Dollars and Jens
Sunday, October 21, 2007
I don't regularly read the Muhlenkamp quarterly letter, but I did once note the URL theorizing that it might be a good idea. He seems to think the worst is over.

Here's a bit from this quarter:
Although the Fed stopped raising rates in early 2006, participants in the mortgage and credit markets continued actions that only made sense during the ultra low, short-term rates of 2002-2004. Specifically, mortgage providers continued to write adjustable rate mortgages and as rates moved up, rather than writing fewer mortgages, they modified the terms to be able to keep writing mortgages until they broke the market and themselves in February-March 2007. Meanwhile, managers of leveraged buyout funds and hedge funds, which had great success in the period of ultra low short-term rates, attracted huge amounts of money which they attempted to put to work as the rates became much less attractive. In an attempt to continue prior good returns, many of them used greater leverage at a time and under conditions when they should have used less. They pushed their market until it broke in July-August 2007.

While the point of maximum pressure appears to have passed in each of these markets, the fallout will go on for a couple of years in mortgages and possibly longer in the credit markets.
I've been under the impression that most of the mortgage turmoil would be in Q4 of 2007 and Q1 of 2008, but I've noticed that I tend to expect things to be done before they're done. Long before they're done - I made more money than I lost shorting Internet stocks, but that's probably because I had the good fortune not to have any money to invest until around 1999. I've owned QQQQ put options for several years now (though I did justify that, pre-facto, as at least as much a hedge as a bet).

At any rate, I don't now believe that everything will resolve itself by next April, but the magnitude of the problem might at least be clear. If I ever have the temerity to call a bottom, though, that's probably a good time to set an alarm for three years later.

If that's not pessimistic enough for you, one last thing:
We can never say for sure that some other market won't break, or that an outside event like 9/11/01 won't occur, but we don't currently see additional likely candidates.
If you gave me 10-1 odds against a 9/11-size terrorist attack in the next three years, I'd be happy to take those odds. I have no special knowledge, mind you, mostly just a lack of sanguinity in the relative difficulties of playing defense and offense.

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