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Five Things You Need to Know: Who's Buying Subprime Now?; S&P Delinquently Considers Delinquency; Defending M3; Minyanville Oracle Index; Reconstituted and Rebalanced Minyanville Oracle Index

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What you need to know (and what it means)!

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Minyanville's daily Five Things You Need to Know to stay ahead of the pack on Wall Street:

1. Who's Buying Subprime Now?

As problems at two Bear Stearns hedge funds have Wall Street mortgage desks scrambling to offload subprime debt to bids as low as 30 cents on the dollar, the question now is who is buying what they're selling? Why, the usual suspects of course: university endowments. Seriously.

  • According to the Wall Street Journal, university endowments are stepping up as buyers of subprime debt.
  • "There's an opportunity out there to buy these loans at a discount," Lou Morrell, vice president for investments and treasurer at Wake Forest University told the Journal.
  • Wake Forest's $1.2 billion endowment is in the process of placing about $25 million with a hedge fund to invest in subprime mortgages, the newspaper reported.
  • Because subprime loans could sell for steep discounts, "they will be popular with a lot of endowments out there," Morrell said.
  • Wake Forest isn't alone. Vanderbilt University has earmarked $50 million to invest in debt backed by subprime mortgages.
  • Bill Spitz, chief investment officer for the $3.4 billion endowment at Vanderbilt, says he has no expertise in the mortgage market, but is placing money with a new fund from Trust Company of the West as part of Vanderbilt's strategy of putting as much as 5% of the fund's assets into "opportunistic" investments they hope can boost returns, the Journal said.


2. S&P Delinquently Considers Delinquency

Delinquency rates for residential real estate loans are considered "low by historical standards" by most housing boom apologists. According to data from the Federal Reserve, delinquency rates at all banks on residential real estate loans are barely at 2%. But here's the catch: what exactly IS a delinquent loan?

  • According to the Fed, delinquent loans are those past due thirty days or more and still accruing interest as well as those in nonaccrual status.
  • However, the problem is delinquencies - low "by historical standards" but running at their highest rate since 2002 (you know, 2002, the good old days of what the Fed feared would be a deflationary collapse) and as of first quarter data just posted their largest year-over-year surge ever - are very likely dramatically underreported.
  • Why? Because lenders have many incentives to modify loan terms to help borrowers avoid default or delinquency.
  • These days lenders are doing everything from changing the terms of mortgages to lengthen the maturity and lower the payments, to forgiving payments outright for a period, to decreasing the interest rates.
  • That's all well and good... unless the models for pricing mortgages rely on delinquency rates and defaults to help establish risk parameters... as we are now discovering.
  • Now, Under proposed new rules, S&P said it may change its debt rating criteria on home-mortgage bonds and begin classifying loans as delinquent or in default when their terms are changed to be more favorable to borrowers.
    Bloomberg.
  • Delinquency or loss rates are tracked as part of so-called triggers in the securities that control the amount of protection investors in the securities receive, the article explained.
  • And as we now know, excluding a loan with changed terms from delinquency or loss rates may mislead investors on the performance of the security.
  • In other words, objects in mirror may be closer than they appear.


3. Defending M3

European Central Bank President Jean- Claude Trichet defended the role of money analysis in setting interest rates overnight, saying central banks including the U.S. Federal
Reserve ignore it at their peril, Bloomberg reported.

  • The European Central Bank relies heavily on monetary indicators, especially M3, to predict inflation and guide central bank policy.
  • In contrast, the U.S. Federal Reserve ignores M3, and last year went so far as to simply stop reporting it altogether.
  • Trichet said that while prolonged periods of low and stable inflation make it more difficult to interpret changes in M3, "the long-run relationship between money growth and subsequent inflation is still in the data.''
  • This is true "not only for the euro area, but also for the United States, where the stability of such a relationship has been most strongly questioned in the past,'' he said, according to Bloomberg.
  • The ECB views M3 expansion above 4.5% as inflationary.
  • Yet M3 has expanded more than the 4.5% in every month since May 2001, increasing 10.4% year-over-year in April, almost the fastest growth in 24 years.
  • Here in the U.S., according to the John Williams' Shadowstats Web site, ongoing M3 growth has broken above 13%, now at a 33-year high, and is nearing levels last seen before 1973/75 recession.

    M3 - Click to enlarge.


4. Minyanville Oracle Index

"Oh Oracle, we pray to receive thy wisdom and guidance, that it deliver us from our epic journey; beset on all sides by villains yet vanquished, battles yet fought, ships for now unbroken upon the rocks of unknown lands. Tell us, oh Oracle, what should be the fate that awaits us?"
- Unidentified self-described huge oracle fan, circa. 1929

If there is one thing that can truthfully be said to have endured the inexorable progress of time, it is this: Everybody loves a good oracle!

In ancient Greece, no self-respecting warrior would have dreamed of making an important economic decision, or brutal and unprovoked cross-border invasion, without first consulting an oracle. If the King of Thebes had only listened to his oracle, perhaps he could have avoided being viciously murdered by his own son, Oedipus, who would later go on to sleep with his own mother before scratching his eyes out. At the very least, he might have decided against naming his son Oedipus.

What is it about an oracle that inspires such awe and reverence? Could it be the fancy robes they wear? No, it could not be. Instead, it is their ability to see and predict the future!

People who can accurately predict the future tend to freak other people out. Especially people who have trouble remembering things that have already happened! We at Minyanville, like you, are among those totally freaked out by people who can predict the future. Who knew? The oracle knew, that's who.

Last year, while pretending to do science we constructed what we call the Minyanville Oracle Index. The Minyanville Oracle Index is a capitalization-weighted* (see chart below) basket of 10 oracles that were carefully selected from among the 10 oracles that immediately came to mind.

Thanks to the Minyanville Oracle Index, traders and investors will one day be able to accurately predict the future of a basket of oracles who are themselves predicting the future. This could theoretically allow an investor or trader to potentially predict the future of the future itself!

Friends, what if I told you that not only could you know the future in advance, but you could also know the future of the future even before those who already know the future? Would you consider that to be an advantage in today's highly competitive market? I should think so. In fact, thanks to the Minyanville Oracle Index, I don't just think so, I know so. Moreover, several minutes ago before I even wrote that last sentence I knew that I would know so! And I knew that I would know that too! Yes, I even knew that. And that too. I know! Whatever.

The most famous oracle of all time, and the largest weighting in the Minyanville Oracle Index, is the Oracle at Delphi, which carries a 28% weighting in the index.

Oracle at Delphi - Pythia

Dating back to 1400 B.C. the Oracle at Delphi, known as Pythia, lived in a shrine around a sacred spring near the foot of Mount Parnassus. People traveled from all over Greece to ask the Oracle at Delphi questions.

The Greeks considered the Delphic Oracle to be the center of the world. This is probably because no one thought to ask her if she was located at the center of the world, because if they had thought to ask , "Hey, are you located at the center of the world?", she of course would have replied, "No." Why would she have replied no? Because she is an Oracle, jackass, and so naturally she would have known the answer to such a simple question right away. Moreover, the question "Hey, are you located at the center of the world?" is not even about the future. It's about location, which exists outside of time in what is called Real Estate. But I digress.

One funny thing about oracles: The bigger they are, the harder they fall. Several years ago scientists discovered that the Oracle at Delphi sat above a fault line running east to west. That would be no big deal, except for the fact that the location above the fault line meant the oracle's trance-like behavior was simply the result of constantly inhaling ethylene gas produced from below the surface of the earth. That too would be no big deal, except ethylene gas produces a narcotic effect in those who inhale it. Turns out that what the oracle meant by "predicting the future," was "sitting around in a temple-like shrine all day getting high and saying weird stuff." It's a long way down from the top.

Minyanville Oracle Index
* By "capitalization-weighted," we mean random.



5. Reconstituted and Rebalanced Minyanville Oracle Index

In addition to the Oracle art Delphi, the Minyanville Oracle Index consists of 9 other components. Below are the reconstituted and rebalanced components and weightings of the Minyanville Oracle Index:

1. Oracle of Delphi

Dude, it would be awesome if the Oracle at Delphi really looked like this!
28% weighting

2. Oracle of Omaha

Classic oracle pose.
Warren Buffet, 19% weighting

3. Oracle of Oracle

Semi-modified modern oracle pose.
Larry Ellison, 16% weighting

4. Oracle of Urkel

That's one way to do it.
Jaleed White, 10% weighting

5. Oracle of Motorcycles

The Adventure MotOracleCyclist pose.
Jim Rogers, 9% weighting

6. Oracle of Margin Calls

Prediction: More selling.
Bear Stearns, 4.5% weighting

7. Oracle of U.N.C.L.E.

We think he's predicting danger.
Robert Vaughn, 4.5% weighting

8. Oracle of Barnacles

Classic oracle "ready" pose.
SpongeBob SquarePants, 4% weighting

9. Oracle of Anti-Cristal

Definitely not predicting any bubbles in the near future.
Jay-Z, 3.5% weighting

10. Oracle of LA County Jail

Didn't see this one coming. No, wait, actually we did.
Paris Hilton, 1.5% weighting

No positions in stocks mentioned.

The information on this website solely reflects the analysis of or opinion about the performance of securities and financial markets by the writers whose articles appear on the site. The views expressed by the writers are not necessarily the views of Minyanville Media, Inc. or members of its management. Nothing contained on the website is intended to constitute a recommendation or advice addressed to an individual investor or category of investors to purchase, sell or hold any security, or to take any action with respect to the prospective movement of the securities markets or to solicit the purchase or sale of any security. Any investment decisions must be made by the reader either individually or in consultation with his or her investment professional. Minyanville writers and staff may trade or hold positions in securities that are discussed in articles appearing on the website. Writers of articles are required to disclose whether they have a position in any stock or fund discussed in an article, but are not permitted to disclose the size or direction of the position. Nothing on this website is intended to solicit business of any kind for a writer's business or fund. Minyanville management and staff as well as contributing writers will not respond to emails or other communications requesting investment advice.

Copyright 2011 Minyanville Media, Inc. All Rights Reserved.

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