The idiot stock market

Remember that day last October, when Countrywide Financial Corp. reported a $1.2 billion third quarter loss and the company's stock shot up 30 percent (see "Pop the champagne! We only lost $1.2 billion")? Investors were expecting worse, and they took Countrywide execs at their word when they said the company would be back in the black in 2008.

Today, Wells Fargo and JP Morgan Chase helped financial stocks partly recover from yesterday's sell-off, by reporting more than $2 billion in write-downs and charge-offs on bad mortgages or mortgage-related investments (see Inman News story). Wait, was that the good news? Well, yes, compared to Tuesday's announcement by Citigroup Inc. that fourth-quarter losses totaled $9.83 billion, thanks to $18.1 billion in write-downs on investments tied to subprime mortgages.

Unlike Countrywide last October, Wells Fargo and JP Morgan Chase both managed to turn a profit for the quarter. But it was still a little strange to be reminded again that we now live in a world where 10-digit write-downs are seen as good news.

To be fair, investors also seemed to be in the mood to buy because the Consumer Price Index was up just 0.3 percent in December, heightening the possibility that the Fed will make that 50-basis-point cut in the federal funds rate many have been clamoring for.

"And why do we care about the stock market?" Inman Blog's real estate-obsessed readers sometimes ask when we start down this road.

For one thing, if you believe in the wisdom of crowds, what investors think of the health of the big companies that have come to dominate mortgage lending could tell us something about where housing markets are going.

Even if they are wrong -- as they were in their rush to buy Countrywide stock last fall -- investor confidence (or the lack thereof) in a company can influence its ability to raise additional capital. If they can't raise money, they may have to curtail lending or close their doors, making it harder for prospective home buyers to get a loan.

Standard & Poor's analysts said today they are raising their assumptions about what the losses on subprime loans made in 2006 will ultimately turn out to be. Before they were saying 14 percent. Now it's 19 percent. The rating agency also changed some other assumptions it uses to evaluate investments that are backed by mortgage loans, which could result in more downgrades on mortgage-backed securities issued in 2006. Banks and bond issuers would have to do more write-downs, and that could further restrict lending.

Standard & Poor's said the new assumptions were based on growing consensus that national home-price declines are going to be greater than previously thought -- 8 percent to 11 percent -- and that the slump will last longer than expected, too. But the Wall Street Journal noted that the new projections are in line with values of the ABX index -- publicly traded derivatives tied to subprime-backed investments. Another case, perhaps, of the "wisdom of crowds" influencing lending and therefore housing markets.

Mortgage broker and syndicated columnist Lou Barnes prefers to call it "the idiot stock market" -- or at least that's what he said last week, after stocks initially soared on news that Bank of America planned to acquire Countrywide.

While investors were relieved that Countrywide's doors will remain open if the deal goes through, Barnes questioned the wisdom of Bank America's plan. But he also made a larger point -- one that may also be the best reason for those in the real estate industry to follow what's happening in equity markets. If the Fed makes dramatic cuts in short-term interest rates to try to stimulate economic growth, that may help stock market investors in the short run. But such a move could also send mortgage rates up, because it will get bond market investors worried about inflation.

Judging by his recent comments, Federal Reserve Chairman Ben Bernanke looks to have been won over by the arguments of the idiot stock market: that the economy is tanking, and to hell with inflation -- it's time for a drastic rate cut. But there's also a chance that Bernanke and other Fed members are only stepping up their rhetoric in the hopes that their words alone will diminish the need to take action (see "Can Fed talk the talk without walking the walk?").

All rights reserved. This content may not be used or reproduced in any manner whatsoever, in part or in whole, without written permission of Inman News. Use of this content without permission is a violation of federal copyright law.