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Thursday, August 23, 2007

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Debt crisis. No problem. Contract stock prices by exactly 10%. Inject liquidity and lower the discount rate. Goldman creates a fund to buy the mezzanine loans off the balance sheets of major banks( I m sorry but this begs the question…exactly who is dumb enough to invest in a fund that buys loans in deals that could not get market financing the first time?), open high yield spreads to 400bps over treasuries, leave emerging mkt debt at +250. Crisis over, resume upward march f the market. Seems a little scripted to me. But, for the moment that’s where we are.

No one is talking about all the loans that will not be able to refinance in the year ahead. That’s a lot of paper and a lot of real estate someone is going to have to figure out how to move. As Wilbur Ross noted on CNN.Com:

Now that we have identified the cause of the disease, how severe and how contagious is it? The present $200 billion of delinquencies will grow to $400 billion or $500 billion next year because $570 billion more low, teaser-rate mortgages will reset to market and consume more than 50% of the borrowers' income. Therefore most of the loans will be foreclosed or restructured. Probably 1.5 million to two million families will lose their homes. Meanwhile, few lenders will put mortgages on the foreclosed houses, so the prices will plummet

No one seems bothered by the fact that junk over treasuries are still low by historical measures, or that in past credit event spreads blew out to well over 1000 bps. No one is bothered that there are still a whole lot of structured debt products out there and no one knows exactly who owns them or what they are worth. Sound the all clear and buy em seems to be the mantra.

I just cannot buy into it. A one-month credit crisis? Are you kidding me? This will continue to have an impact in the stock and real estate markets for a while yet. There are all those loan resets. It will be much harder to do LBO and PE deals with debt as loan underwriting is actually back in vogue and you will have to be able to prove that you can afford to repay the loan. This will be a drag on stock and bond prices. I don’t think the fed can bail the markets out either. After initial skepticism that the fed will lower in September but now I think they might. Certainly the futures market thinks they will. It is not however, to help the markets, but because the economy is slowing. The consumer is slowing down; unemployment will rise with newly unemployed mortgage brokers and processors padding the rolls. The Early September economic releases will bear watching closely. I think the market may be screwed here. If they don’t lower rates, there is a debt problem that the street cannot refinance. If they do, because the economy has weakened, that also bodes ill for stock prices.

I am not a long-term bear. Last Friday I had buy orders loaded up and ready to go as I expected a huge sell off before bernake and Co. stepped in. I was sure we would have a buyable sell off that would create short-term opportunities in stocks. Instead, courtesy of the fed I am still on the sideline. I won what I won here but I cannot bring myself to add at these levels. We need to be lower to reflect the worsening economic conditions and levels of risk that exist in the market and the world.

In running my screens this morning I found nothing new of any real interest. The runs are full of mortgage reits and real estate related companies. Let me stress that I truly believe that these securities will be one of the single great opportunities of a lifetime just like junk bonds in 2001. It’s just too early but companies that have quality real property, reasonably financed and managed are coming down in price. When we get another good sell off and the shares start getting puked at ridiculous prices, I will buy them. Right now, prices are just reasonable.

I remain a buyer of ADPT, ESST, EIHI,BHBC and BERK. They all fall into the too cheap not to own category.I am keeping a ver close eye on a lot of small banks as the prices move down. Small local banks with good management and an indepth knowledge of their market are one of the most fruitful investments you can make, provided you buy them right.Wen prices of the majority of them get under or close to tangible book value it tends to touch off a consolidation wave and strong stock price moves. I am looking for opportunities to sell near term puts in CHIC, BGP,UNM and DDS at good levels. I am still short USNA ( like my gun and my scotch bottle I ll give this one up when they remove my cold dead hands. I am very much of the opinion that the company has zero value), and on any more rally in prices I shall join the esteemed Mr. Crossman in being short the emerging markets buy buying puts and selling call spreads on EEM.

All clear? Not yet

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