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Mortgage ETFs: Long, Short, Why?

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Feb 4, 2009 3:24 am

Proshares, God bless them, is launching two mortgage ETFs: Prime and Alt-A. The way I see it, there are two primary risks: economic and legislative. They say that the market is extremely inefficient. Performing loans, AAA, are being priced at junk status. Yield talk is about 15%.

1. The current administration is eager to “fix” the US banking system. Some economists believe nationalizing the banks is inevitable. From today’s "The same crap asset that the government will buy on your behalf has four different values:

The carrying value: $0.97. The dreamy hallucination that the bank that is stuck with the assets is telling its shareholders it is worth. The fact that there is almost no scenario that would lead to the crap asset actually being worth this much is why no one trusts banks anymore.

A third-party assessment of value: $0.87.   S&P’s sharp analysts, the ones who almost certainly rated this security AAA when it was first dumped on unsuspecting buyers, say it is worth more than 10% less than the bank says it is worth.

A conservative third-party assessment of value: $0.53. What S&P estimates the crap asset is worth if the economy doesn’t immediately rebound, which is about half of what the bank says it is worth.

The market’s objective assessment of value: $0.38. Unlike the bank and S&P, markets have no incentive to misrepresent the true value of an asset (or to look at it through rose-colored glasses). And the market says the asset is worth about a third of what the bank says it is worth.

Translation? We’re going to overpay for the crap assets and secretly recapitalize the banks at taxpayer expense."

2. Can mortgage pricing rise in the face of 8%-9%-10% unemployment? Based on my personal experience in South Florida, the situation is getting worse. Home equity lines are getting closed, commercial lines of credit are getting called, credit cards are slashing lines, and bank loan committees are running tighter than a nun’s corset.

All businesses, maybe with exception of general MDs and liquor stores, are feeling the slowdown. We are facing a new baseline for consumer consumption where old spending habits are gone and less discretionary spending will emerge.

Feb 4, 2009 1:46 pm

Interesting theory.  Probably makes sense.  We can’t see it right now, but once we are through this debacle, inflation re-emerges, and people are back to work, this too will become a distant memory and people will start spending again.  Remember, there will be lots of deferred purchases pent up in the market (autos, homes, major appliances, home repairs/remodels, etc.).  This goes the same for businesses.  Everyone is clutching their wallets right now.  In my previous career as a finance director, this was more common (I worked in Manhattan during 9/11).  We went through real rough patches in my industry, and spending was basically halted altogether, outside of the essentials.    But once revenues started flowing again, we went on spending sprees.

  I can say, and only anecdotally, that even very wealthy business owners are holding on right now.  Several that I know are very concerned.  Their previously "recession-proof" businesses are getting slammed, and they have serious concerns.  Funny thing is, I know a few "sandwich shop" owners that have said they are doing very well.  As-well or better than pre-debacle.  Now, these are not the $9/ pannini sandwich shops.  These are the $4 turkey on rye type of places.  But just an interesting observation.