Michael Shulman

The Best Way to Trade the Banks in Early 2009

by Michael Shulman   12/24/08

The core, as always, is housing -- falling home prices, defaults, foreclosures and more bad mortgages than forecast.

Let's review the stats:

• One in 11 American homeowners is in default or foreclosure.
• One in 5 American homeowners (or 1 in 4, depending on who you read) lives in house worth less than their mortgage.
• Home sales were, arguably, the worst ever on record in November: Existing home sales fell 8.6%; existing home prices in Q4 fell 12% across all regions of the United States, led by a 12% drop in the Northeast; and new home sales fell 2.9% in November compared to a disastrous November 2007.
• More than 600,000 homes went into foreclosures proceedings in Q3, credit quality deteriorated and almost 9% of Americans are not paying their mortgages on time.
• More than half of modified loans are back in default or foreclosure.

And the situation is only going to get worse in 2009.

Some analysts see the option ARM, Alt-A and recession-driven mortgage meltdown in 2009 and 2010 as greater than the subprime mess (listen to what they have to say in this "60 Minutes" piece on The Mortgage Meltdown).

But wait, you say, the Fed is buying this stuff. Wrong -- the Fed is buying new stuff. And according to its charter, not policy but its legislative mandate, the Fed can only buy high-quality debt -- and that's not what we're dealing with here.

It starts with housing, then home prices, and then it goes to credit in general.

Did you know that $530 billion in commercial property loans come due in the next three years, and there isn't any money to roll them over? Or that credit card debt is no longer being securitized as no one will buy the bonds?

And this stuff stays on bank balance sheets. Again, Uncle Ben cannot buy these assets unless they are very highly rated and have truly secure collateral.

Wall Street Still Has Its Head in the Sand

Thus far, I have been focusing on the new problems Wall Street is underestimating. They are also underestimating old ones.