Fool's Gold by Tett Gillian

Author:Tett, Gillian [Tett, Gillian]
Language: eng
Format: epub
Publisher: Liitle, Brown Book Group (Digital)
Published: 0101-01-01T00:00:00+00:00

CHAPTER TEN

Tremors

In October 2006, Bill King, the man Jamie Dimon had charged with working out JPMorgan’s mortgage pipeline, travelled to Rwanda to participate in a project to help local coffee farmers develop their businesses. One day, after visiting the plantations, he returned to his hotel to hear his boss’s voice at the other end of a crackling phone line. ‘Billy, I really want to you to watch out for subprime,’ Dimon said. ‘We need to sell a lot of our positions. I’ve seen it before. This stuff could go up in smoke!’

King was not too surprised by the intervention. Dimon was a hands-on manager with strong knowledge of the market, who had no qualms about disturbing his employees’ holidays if he considered a matter urgent. And by the autumn of 2006, Dimon thought the housing sector was becoming just that.

In the spring of 2006, US house prices had started to slide. ‘A housing crisis approaches,’ a column in Barron’s magazine boldly declared by August, pointing out that the median price of new homes had dropped almost 3 per cent in the previous eight months, while sales of new homes had fallen 10 per cent, leaving new home inventories at record levels. ‘The national median price of housing will probably fall by close to 30% in the next three years [based on] simple reversion to the mean,’ it added, meaning that the steepling prices of the past few years were the result of a bubble. The predictions of doom were derided by the housing and mortgage industry. David Lereah, chief economist of the National Association of Realtors, declared that a ‘soft landing’ for the market was in sight. Home builders, though, started to slash their forecasts. ‘Builders that built speculative homes are trying to move them by offering large incentives and discounts, and some anxious buyers are cancelling contracts for homes already being built,’ observed Robert Toll, CEO of luxury home builder Toll Brothers, after its stock crashed 50 per cent for the year by August. Forbes magazine tartly observed: ‘When even Toll Brothers, the high-end builder, suffers cancelations, you know the real estate boom is over.’

On 6 October, home builders Kara Homes, known for their construction of ‘McMansions’, filed for bankruptcy protection, less than a month after reporting what it called the ‘two most profitable quarters in the history of our company’. The delinquency rate on subprime mortgages rose from 12 per cent to 14 per cent.

Troublesome as they were, these signs of housing strain did nothing to stop the mortgage-based CDO machine. Between October and December 2006 alone, banks issued a record $130 billion worth of CDOs, double the level a year before, and 40 per cent of those were created from asset-backed securities consisting primarily of subprime mortgages. That brought the total sales of cash CDOs to $470 billion for the year. Issuance of derivatives-based CDOs was even higher. One particularly fast area of growth was so-called ‘mezzanine structured finance’ CDOs, or instruments created from the riskiest pieces of risky ABS.

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