INVESTING: Subprime lenders slammed as housing bubble bursts

Subprime is a funny term. The word prime connotes best of class, front row, all that stuff. Stick the word sub in front of it and it seems as if you are getting something a few rows back, but still better than average. Pertaining to the residential mortgage market, however, the
word means something entirely different.

Asset bubbles are created from something genuine (the Internet is indeed changing everything) and they are extended through the use of leverage. Now that the housing market bubble has burst, we are beginning to see all the creative ways in which leverage
found its way into the bubble.

While I was a little shocked the first time I saw “no money down” a few years ago, by recent standards that was downright Warren Buffett-ish. The mortgage companies kept dipping further down the credit quality ladder until a heartbeat and a hand to sign with were the only requirements. There is a special sector of the mortgage market that specializes in dealing with people in the credit basement. It is called the subprime mortgage market.

Until a few weeks ago, there were a handful of major players in this sector, along with dozens of smaller companies and divisions of major financial concerns. In the last two months, more than 60 of the smaller players have gone bankrupt, GE fired 20 percent of the employees who worked in its subprime division, and firms like Goldman Sachs and
Merrill Lynch are being dragged through the mud for getting involved in this market. Ugly doesn’t begin to describe the fallout.

The largest company in the space, New Century Financial, has suffered an 80-percent stock decline in the last three months. Fraud accusations and book-cooking claims are coming down on New Century now.

As you might expect, our trusty federal government is trying to come to the rescue. Congressional hearings are being scheduled to find out how this fleecing of America could have been prevented. The real tragedy will occur when our government starts to pass more harmful laws that will slow down what promises to be a long and painful recovery process.

A few useful ideas popped into my head as the headlines were at a fevered pitch. One is that the bubble is most definitely broken now, and you will never again see residential real estate experience the kind of moves it did in the last five years.

Another useful nugget is to not be in a hurry to buy stocks related to the sector. Home builders and mortgage companies alike will move and sputter for at least the next several months, if not years.

Even so, if you’re in the mood for a big gamble, buy a little Novastar Financial. It is the second-largest subprime provider and its stock has also been bombed recently. There’s the off chance that Bank of America will buy Novastar for what amounts to lunch money for a regional branch.

But as I said, this is a big gamble. Even with the stock at $5, down from $35 a year ago, it could fall further, bottoming out at as low as $2. But I understand that sometimes you look to Wall Street for a little casino action, and this play might just scratch that itch.