The Fate of Subprime Debt: More Than Half of US ARMs to Go Bad

"It is not given to man to know his fate," we keep saying. And yet, his fate is often right in front of him. Anyone can see it coming.

What other fate could there have been for subprime lending…except the fate we are watching right now?

Beazer Homes (NYSE:BZH), one of the biggest builders, is rumoured to be facing bankruptcy. So is one of the biggest mortgage companies - American Home Mortgage Investment Company (NYSE:AHM). Bloomberg reports that the firm "lacks cash to fund new loans".

Is this what the deflating of a credit bubble looks like? Yes, it is. And there's plenty more where that came from.

Ludwig von Mises once said:

"There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved."

"Unfortunately, it's too late to stop the crackup," says our friend Mike "Mish" Shedlock. "All you can do is be ready for whatever market volatility is headed down the pike."

It will take years for the housing slump to end, says a New York Times article. Many house buyers apparently didn't even realise that their mortgages had adjustable rate clauses. Now, they're finding out…and finding it difficult to cope.

Economist Gary Shilling thinks as many as half of all subprime ARMs will go bad - meaning, about 1.7 million homeowners will be forced to give up the roofs over their heads. So far, house prices are down about 3% coast-to-coast, according to the Case-Shiller index. JP Morgan (NYSE:JPM) predicts that the index will go down 15% to 20% in the next two or three years.

"The worst is still ahead," says the NYT piece. ARMs really caught on in the spring of '05. The peak in adjustments will hit in October of this year - with about US$50 billion in mortgages up for reset.

How will consumers make the higher payments? Won't they have to cut back elsewhere? Won't lower consumer spending have an effect on the rest of the economy? And what about all those housing-related jobs…what will those people do? Aren't these follow-on effects also right in plain view?

If so, US Treasury Secretary Henry Paulson claims not to see them. The problems in subprime pose no threat to the rest of the economy, he says. His comments remind us of an old expression from the Soviet Union: Nothing is ever more certain than when it has been officially denied.

In fact, credit problems are turning up everywhere. For while the cheap suits were selling subprime ARMs to unsuspecting homebuyers in poor neighbourhoods, the expensive suits were throwing money all over town.

We got word yesterday that France's Oddo Asset Management Company had to close three hedge funds. And a couple funds in Australia are in trouble too.

Meanwhile, as much as US$50 billion worth of mergers, acquisitions, leveraged buyouts and other corporate paper is said to be either on hold…or waiting for finance. Blackstone (NYSE:BX), the great private equity firm, got its paper off before the credit bubbles sprang a leak. But its shares are now selling for 20% below the IPO price. Competitor KKR (AMS:KPE), with an IPO in the pipeline, is rumored to be considering canceling it. And the junk bond market has just suffered its worst month in five years. But what did you expect?

Bill Bonner
The Daily Reckoning Australia

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