Don't Worry, Be Happy

♠ Posted by Emmanuel in , at 3/06/2007 11:13:00 PM
Pardon me for harping on last week's global stock market sell-off so much, but its ramifications have wide-ranging effects on the international political economy. In a deeply interconnected global economy, it is said that when the US sneezes, the rest of the world catches a cold. Unless proven otherwise, I will stand by that assertion. Just today, American bourses mounted a recovery of sorts as the Dow Jones Industrial Average gained 1.3% and the technology-laden NASDAQ 1.9% in the wake of a becalmed Asia. Sentiment may largely be behind this move, as a streak of poor economic data continued with January factory orders in the US falling by 5.6%--the largest drop in six years. The National Association of Realtors also said that pending home sales in January fell by 4.1%, supposedly because of "near-term weather disruptions." Don't worry, be happy.

An important driver of the recent sell-off in America has been increasing caution over subprime mortgages. Simply stated, these are home loans granted to borrowers with spotty credit histories. But, just as the housing sector has entered a slump, many loans granted to subprime clients have gone bad as the lack of diligence on the part of lenders in assessing credit risk has come back to haunt them. Still, today's stock-market gains have served as a panacea for those who believe that the rot in the subprime lending sector will not spread elsewhere. The various ABX indexes, which are used as benchmarks in insuring against mortgage risk, have recovered a touch. The closely-watched BBB minus series (representing the lowest credit rating) for loans originating from the second half of 2006 has shown signs of life after a precipitous fall -

Former Goldman Sachs CEO and current Head Cheerleader Treasury Secretary Henry Paulson also says don't worry, be happy:
U.S. Treasury Secretary Henry Paulson moved to soothe concerns about rising defaults at subprime mortgage companies, saying the woes won't spill over to banks that make less risky loans.

"Credit issues are there, but they are contained,'' Paulson said to reporters in Tokyo during a four-day tour of Asia. The U.S. financial sector is healthy and most institutions won't feel "a big impact.''

It's fair to say that Mr. Paulson did not read today's Bloomberg's article on the subprime situation--especially with regard to his former employer:

Goldman Sachs Group Inc. and Lehman Brothers Holdings Inc. would be hardest-hit on Wall Street if the slump in subprime mortgages becomes a credit crisis like the one that followed Russia's debt default in 1998, Sanford C. Bernstein & Co. analyst Brad Hintz said.

In that "worst-case scenario,'' pretax profit at Goldman, the world's biggest securities firm, would tumble 24 percent, Hintz, who's based in New York, estimated in a note to investors today. Lehman Brothers, the Wall Street's fourth-largest firm, would suffer a 20 percent drop in pretax earnings, he said.

Suffice to say, I am skeptical that the subprime mortgage meltdown is an isolated incident. As some say in jest, the 2000 stock market crash was just a localized problem in certain parts of the technology sector. Be wary: the cheerleaders will try to calm the markets, but harsh reality has a way of intruding on don't worry, be happy. Do catch the classic 80s song of the same title by Bobby McFerrin with its apt lyrics about the deadbeats causing much mortgage heartburn:

The landlord say your rent is late
He may have to litigate
Don't worry, be happy