Will The Real “New Subprime” Please Stand Up?

Everything is contained, nothing is contained.

Black Swan talk has been phased out, the media/blogosphere has figured out that you guys will no longer automatically click a headline just because it references that trope.

Instead, they’re going with “blank is the New Subprime”.  And it’s working, you’re clicking.

But let me not dismiss all that clickery and blogitude out of hand without considering the underlying question that it’s all asking:

What is the New Subprime?  Some candidates for your consideration…

“Silver is the New SubPrime”

This is by far the least likely of them all so let’s get this it of the way.  Not every crashing tree has the ability to fell the entire forest around it.  Silver is a small market, relatively shallow and not all that wide.  The great institutions of the financial world couldn’t really care less about it – if anything the rumours of the last year would give you the impression that giant banks actually need it to crash in order to unwind naked short bets.  Silver could go to 12 bucks a brick for all we care, it may hurt a few Canadian asset managers but it is anything but systemic.  You can make the argument that it is a harbinger of things to come for all risky commodity bets as Alen Mattich does, writing at WSJ’s The Source:

Depending on how leveraged the silver market is, silver’s fall could yet have systemic effects elsewhere in the commodity complex. But even if silver market margin calls prove to be modest, there is also the possibility it will cause some sober reflection among investors with large speculative positions in other commodities

Yeah, I don’t know.  Sounds like a stretch.  We’re not talking signals here, we’re talking the new subprime.

“The US Dollar is the New Subprime”

I’m not a dollar bull, but the greenback ain’t going down 52 out of 52 weeks in a year.  This week’s minor snapback was a wake-up call for those who are combining their political views with their investment views, a self-inflicted gunshot wound of a strategy if ever there was one.  Yes the budget is a wreck, but according to a paper at Value Restoration Project I caught thanks to my friend Mebane Faber, it turns out that during times of strife, money doesn’t “act” the way you think it does when the going gets rough:

In the short term, risk appetite drives currency. In times of risk seeking, capital flows to higher inflation, higher yield currencies. In times of risk aversion, CAPITAL COMES HOME. It does not, according to Persaud go to the “safest” currencies, but it comes home.

Should China stub its toe during its inflation battle or should Europe’s financial crisis worsen, that’s a lot of repatriation back into the USD.  The dollar’s been in decline as a store of wealth since the Olsen Twins were wearing diapers, saying “You got it, dude” to Uncle Jesse.  Now they’re chain smoking in the West Village and sleeping with Lance Armstrong – no dollar weakness-induced crash during all that time.  The reality is that the weak dollar has been a boon to virtually every industry doing business overseas save for the travel agencies.

“Commodities are the New Subprime”

OK, now we’re getting into some meaty stuff here.  I won’t pretend to have scoured the Value-At-Risk calculations of the world’s major banks and I’m fairly certain that the figures they supply are Fudgy the Whale anyway.  Banks have become major players in futures over the last decade, their very reason for existence is finding the bull markets and exploiting them.

Bloomberg’s Matthew Lynn recently noted that:

Investors held a record $412 billion of raw-material assets at the end of March, almost 50 per cent more than a year earlier, according to estimates by Barclays Capital.

He argues that banks are loaded with commodities and increasingly their profits have come to depend on their trading of them.  He is correct, but for every buyer there is a seller.

It is important to note that the banks are as apt to be short or hedged as they are to be leveraged long at any given time.  Because this is the case, we are free to worry about their exposure should the commodity rout persist, but the evidence of their participation in these markets – and on what side of the trade they may be – has yet to give me cause to freak out.  This is one I’m keeping an eye on, however; you still have a lot of the same schmucks running these institutions from the credit bubble era because we went Japanese instead of going Swedish on them during the bailouts.

“Muni Bonds are the New Subprime”

This is a tough one.  Barron’s did a roundtable last weekend with a few of the smartest muni bond managers in the nation.  None of these guys are Babes in the Woods, hailing from shops like Nuveen and BlackRock.  Granted, they’ll always be somewhat constructive as they have assets to raise after all, but their arguments against the Meredith Whitney doomsday scenario were all well-reasoned and grounded in both historical context and fact.  Here’s Lord Abbett’s Daniel Solender answering a question about the fiscal strain the states are under now:

By law, 49 of the 50 states must balance their budgets; only Vermont doesn’t and it does anyway. We’ve had several straight quarters in which revenues have been up on the state level. They’re not back to where they were in 2008, but they’ve really been coming back at a pretty good pace. And the next level is the local governments.

One other key concept on munis is that the market is far from monolithic, there are all kinds of credits with all kinds of revenue streams backing them.  I’m not sure if the term contagion ought to apply to municipal bonds in that the finances of Cleveland have very little bearing on the revenue collection in North Carolina.

The big fear I will acknowledge here is a retail stampede out of the paper itself.  The rocky trading in the National Muni Bond ETF (MUB) in the wake of Meredith Whitney’s now-infamous call was more a function of poor market mechanics than any actual issues with the underlying.  Muni bonds are distinct from all other bonds in that their tax-free feature means that the investor base that is 70% individual vs institutional.  This is a good thing or a bad thing, depending.  Should all the retail holders get spooked again at the same time, there could certainly be another spate of panic as relatively illiquid bonds are dumped en masse leading to dislocations – but smart managers will seek to exploit that dislocation pretty quickly, just as they did this winter.


The real danger of subprime heading into the crash was its having been bundled into so many collateralized securities along with higher-rated pools of assets.  Its ability to contaminate was a function of its ubiquity where it didn’t belong.  So-called double and triple A fixed income securities were packed with junk in such a way that the value of everything became suspect.  As far as I can tell, there aren’t many products being sold to insurance companies or banks with a hidden silver component right now.

Silver, the dollar, bank holdings in commodities and the muni bond market all bear watching for signs of stress and strain, I’m not sanguine about any of them.  But I’m also not sure any of them represent The New Subprime.  At least not yet.


I’ve heard some interesting follow-on candidates since publishing – these include Treasurys, China and College Debt/Student Loans – I may have to revisit in a sequel post.  Thanks for the feedback, gang.

This post was published at The Reformed Broker.