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host · 03-03-2007, 01:16 PM

This was "the news" on thursday:

Quote:

http://www.marketwatch.com/news/stor...8EF19A722BA%7D
New Century upgraded at Bear Stearns

By Alistair Barr, MarketWatch
Last Update: 4:19 PM ET Mar 1, 2007

SAN FRANCISCO (MarketWatch) -- New Century Financial Corp. was upgraded Thursday by analysts at Bear Stearns, saying the risk of the subprime lender's shares falling further is limited by the potential for an acquisition of the struggling business.
Shares of New Century (NEW :

News , chart , profile , more
Last: 14.65-1.20-7.57%
4:03pm 03/02/2007
were lifted to peer perform from underperform by Scott Coren and Michael Nannizzi at Bear Stearns.
The shares climbed almost 3%to $15.78 during afternoon trading Thursday. They've still slumped almost 50% so far this year due to signs of a credit crunch in the subprime-mortgage industry.
Subprime mortgages are offered to home buyers who fail to meet the strictest lending standards. Companies like New Century that specialize in these types of loans have suffered as housing prices stopped rising and interest rates climbed from record lows. See full story. ....

....and yesterday.....just a day later:

Quote:

http://www.marketwatch.com/news/stor...t=MostReadHome
New Century says it faces criminal probe
Subprime-mortgage lender warns it will likely breach lending covenant

By John Letzing & Alistair Barr, MarketWatch
Last Update: 9:04 PM ET Mar 2, 2007

SAN FRANCISCO (MarketWatch) -- New Century Financial Corp. said late Friday that it's facing a federal criminal probe and will likely breach a major lending covenant with its financial backers, bringing into question the survival of the second-largest U.S. subprime-mortgage lender.
The U.S. Attorney's Office for the Central District of California is conducting a federal criminal inquiry into trading in New Century securities as well as accounting errors, the company wrote in a regulatory filing late Friday.
The Securities and Exchange Commission also is looking into the company, as is the regulatory arm of the New York Stock Exchange, New Century disclosed. The company added that it is complying with all three inquiries.
Shares of New Century (NEW :
new century financial corp m com
News , chart , profile , more
Last: 14.65-1.20-7.57%
4:03pm 03/02/2007

NEW14.65, -1.20, -7.6% ) were down almost 25% in after-hours trading Friday at about $11, after falling more than 7% in the regular session to $14.65. .....

My observations are that is possible that Bear Stearns had some large holders of NEW that needed to unload their shares before the impending news, hence, the "upgrade".
<img src="http://chart.finance.yahoo.com/c/1y/n/new">
It is not as if "the news" was unknowable:
comments in reaction to the 02/04/07 New Century Financial conference call:

Quote:

http://forum.themarkettraders.com/re.../3023#msg-3023
....Financial Fantasy Land

I listened to the New Century Financial conference call today, and I'm convinced the executives of that company are from another planet. I think most of the analysts who called in would agree with me. They seem to be from a fantasy world where financial results according to GAAP are all that matters, and to the extent they can manipulate earnings, they are able to manipulate the truth.

When the call started, the stock was already down about 3.7%, having missed their estimates for the first time in ages. As the call went on and one amazing revelation after another came out, the stock kept dropping and now is down about 10%. Among the things that were revealed:

1. They borrow $1 Billion for 1 day every quarter so that they can show that Cash on their balance sheet.

The Billion dollars they borrow for a day is to help them "explain" their financial situation better. If they didn't borrow that money, then people might be confused and think they didn't have that much cash. As we all know, the amount of cash you own is of course equal to the amount of money people are willing to loan you. We should thank them for simplifying their accounting for us by borrowing money they don't really need right now and putting it where we can see it on their balance sheet.

2. They sell mortgages to themselves because they can report higher gains on the sales than if they sold them on the open market.

They were especially proud of becoming a REIT and all the imaginary benefits that bestowed on their results. While selling mortgages from their lending unit to their REIT unit resulted in nice gains on their income statement, the gains weren't taxable because they weren't real. Talk about the best of both worlds!

3. They aren't assuming any losses on certain portions of their loan portfolios now because most defaults occur later in the life of the loans.

The business of profiting from making bad loans depends on lending more money each and every quarter. People don't usually buy homes if they are already in deep financial trouble. It takes them awhile to get in trouble, so new loans rarely default. Therefore, new loans don't need to allow for losses because losses won't happen until the future. Since there's no guarantee there will even be a future, what's the point in allowing for such losses anyway?

4. They lowered their assumptions of future defaults which boosted earnings by 8 cents per share, and they now think $90 Million is enough reserves for future defaults on $19 Billion worth of loans.

Sure, some of their loans are delinquent, and while its nice to report late fees on these loans as profits, some allowance should probably be made for the remote possibility that there is a tiny inkling of a chance that they might lose money on these a minute faction of these loans, so it wouldn't do too much harm if they reserved a little bit of money for these loans when earnings are good. If they ever have a need, they can lower their assumptions to inflate their earnings, like they did this quarter.

What's that? All you banking analysts don't think they're setting aside enough reserves? By an order of magnitude? Well, let me assure you that their experience during the last 8 years (the greatest housing boom, HELOC expansion and cash out refinancing surge of all time) indicates that loans almost never go bad. All they have to do is rely on past results to indicate what will happen forever into the future. So obviously you are all wrong!

5. They believe that their customers can handle a 34% increase in mortgage fees on their ARMS.

20% of their loans over the past 2 quarters have been interest only, so obviously their customers understand interest. Besides, they have a lot of customers who actually have decent credit ratings. These types of people know how to budget and plan for the future.

6. They believe that housing prices can't go down by 10% and even if they do, their customers won't walk away from loans.

It's never happened before on a national level, and they say that all the talk about a housing bubble is dying down. Besides, they aren't making any more land and housing prices always go up. Plus, once customers learn to account like New Century, nobody will ever have to lose money again!

7. The compression of margins is temporary.

As rising short term rates crashed head long into falling 10-year bond rates, and as increasing competitiveness among mortgage lenders crashed head long into declining demand, margins were squeezed. But relax, this is temporary. It will only last until the weak links are squeezed out of the market. NEW tried to "lead the way" by raising rates higher, but their competitors didn't follow. When they lowered rates back down again, their competitors lowered rates further. Even though demand for loans is still slowing, and the lenders all depend on increasing originations to avoid blowing up their business models, the pressure on margins must decrease!

8. They can hedge away the risk of rising interest rates.

They buy derivatives that pay off if interest rates rise. If rates rise slowly over time, they get clobbered like CFC did. If rates rise rapidly they get to report a nice short term gain, then buy new derivatives at higher prices. If interest rates rise so quickly that their counterparties can't make their payments, then the housing market is doomed anyway, so there's no point in worrying about that single aspect of a meltdown.

In a sense, the views of the NEW executives typifies what is wrong with our entire financial system. Risk has been imagined away, and the resulting imaginary profits are taken as reality. Level upon level of creditors has leveraged themselves into the false reality that will one day come crashing down. We have:

1. Interest rates at suppressed levels because the Fed has injected record amounts of liquidity and foreign central banks have bought treasuries disproportionately to keep their currencies week, while propping up a US Government that is bound for bankruptcy.

2. We have homeowners borrowing more than they can afford at these temporarily reduced adjustable rates who are bound to default once rising payments and their inability to borrow new funds push them past the breaking point.

3. We have crazed mortgage lenders like NEW, CFC, IFC, NFI and others making bad loans at an accelerating rates to stave off the inevitable.

4. We have mutual and pension funds throwing other people's money at the crazed lenders to purchase exploding corporate bonds.

5. We have hedge funds selling derivatives to soak up interest rate risk in search of short term profits and higher NAV based fees.

In short, we have one domino after the next, all lined up ready to topple once the kindness of foreign governments runs out and the unsustainability of our twin deficits comes home to roost and the fantasy world we live in is exposed.

The point of the above info is that the DOW 30 stock index DJIA , experienced it's largest weekly decline in the week that ended yesterday, in the last 42 months...

The fraud at NEW, the second largest US subprime lender, and the sudden, sharp decline in it's stock price, is not an isolated incident. About 25 other sizeable sub-prime lenders have gone out of business or been "absorbed" by other companies, just in the last 10 weeks:

Quote:

http://www.conntact.com/article_page.lasso?id=40702
Mortgage Firm's Implosion Rocks State

Was once-high flying MLN a victim of housing downturn or author of own ills?
<img src="http://www.conntact.com/images/fs_mln.JPG">
Business New Haven
02/19/2007
by Liese Klein
When it's completed, the 310,000-square-foot structure along I-91 in Wallingford will be a showpiece - a striking blend of arched rooflines, cubic office blocks and glass. The building's skeleton is impressive even now as cranes and dozens of workers cluster at the site, at the intersection of I-91 and Route 68.

But in the first weeks of February, workers took down signs trumpeting the future owner of the building - Middletown-based Mortgage Lenders Network (MLN). Even as hardhats braved freezing temperatures to install the structure's environmentally friendly elements, Mortgage Lenders filed for bankruptcy, then revealed its intentions to liquidate.

A company once touted as one of the state's brightest hopes for job growth is now facing complete disintegration, with customers, creditors and employees alike threatening legal action.

MLN officials did not respond to repeated requests for comment.

How did a company that drew Gov. M. Jodi Rell to the groundbreaking of its new headquarters less than a year ago fall so far, so fast?

One clue can be found on a Web site (http://ml-implode.com/) illustrated with big red letters and an image of an explosion: "The Mortgage Lender Implode-O-Meter." The site, run by a self-described "scientist, mathematician, entrepreneur and activist," tracks the fate of the 20 mortgage lenders that have "gone kaput" just since December of last year.

Many of the casualties specialized in so-called sub-prime lending, or mortgage loans to those with poor credit. Sub-prime lending took off in the recent housing boom as a high-risk, yet high-profit niche in an industry with traditionally low margins.

But lenders nationwide who leapt into the sub-prime market are suffering as those homeowners fall behind in a tough housing and job market.

If you believe, as I do, that the mortgage industry, home construction industry, and the residential realty industry, and the speculative financial bubble that grew them since 2001, are responsible for most of the US job "growth", and that MEW (mortgage equity extraction), drive by bubble prices for real estate, driven by lax lending standards, and "interest only", no down payment loans, was the source of the money that drove the spending spree of the past 5 years in the US, since wages remained flat, on average, doesn't it seem likely that "the economy" will be the 2008 presidential campaign issue, as early as late this spring?

I'd also like to discuss what to do about it, both on a personal finance level, and on a macro level....