Best of Kass: Subprime Bracketology

Spending on everything from appliances, furniture, flooring, roofing, paint, televisions, telephones and tools will suffer from the lower housing turnover and activity. The cessation of refinancing cashouts could have an even broader effect, constraining discretionary spending on restaurants, apparel, vacations, remodeling projects, automobiles and other durables.

With the demand for a broad array of consumer goods and services moderating, corporate profits are at risk -- and will quickly disappoint relative to expectations. Up until now, the service sector has remained healthy (even while housing and autos weakened), but even the buoyancy in services will be pressured and put to the test in the months to come. In the fullness of time, the rate of job growth will decelerate even more markedly than we have seen over the last several months as construction unemployment accelerates and the contagion permeates the broader job market.

More tepid top-line sales growth will weigh on corporate profit margins (one of the cornerstones to my bearish case for equities and valuations) as operating leverage will be difficult to come by. Unfortunately, all this will occur at the same time cost pressures remain high.

The CRB RIND Index -- an index of spot raw material prices -- just made a multiyear high last week, while unit labor costs have upticked to levels not seen in years.

In summary, the credit contagion that started with the fungus of subprime lending will hit an already weakened housing market and could spread to other securitized markets. Its impact will be felt broadly and should have a pronounced negative effect on personal consumption, corporate profits and stock prices. It will suck.

---

Four to Blame for the Subprime Mess
Originally published on 3/14/2007

3/14/2007 9:27 AM EDT

As I mention in my piece below, in time the broad-line money center banks stand to benefit from the carnage in subprime lending.

I will be adding to JPMorgan Chase (JPM Quote)), Bank of America (BAC Quote) and Citigroup (C Quote) longs on any further weakness.

My visceral feel is that we have an up day today based on the magnitude of the blood letting yesterday.

Long JPM, BAC, C

3/14/2007 8:52 AM EDT

There are four main culprits responsible for the expanding subprime debacle that threatens to upset the 'Goldlicks' scenario so many are trumpeting. I've listed them in descending order of importance -- and ranked by school grade!:

Culprit #1: Former Federal Reserve Chairman Alan Greenspan was no smarter than a fifth grader.

Greenspan did two big things wrong.

First, the former Fed chairman took interest rates far too low and maintained those levels for far too long a period in the early 2000s, well after the stock market's bubble was pierced. (Stated simply, he panicked).

The Fed's very loose monetary policy served to encourage the new, marginal and non-traditional home buyer -- the speculator and the investor, not the dweller -- to embark on a speculative orgy in home purchases not seen in nearly a century.

Over time, home prices, especially on the coasts, were elevated to levels that stretched affordability well beyond the means of most buyers. Ultimately, despite relatively strong employment and low interest rates, the residential housing market crashed hard.

Second, Greenpsan suggested -- at just the wrong time and at the very bottom of the interest rate cycle -- that homeowners retreat from traditional, fixed rate mortgages and turn to more creative and floating rate mortgages -- interest only, adjustable option ARMs, negative amortization, etc.