Minyanville's daily Five Things You Need to Know to stay head of the pack on Wall Street:
1. Subprime Woes Now Contained to Global Risk Appetites
A report by the Bank of England raises concerns that improper "distribution of risk" - of the sort that has fueled problems in the US subprime market - is related to "perverse incentives" created by loan originators in response to heightened risk appetites.
- Uh, what was that?
- In plain (non-economist) speak, they're simply worried that the same factors (heightened risk appetites combined with weak lending standards) responsible for the US subprime debacle may be in place across a broader spectrum of lending markets.
- Here in the U.S. Federal Reserve officials would have us believe that it's basically just a few bad apples (by "few" they apparently mean the more than 50 subprime lenders that have gone out of business over the past 15 months) writing loans to weak borrowers responsible for the subprime issues.
- What the Bank of England suggests in a rather roundabout way - and this is a crucial departure from U.S. Fed-speak - is that heightened risk appetites combined with weak lending standards are what is responsible for the subprime default explosion.
- In our view, heightened risk appetites are the horses that are pulling the carts... and the carts are basically global lending markets... not just a caravan of subprime gypsies camping on the outskirts of town.
2. Oh, By the Way, Heightened Global Risk Appetites Have Peaked
A cooling housing market and higher interest rates have made homeowners more reluctant to tap the equity they may have built up in their residences, the Wall Street Journal observes this morning.
- The amount borrowers owe on their home-equity lines of credit has slipped in the past six months to $561 billion at the end of last month, the first such decline since 1999 according to WSJ writer Ruth Simon.
- Now one might think, "OK, but $561 million ain't exactly chump change... although I spend that on snacks between lunch and dinner."
- Home-equity borrowing did increase 9% year-over-year through March.
- All true (except for the snack budget)... but keep in mind that, according to the article, the average annual growth rate of home-equity loans over the past five years is a whopping 21%.
- A recent paper by the (starved for anonymity) former Federal Reserve Chairman Alan Greenspan and Fed economist James Kennedy says borrowing against home equity "freed up" $187 billion per year between 2001 and 2005.
- Hahaha. "Freed up"! Get it? Home-equity borrowing "frees up" cash for consumers.
- So if "borrowing" against your home "frees up" cash, that must mean it's really not like "borrowing" at all! It's free!
- At least as long as the price of your house keeps going up.
- But everyone knows home prices never go down.
3. Subprime Woes Also Now Contained to Alt-A Mortgage Bonds
In yet mores signs that the containment is spreading, Standard & Poor's said it may lower ratings on bonds from 11 different Alt-A mortgages, according to Bloomberg.
- The move would more than double the number of its warnings on bonds of Alt A mortgages.
- And why are they lowering their ratings?
- S&P said it's considering the move amid higher-than-anticipated delinquencies.
- S&P said the early delinquencies in the bonds may be high because of "aggressive residential mortgage loan underwriting, first-time home-buyer programs, piggyback second-lien mortgages, speculative borrowing for investor properties, and a higher concentration of `affordability' loans,'' Bloomberg reported.
- Issuers of the ALT-A bonds involved include Bear Stearns, Bank of America and Countrywide Financial.
4. Subprime Woes Now Contained to Corporate Debt Too
Echoing the spreading containment above, BlackRock chief Larry Fink says lenders to highly indebted companies are making many of the same mistakes that undermined the US subprime mortgage market.
- "If I was the chairman of the Federal Reserve, I'd be paying attention more to that because, to me, this is going to be tomorrow's problem," Fink told the Financial Times.
- “Standards have deteriorated to levels that we never even dreamed that we would see," he added.
- While Fink noted that there were no signs of "contagion" in other markets, we imagine that it all depends on what ones definition of the word "contagion" is.
- True, there's no direct viral contagion; subprime loans have not mutated and "infected" other markets.
- But we're worried about behavioral contagion, psychological infections - that's what financial manias and hysteresis are at their core.
- And that's where the trouble lies.
5. Comparative Math Quizzes
A glance at two separate student questions reveals how much more advanced Chinese students are at mathematics than their counterparts in the UK, the BBC says.
- The UK's Royal Society of Chemistry is offering a £500 prize to the first person to correctly answer a question used by Chinese education authorities to assess pre-entry students.
- Below is the Chinese math question:
- By comparison, below is a question set by an English university for first year students:
- Finally, below is a question for fourth-year students at an American university:
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