Kass: Subprime's Siren Call

Time and time again -- whether it be junk bonds, tax shelters, technology stocks, high-priced IPOs, glowing research reports -- Wall Street (despite former New York Attorney General Spitzer's noble initiatives) continues to exist for the purpose of raising capital (i.e., selling stocks and bonds) and not for the purpose of producing objective research and making clients money.

The brokerages' ties (in packaging and trading mortgage products) and earnings exposure to the subprime collapse -- they have 60% of the market share of the mortgage financing market -- were covered in depth in yesterday's New York Times article by Gretchen Morgenson. (Editor's note: A subscription is necessary to access this link.)

Broadly Negative Multiplier Effect

From my perch, the collapse of the subprime markets -- delinquencies now stand at 12.6% for subprime and 4.7% for the overall mortgage market -- within the context of the $6.5 trillion mortgage securities market will have a broad and negative multiplier effect on mortgage activity (housing turnover) and retail spending. It will also serve to further grease the current slide in new residential construction activity and hasten the drop in home prices.

It is important to understand housing's disproportionate role in terms of buoying employment and industrial production from 2000-06 in order to appreciate how violent the reversal's effect might be on aggregate economic growth. As I wrote back in October 2006:

The real estate industry has been responsible for 40% of the job growth since 2001.

The rise in home prices has provided for 70% of the increase in household net worth since 2001.

The increase in consumer spending and real estate construction spending has contributed to 90% of the growth in GDP since 2001.

Not only did new home construction embark on an era of unprecedented growth, but the broad rise in national home prices gave way to the concept of the "Home as an ATM" -- a source of cash, a substitute for savings and an enabler of the consumption binge (which was above and beyond the income means of the average consumer).