Marc Carlisle: Now is the time to invest for cheap

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By MARC CARLISLE
On the Marc
March 26, 2008

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Next week, IRA, pension and retirement statements bearing the red ink of the first quarter’s losses will arrive in millions of mail and e-mail boxes. The write-down in the value of subprime mortages has led to a credit crunch, a weaker dollar and a recession.

Many investors will let their money ride for lack of alternatives — interest rate cuts by the Federal Reserve has made international investments expensive and the rate of return on time deposits a joke. More will stand pat in the belief that the value of their holdings can’t go any lower and must rebound, manfully ignoring the example of Bear Stearns, a Wall Street securities firm whose market value on March 1 was $80 a share.

Within a week its real value became evident, and shares were valued by the penny.

While the firm’s 125,000 shareholders chalked up spectacular losses, other investors who bought Bear Stearns at pennies per share made an enormous profit as JP Morgan Chase & Co. announced a $2 per share bid, an offer later raised to $10 per share. For those of you headed for the post office for an envelope full of red ink, take a lesson from JP Morgan — if you want to make money, big money, for the rest of 2008, get yourself into subprimes, the very investments that caused your losses.

It’s not as crazy as it sounds. Bear Stearns set sail with the Tidy-Bowl man because market forces failed. The marketplace initially overvalued subprime paper, and overvalued the underlying real estate. Bear Stearns losses were literally on paper, created by the same market forces that valued Bear Stearns at $80 on Monday and pennies the following Friday.

True, there are 14 problem subprime mortgages out of every 100, but nine out of 100 conventional mortgages are rated as problems. For the other 86 loans, the debt service is there, and the number of subprime problem mortgages will fall as the lenders renegotiate the terms of the problem loans. Moreover, the underlying asset, the real estate, is still there, and you find me a realtor who believes that prices won’t recover.

The conservative Federal Reserve knows the numbers better than anyone, which is why the Fed, on our behalf, is guaranteeing $30 billion in subprime paper held by Bear Stearns to sweeten the deal for Morgan. The Fed believes we’ll get our money back. As the only large bank until now with minimal subprime exposure, Morgan was likely the only banking house that could buy Bear Stearns without a shareholder revolt.

But Morgan is buying Bear Stearns because they expect to make money, a lot of money, or they wouldn’t have quintupled their bid from $2 to $10 per share so casually in the face of no organized opposition from Bear Stearns shareholders.

Federal guarantees are nice, but were probably not central to Morgan’s calculation of its likely return. If Morgan felt guarantees were essential because the subprime paper would prove worthless, they wouldn’t be taking the risk of buying Bear Stearns in the first place.

At the Fed, the central bank has without debate, changed government policy to extend a greater value of guarantees to JP Morgan than to vets returning from Iraq in search of a home. But $30 billion is just the start. In the S&L crisis, government had no choice but to act since we had guaranteed depositors’ accounts up to $100,000 (and later much more) if an S&L failed.

There are no deposit guarantees in this case; Bears Stearns isn’t even a bank. The Federal $30 billion in guarantees for Morgan were discretionary, but having made those guarantees, we’ll soon be on the hook for a trillion dollars more to cover everyone else.

For investors, however, subprime paper backed by the full faith and credit of our government, could prove not only a secure investment, but very profitable as the same market forces that valued Bear Stearns at $80, pennies, then $10 in a matter of days realize there is no subprime crisis, none other than the one market forces helped create.

First, however, review your statement and consider: If market forces repeatedly misvalued Bear Stearns and subprime paper, what else have they got, are getting, or will get wrong?

Marc Carlisle writes a Thursday column. He can be reached at summitindie@yahoo.com.