Saturday, September 08, 2007

The Sub-Prime Summer IV

The big question this summer is whether the economy is more Weebles or Jenga. Friday was just another in a series of big stock sell offs and finger pointing this round goes to a jobs report that was bleak to say the least.

It's Worse Than the Bulls Thought: As for the jobs report itself, it was indeed a horror show as an expected 105,000 job gain turned into an actual 4000 job decline in payrolls. So what if the unemployment rate didn't fall. This was a harsh reality for the markets to digest.

At this juncture, any talking head who views the recent market dips as that proverbial "buying opportunity" is either a fool or secretly loading up on his shorts. Clearly, the market worm has turned and stocks are in a technical downtrend. For those with weak stomachs for shorting, cash is king, at least for a month or two.

In an arbitrage world full of computer assisted derivative manipulations the foundation of the economy remains grounded in the real world.

U.S. Stocks Fall After Payrolls Drop: “If people lose their jobs, they stop spending, they default on debt, they can't pay their mortgage,'' said Neil Wolfson, who oversees $48.1 billion as president of Wilmington Trust Investment Management in New York. ``That's the worst-case scenario that people are worried about.”

Tanta at Calculated Risk is writing up lengthy and technical explanations of the changes in mortgage lending practices and markets. Our present situation is extremely complex but I do like this part of her summary.

Mortgage Origination Channels for UberNerds: In the old days, the depository lenders had “loan officers.” They were actually officers, and they actually decided whether to lend people money or not. In and around the 1980s, an idea arose that “loan officers” should primarily be “salespeople,” not credit underwriters, because they could reel in more borrowers that way. We took them off salary, put them on commission, and sent them to sales seminars in which everything they ever knew about evaluating credit risk was rinsed out of their brains in a deluge of sales tactics and lead generation and unspeakable “motivational” rhetoric. This resulted in a horrifying pile of terrible loans.

“Loan officers” became pure salespeople, who turned over their applications to underwriters, who were salaried and paid a lot less, in most cases, than the loan officers. These underwriters were stuffed into cubicles in “back rooms” where they were expected to uphold the institution’s credit standards in the face of an aggressive sales force who didn’t get paid unless the underwriter caved in. Since loan officers were paid on volume, not profitability or loan quality, the LO just wanted to get to the closing table as often as possible. The underwriters got paid whether the loan closed or not, but they quite often didn’t get paid enough to want to be beaten to a bloody pulp by salespeople and branch managers and production vice presidents.

Generally the underwriters reported up to the chief credit officer, who reported to the CEO. The loan officers reported up to the senior production manager who reported to the CEO. The CEO settled arguments based on either the good of the company or the bonus pool.

Think of this description as one Jenga block in the whole construction. Perhaps the question to focus on is not if the tower is going to fall, but rather how many Weebles get broken when it happens.