Location: New York
Author: Lenny Broytman
Date: Thursday, December 6, 2007
The survival-of-the-fittest maxim Darwin spent a lifetime preaching applies to nearly everything.
And according to Barrons’ Don Brownstein, the world of finance is no different. Brownstein, a former philosophy professor and the chief executive officer of Structured Portfolio Management, notes that the theory is a major factor in the entire subprime debacle.
Brownstein begins my comparing the current financial problems present in the US to the population of white-tailed deer in Westchester, Connecticut. As Brownstein analyzes, the predatory nature of the current US credit market has helped to create a world in which a vast abundance of lenders are praying on borrowers with money.
By late 2006, as Brownstein notes, defaults began to mount and the economy was starting to realize that the lending sector had, perhaps, gotten in way over its head. As Brownstein writes, “That was the tip-off that triggered SPM to short subprime via the ABX subprime index and credit default swaps.”
As of this point, SPM, who is no longer suffering as badly from subprime exposure as it once was, is now on the prowl for healthier, more stable mortgage-backed securities and corporate bonds.
For Brownstein, the real crisis currently at hand in the US has to do with real estate more than anything else. Because of a tremendous rise in capital availability and a market that saw housing prices soar out of control in 2001, lenders began to dip to the subprime borrowers. With a market that quickly became infiltrated with lenders eyeing fat commissions with every subprime deal they closed, crisis was almost inevitable.
Brownstein also fielded the question of just how bad this subprime crisis can potentially get. “There are just so many borrowers out there but if you lever their loans over and over and over you can sell more bonds and that’s what happened,” says Brownstein. “The end result of this thing is we had a stupendously levered market and if you think of the leverage as an inverted triangle or pyramid, then you have this stupendous inverted pyramid balanced on the head of a pin and then the pin is the sub-prime borrower. This pin was constructed not from high tensile wire but from sugar candy and it’s melted. So now the poor pyramid, if it’s not already fallen, it’s tilting and is about to fall.”
Brownstein also touched on the Citigroup situation and their recent efforts to secure a credit relationship with Abu Dhabi. He cites Citigroup’s rather hefty 11 percent interest rate for the aforementioned and says that it is very likely that this is in fact a good indicator that times are getting rough. According to Brownstein, a recession is closing in on the US economy a lot closer than we think.
Although he does concede that the Federal Reserve does have the ability to make things a little bit better in the future, their ability to find a magical solution for what is now happening is fairly limited.
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