week's releases, you have to weigh the real consequences of subprime with the data we have out there now.

First, we need to analyze how much of subprime is fraudulent, and how much of it is from flippers vs. undocumented immigrants.

I say this because if you are going to put no money down on a house, why in heck should you keep the house if it doesn't go up in value unless you bought only one house and you can refinance? I think the number of foreclosures in the latter cohort is smaller than you think. The former cohort, though, carries a high walkaway factor. And I think the speculators were big. The so-called "tightening" of credit standards is simply a return to where we were in 2004.

Going forward, credit-toughening-wise, if you are going to get a loan with little money down, you can easily get one from the Federal Housing Administration, but you have to put 3% down. Can we accept that if you can't put 3% down, you aren't ready for the American dream?

You can't, however, get an FHA loan to speculate on a house, and you can't get one if you are an undocumented immigrant. The Washington Post says 25% of these immigrant loans are going to foreclosure. We don't know how many of these were made, although the Post says 375,000 were made in 2005.

Now, how bad is it going to be for the public homebuilders? Take a look at the earnings call from KB Homes(KBH Quote). Let's stipulate that KB Homes is one of the worst homebuilders, with a big California component. But if you go through the quarter, the exposure to bad loans has already washed through. The building of new homes has been cut back to "only build if sold ahead." The building loans are from Countrywide(CFC Quote), which maintained higher standards. This is one incredibly well contained mortgage meltdown, if you use the benchmark of a homebuilder that is worst in show.

And if we really had a huge problem in subprime, it wouldn't be a question of it spilling over to prime. It would be a question of how badly Wells Fargo(WFC Quote), WaMu(WM Quote), Cerberus Capital Management and General Electric(GE Quote) have been hit. Those are the legit subprime companies besides Countrywide, which has already said it's not much of a problem. These are the lenders who are not fly-by-night mortgage brokers with no deposits to back their bad loans.

I am not minimizing the headline risk to this industry. And I am worried about employment. Any reversal of the tepid employment growth we have will change the demand side for certain and put out more supply.

But a lot of this problem is known. When a problem is known, it tends to get discounted by the market, unless the people in the media haven't done their homework.

Oops, that's a given, so there will be more headline risk ahead. But I'm beginning to believe that the knowledge of the problem is getting built into the market.

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