by Erik Hare

Created on: June 30, 2007

When I was a kid, about the time "Mary Poppins" was filmed, banking was boring. They borrowed money at the prime rate, added a little to it, and loaned it back out. A bank made its money on the spread between the rates, and that was that. What mattered most was "credit worthiness", or the ability to borrow money and keep the whole thing going.

Funny thing happened to it all, at least in the mortgage banking industry, in the 1990s. So many people who didn't have access to good credit seemed like an opportunity waiting to happen rather than a foreclosure waiting to happen. Loaning out money was all about new opportunities and new products - certainly not boring.

This brings us up to today. The mess is substantial, and is in the mainstream nooze all the time. There is a website, lenderimplode.com, that tracks the grisly details. The only large sub-prime lender that has yet to announce fallout is Minnesota's own Wells Fargo, and the rumors are starting to get pretty ripe.

It's not as if we didn't see this coming, after all. Many of the articles on the topic are written by financial analysts who can legitimately claim, "I told you so". After all, new products in banking mean reaching a part of the world that hasn't been served before, which means there is risk being taken on as the default rates aren't well known. It's a lot like putting your tuppence down on the lottery and having your parents say, "That's not going to get you anything". Usually, it doesn't. They told you so.

But none of this will stop the turmoil. As veteran investment advisor John Mauldin tells us,
If you put just 4% (and it could be more!) of the homes sold
in the last two years back on the market within the next six months, it is
going to have a serious effect on housing valuations. While anecdotal evidence suggests home prices in many areas are starting to fall, lenders have not yet capitulated. In one county in California last week, 179 homes were put up for auction at the courthouse, with a reserve price of the mortgage value set by the lender. The lenders did not sell one home.
The fallout from this is likely to be devastating. Bubbles like this are caused by excessive capital allocation to one sector, and burst in a way that destroys capital by lowering the apparent value of what was purchased. The telcomm implosion of 2000 made the "dark fiber" of built infrastructure apparently worthless. In this case, the capital being consumed will come from the young and relatively less well off citizens across the US, who are the people who probably need it the most if we are going to have a fluid free market. I will not shed one tear for New Century, but their customers are
likely to be many of my neighbors.

What can we do about it? Sadly, not much. It's time to simply watch this unfold, andhope that the Feds worry about this more than they worry about inflation beingabove 2% (tuppence on the Pound). Over the long haul, there's only one thing we can do and that's to make banking boring again.

You see, Michael, you'll be part of Railways through Africa!
Dams across the Nile!
Fleets of ocean greyhounds Majestic, self-amortizing canals!
Plantations of ripening tea!

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