Bloomberg is reporting that the subprime shorts of the real estate mortgage collapse are now piling into long positions. Jon Paulson, inter alia, who made a killing ($15 billion, yes with a “b” in one year–2007), betting against subprime mortgage debt is now betting that the debt will increase in value. And why shouldn’t it? The Fed’s doing more of the same thing that stoked the furnace the first time around. Paulson’s not crazy; he knows that doing the same thing and expecting different results, however, is. From the article:
Hedge fund manager Kyle Bass, who made $500 million betting against subprime debt in the crash, is raising a fund to buy home loan securities. He’s joining Greg Lippmann, a former Deutsche Bank AG trader, and John Paulson, who made $15 billion in 2007, in betting on default prone mortgages. Goldman Sachs Group Inc. (GS) and American International Group Inc. (AIG) have also emerged as buyers this year as trading more than doubled for non-agency mortgage notes.
The $1.1 trillion market for U.S. mortgage bonds without government-backing is joining a global rally in everything from stocks and commodities to company loans, as confidence grows that Europe’s sovereign debt crisis will be contained. Investors are speculating the riskiest mortgage securities are priced to withstand an economic slowdown and home price declines even as President Barack Obama and the Federal Reserve pursue policies to combat the six-year residential real-estate slump.
If everything rallies simultaneously, does it really reflect anything more than that mechanism through which everything is priced (i.e., money) has lost value relative to that which it is intended to represent? These new subprime mortgage bets, given the environment in which they are being made, seem a sound one. But what sort of bet really are they? Are they a bet that subprime mortgages are more likely now to be paid by the borrowers? Or are they a bet that the federal government, through the Fed or other means, is likely to ensure, in ways not dreamt of five years ago, that borrowers are able to pay back their mortgages instead of losing their homes to foreclosure? This is, after all, an election year. A subprime mortgage bet is really nothing more or less than a political wager. Wall Street needs to replace all those quants with political scientists.
Anyone with growing confidence about Europe’s sovereign debt crisis is an utter fool. The long-term trajectory for the European welfare state is down, down and down. There will be bounces along the way, but Europe’s fifteen geologic minutes of world economic and cultural hegemony are over. One day in the not too distant future, people will pull out a globe and zero in on the miniscule Asian peninsula that comprises Europe and wonder how in the world its cultures, spun out of bunch of barbaric tribes only a few centuries before, had come to so dominate the world. Then, as now, there won’t be a good answer.
It was inevitable that subprime mortgage lending would make a comeback. Except that everything’s worse, nothing’s changed. There is still a massive trade deficit that must be financed, and since our sellers like to provide vendor financing, it mostly comes back to us in the form of investments that need to be made. There is an enormous glut of money (Greenspan famously called it a “savings glut”, as if) in excess of goods and services it needs to represent, pushing returns on money deep into negative real territory. There are more people than ever that don’t qualify for regular lending programs. The resurgence of subprime lending is upon us. It will end as sadly as before. You heard it here first.