Fallout in the Subprime Mortgage Market

Fallout in the Subprime Mortgage MarketIt is only a matter of time before troubles occurring in the subprime mortgage market spill over into the stock market. Most economists believe more than $1 billion worth of adjustable mortgages are scheduled to reset higher this coming year. In the early parts of 2007 we are already seeing the impact of so called exploding arms in the housing market. Foreclosures rates are skyrocketing higher as homeowners have been unable to keep up with their mortgages. At the present time foreclosure rates are still running in the upper range of historical averages, but should more significantly higher in coming months. Banks profiting from risky lending in recent years are rewriting lending standards to push out marginal buyers and selling off risky loans to anyone willing to buy them.

It appears it will only be a matter of time before concerns about mortgage defaults spill over into the stock market. Ever since the dot-com implosion, irrational pessimism has held over the stock markets. This continual sense of fear finally seems to be receding. Financial Watch is very bullish on the U.S. stock market this year, but strongly believe returns will be more volatile than in recent years. While the consensus is calling for gains in the upper single digits, we believe the markets should rally 20% this year.

In our forecast of gains approaching 20% we are factoring in a major market correction brought on by rising subprime defaults. It is near impossible to know how much damage investors may suffer. Lenders focused on serving questionable homebuyers seek to minimize their own risks by selling loans to investment banks and pension funds. New Century Financial and most recently Novastar have been forced to buyback mortgages that fell into default that were originated by the lenders. In our opinion neither of the market leading lenders will survive 2007.

The tip of the iceberg we are seeing right now has all of the makings to rival fallouts seen with Long Term Capital Management in 1997 or the savings and loan crisis of the late 1980s. In both circumstances that market sold off in a panic before recovering most of the losses. Financial Watch expects even the best financial firms to be caught up in the emerging crisis. In our view Goldman Sachs and Bank of America are the two best bets to profit during the upcoming market panic. Patience will be key. From where we are sitting we believe that several more months will pass before subprime troubles start to impact larger banks. However, it is nearly impossible to pinpoint the timing on a market meltdown.

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