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Minyan Mailbag: Subprime or Credit To Blame?


The process by which subprime imploded was a reduction in the credit edifice that supported the values of homes and the derivative securities that were built off of them.


Prof. Reamer,

Dr. Ben Stein in the NYTimes Business section says that losses from subprime mortgages may amount to $33 bln. Also, he writes:

1. The total wealth of the United States is about $70 trln.

2. Much more to the point, the fears and terrors about subprime mortgages have helped knock off 6.7% of the stock market's value in recent weeks. This amounts to about $1.1 trln, or more than 30 times the losses so far in the subprime market.

3. But how are the risks in Thailand or Brazil or Indonesia intrinsically related to problems in a housing tract in Las Vegas? The developing countries are fantastically strong and liquid.

What is he missing in this analysis? Do you think markets are overreacting?

-Minyan VM


He, like so many other analysts, is missing the larger point entirely. This is an asset class blow-up. And that asset class is credit. Sub-prime was simply the tip of a much larger and much more crowded long trade that is unwinding, and that long trade was credit.

The process by which subprime imploded was a reduction in the credit edifice that supported the values of homes and the derivative securities that were built off of them. That same credit edifice generated all manner of similar excesses in other asset classes buoyed by that common denominator: credit.

The blow up in Miami condos has everything to do with the 7% decline in South Korean stocks last night precisely becuase the prices of both were driven up by the same underlying credit creation mechanism.

There has never been an economic cycle - like the one that was birthed in 2002 and died in 2007 - more fueled by - more levered to - credit. It had all sorts of paliative effects on the way up - and only now are investors and consumers starting to understand the downside to that reality.


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