UP AND DOWN WALL STREET
More Meltdown
By ALAN ABELSON / Barron's(USA), 11 April 2009
It's only the middle innings of the great housing bust. Three cheers for Mr. Bass.
CARL BASS IS OUR KIND OF GUY. LET US HASTEN TO confess, we don't know Mr. Bass, apart from the fact that he earns his daily bread running Autodesk , which does some $2 billion a year designing and servicing software, and whose stock was a hot number until it got killed by the bear market (12-month high, 43; 12-month low, a hair under 12; current price, 19 and change). In other words, until last week Mr. Bass was, so far as we were concerned, just another corporate honcho.
What brought our attention to Mr. Bass and won him our instant esteem was an item in the latest screed by our Roundtable buddy and indefatigable tech-watcher, Fred Hickey. More specifically, it directed us to February's conference call with analysts, occasioned by release of the company's earnings for the final quarter of its fiscal year, ended Jan. 31.
Mr. Bass kicked off the proceedings, as Fred noted, by telling the telephonically assembled analysts the bad news. Not only were the bum results a far cry from what he had grown accustomed to, but, he sighed, "the global economic downturn is now significantly impacting each of our major geographies and all of our business segments." The turn for the worse, he made it clear, included emerging countries where business had been robust, like China and India. And, he added, the immediate outlook was more than a touch murky.
None of which deterred an analyst, champing at the bit for good news, from asking whether there were any regions left to exploit that so far had proved immune to the global slump. "Well," responded Mr. Bass, "I think Antarctica has been relatively immune, maybe Greenland, as well, although not Iceland, as we all found out."
Besides the pleasure of finding a CEO with a sense of humor and, equally important, one who doesn't suffer foolish questions gladly, the exchange struck us as symptomatic of the insatiable yearning of Wall Street, in general, and sell-side analysts, in particular, to uncover some sliver of bullishness beneath the dismal surface of the unvarnished truth.
That touching tendency to mistake dross for gold has been much in evidence in this spirited stock-market rally, five weeks running and still kicking. And it has by no means been restricted to analysts; it has infected market strategists and portfolio managers, to say nothing of economists (which is about all one can say about them without resorting to invective).
Even the most unfavorable news, from the relentless shrinkage in corporate earnings to the inexorable rise in unemployment, is all too often blithely shrugged off with the observation that "it wasn't as bad as expected," while neglecting to identify by whom. Nor does it seem even passing strange to the growing ranks of wishful bulls that banks that went begging to Uncle Sam for bailouts and were rewarded with billions have magically discovered, come the earnings reporting season, that, by gum, they're suddenly remarkably solvent (or should we say, seemingly solvent; just disregard several trillion dollars' worth of ugly stuff on their collective balance sheet, please).
We realize, of course, that Washington is on the case. And we feel for the poor, anonymous soul charged with the task of almost daily sending aloft still another trial balloon to rescue the banks. But we suppose she or he does gain a measure of satisfaction from the fact that even if the balloon goes nowhere but poof, more often than not it provides a fresh fillip to the markets.
Indeed, if anything, this whirlwind activity by the administration's economic team, this profusion of blueprints for recovery, so many of which are rapidly discarded or revised or embroidered, by all rights should be giving widows and orphans the jitters rather than prompting them to take the plunge. For it smacks of confusion or panic or both.
Believe us, we're impressed by the vigor of the rally and it's gone much further and faster than we expected. And we think those hearty types agile enough to have played the big bounce deserve a big pat on the back. That doesn't mean, though, that we think it's for real or sustainable.
What would cause us to change our minds is some credible evidence that the dark forces that wrought this dreadful recession are starting to dissipate. Instead, it pains us to relate, we see rough going in the months ahead. And that suggests to these rheumy eyes a disappointed market resuming its skittish ways.
BACK IN MARCH OF LAST YEAR, WE RAMBLED on about a piece on housing by T2 Partners, a New York money-management firm. The report weighed a ton, but its heft was made more than palatable by a profusion of easily accessible bold-face tables and charts and a lucid text happily free of equivocation. We waxed enthusiastic about the analysis (and no, we hadn't been drinking). It was, of course, quite bearish.
Well, the T2 folks recently issued a follow-up to that prescient analysis, again festooned with nifty graphics and graced with straight-from-the-shoulder narration. They're still bearish and still, we think, on the money. That original report, incidentally, has blossomed into a book by Whitney Tilson and Glenn Tongue, who run T2 (you'll never guess how they got the name for their firm); the book is called More Mortgage Meltdown and is slated to be published next month (end of public-service announcement).
In their latest tome, the T2 pair begin with a crisp summary of why and how housing collapsed, in the process wreaking havoc on both the credit market and the economy. Among the usual culprits, most of which by now have had the cruel harsh spotlight of publicity turned mercilessly on them, Wall Street comes in for special mention and, in particular, its critical role in disseminating collateralized debt obligations and asset-backed securities, or -- as they're respectively, if no longer respectfully, known -- CDOs and ABSs.
Those structured monsters, note Tilson and Tongue, were a "big driver" of the surge in financial outfits' increasingly bloated profits. To produce ABSs and CDOs, Wall Street needed "a lot of loan product," of which mortgages proved a bountiful source. It's unfortunately quite simple to generate ever-higher volumes of mortgages. All you need do is lend at "higher loan-to-value ratios, with ultra-low teaser rates, to uncreditworthy borrowers, and don't bother to verify their income and assets."
The only catch is that the chances of such a mortgage being paid off are just about nil, a trifling caveat that bothered neither lenders nor pushers one whit. The result of that cavalier approach, as we all have reason to lament, in the end has been anything but happy: Today, mortgages securitized by Wall Street represent 16% of all mortgages, but a staggering 62% of seriously delinquent mortgages.
As for home prices, the T2 duo reckon, the unbroken monthly decline since they peaked in July 2006 will continue to make buyers hesitant and sellers desperate, while the "tsunami of foreclosures" will maintain the huge imbalance of supply over demand. In January, they point out, distressed sales accounted for a formidable 45% of all existing home sales and, they predict, there will be millions more foreclosures over the next few years.
They expect housing prices to decline 45%-50% from their peak (currently, prices are down 32%) before bottoming in mid-2010. They warn that the huge overhang of unsold houses and the likelihood that sellers will come out of the woodwork at the first sign of a turn argues against a quick or vigorous rebound in prices. Nor is the economy likely to provide a tailwind, since T2 anticipates it will contract the rest of this year, stagnate next year and grow tepidly for some years after that.
The first stage of the mortgage bust featured defaulting subprime loans and their risky kin, so-called Alt-A loans. Together with an additional messy mass of Alt-A loans, the next phase will be paced by defaulting option adjustable-rate mortgages, jumbo prime loans, prime loans and home-equity lines of credit.
All told, Tilson and Tongue estimate losses suffered by financial companies from mortgage loans, further swelled by nonresidential feckless lending, will run between $2.1 trillion and $3.8 trillion; less than half of that fearsome total has been realized. Which is why, they contend, we're only "in the middle innings of an enormous wave of defaults, foreclosures and auctions."
We don't want to leave you with the impression that the T2 guys are cranky old perma-bears. They aren't. At the end of their report they point out that "the stocks of some of the greatest businesses, with strong balance sheets and dominant competitive positions, are trading at their cheapest levels in years." Nothing wrong with the companies themselves, they believe; rather, the stocks got beat up mostly because of the cruddy market and soft economy. Victims, as it were, of the bearish trends.
The names they like that fall into that not exactly overly crowded category are familiar enough: Coca-Cola , McDonald's , Wal-Mart , Altria , ExxonMobil , Johnson & Johnson and Microsoft . That doesn't exhaust their portfolio picks, but those are the ones they obviously think are best suited to ride out any resurgence of the bear market.