NERA Economic Consulting has released a white paper, The Subprime Meltdown: A Primer, which covers the mechanics of the subprime market as well as providing a good top-level overview of the securitization process. If any HW readers out there aren’t in the industry, or don’t understand this process, it’s certainly worth a read from that perspective. Most will want to read the second half of this paper, which provides an analysis of the current troubles in subprime lending versus the subprime credit meltdown witnessed in 1998 — and the authors argue that this time around, it’s a whole new ballgame:
The late 1990s witnessed significant credit deterioration … caused by credit concerns from the Russian debt crisis and the subsequent fallout from the failure of Long Term Capital Management (LTCM). Turmoil in the global capital markets, caused in large part by a debt default in Russia, led to a marked decline in investors’ willingness to assume risk. This was expressed by an increase in the price of â€œrisk freeâ€? US Treasury Securities relative to other credit products (the so-called â€œflight to qualityâ€?) as well as by a lack of demand for certain classes of debt securities, including securitized subprime mortgages, that were perceived as risky.
The authors of the NERA paper argue that the the causes of the current crisis in subprime lending are “clearly different,” and not driven by swiftly increasing prepayments and the same sort of shift in investor’s appetite for risk (as was the case in 1998). Instead, the authors argue that the current crisis is being driven by a massive increase in borrower delinquencies — sort of the trickle-up to 1998’s trickle-down. It’s an interesting paper, and although I agree in large part, I think there are some clear similarities to the market then and the market now — the current mortgage fund troubles at Bear Stearns in many ways ring a loud echo of Long Term Capital Management, even if nobody’s been writing about it (yet).