The sub-prime carnage is now front page news on every possible media; soon enough it may be even become cover story on People magazine as even Britney Spears will soon be asking about it. But many sophisticated observers and investors tell me they had not even heard once about this term until January. Too bad that a minority of observers including - but not only – myself were warning about sub-prime, housing and this incoming disaster since last August; but then no one was listening and/or scorn was thrown on the few that were warning about the worst housing recession in decades and its financial fallout in the mortgage market.

So now that the disaster is too big for anyone to ignore the new conventional wisdom is to try to minimize the extent of the problem. The new consensus view is that “this is only a sub-prime niche problem that is contained and will have no spillover and contagion effects to other mortgages, to the credit market, to the economy and to the US growth rate”. This new consensus is as wrong as the systematic ignorance since last summer by the consensus of that unfolding housing, mortgage, financial and economic train wreck.
 

So, today the consensus is spinning ten soothing new arguments that have as little basis and evidence for them as the consensus ignoring what was going on in the housing and the mortgage market since last summer. The consensus was wrong then and will be proven wrong now.
 

Since daily “don’t’ worry” fairy tales are now being spinned around every hour on many outlets – while a rising number of analysts, media folks and scholars are now recognizing the extent of the unfolding financial and economic wreck – let me present the new ten consensus views about the sub-prime carnage and its fallout (or lack of fallout in the consensus view); and then present the ten ugly realities on how this consensus is wrong on each one of these points.
 

I have already extensively discussed each one of these ten issues in my recent blogs and papers; so I will here summarize my main views and refer you to the more detailed analysis of each argument in my recent writings. But I will soon come back to each of these questions and explain in more detail why – on each – the consensus view is faulty.
 

So here is the top ten list of faulty consensus views followed by the ten ugly realities about then coming economic and financial hard landing…
 

Consensus View #1: The Housing recession is bottoming out.

Ugly Reality #1: The housing recession not only is not bottoming out; it is getting worse and it will be the worst housing recession in the last five decades as my recent analytical paper with Christian Menagatti shows.

Consensus View #2: The subprime carnage is only a narrow and niche problem; other mortgages are fine. So there is no risk of contagion to other mortgages.

Ugly Reality #2: The same garbage lending practices used for sub-prime – no/low down-payment, no/low documentation of income and assets, interest rate only, teaser rates, negative amortization, option ARMs -  were prevalent among near prime and other (option ARM) prime mortgages. These risky mortgages add up to about 50% of originations in 2005 and 2006, as my research and that in Credit Swiss (among others) shows.

Consensus View #3: There may be a credit crunch in subprime but not generalized credit crunch in the mortgage market.

Ugly Reality #3: Not only there is a severe credit crunch in subprime (30 plus lenders out of business); there is also the beginning of a generalized credit crunch for the broader set of near prime and other risky prime mortgages. Default and foreclosure rates sharply up in all mortgages, including near prime such as Alt-A. Lenders and regulators are seriously tightening standards for all mortgages. There is now a sharp swing from very loose to very tight lending behavior by every type of mortgage lender. Ivy Zelman of Credit Swiss recently published an excellent analysis showing that is not just a sub-prime problem. As she put it this credit crunch "will affect the entire housing food chain." There is also a risk of a systemic banking crisis if the economy has a hard landing.

Consensus View #4: The market for securitization of mortgages (RMBS and CDOs) is fine; there is not contagion or distress in it.

Ugly Reality #4: There is a severe disruption of the CDOs market – given the losses of CDO managers and investors - that risks to lead to a seizure of the entire RMBS market as CDO investments are the foundations of the mezzanine tranches of the RMBS market. See the recent excellent Rosner and Mason paper.

Consensus View #5: There is no contagion from mortgages to other credit risks.

Ugly Reality #5: There is the beginning of a slow contagion to other credit risks: widening of spreads to near junk for major broker dealers; widening of CDS spreads for corporates and non residential real estate as measured by CDX, iTraxx and CMBX indices.

Consensus View # 6: There is no contagion from the housing recession to other sectors of the economy.

Ugly Reality #7: There is already significant contagion from the worst housing in decades to the other sectors of the economy: auto is in a recession; manufacturing is in a recession; employment growth is slowing down; every component of real investment (residential, non-residential, equipment and software, inventories) fell in Q4 and is falling at a faster rate in Q1. And now the saving-less and debt-burdened consumer is faltering too as two mediocre consecutive months – January and February – of retail sales show. The US consumer is on the ropes and at its tipping point.

Consensus View #7: The economy will experience a soft landing and the mortgage disaster will have no macro impact.

Ugly Reality #7: The economy will experience a hard landing, at best in the form of a growth recession (growth in the 0%-1%) for most of 2007 or, more likely, an actual recession starting in Q2. Greenspan thinks a recession by Q4 has a 30% probability; the Fed’s yield curve model prices a 54% probability of a recession in 2007.

Consensus View #8: If the soft landing is at risk and the economy may have a hard landing the aggressive easing by the Fed will prevent such a recession.

Ugly Reality #8: The coming aggressive easing by the Fed will not prevent the US hard landing for the same reasons why the aggressive Fed easing in 2001 did not prevent a recession then: when you have a glut of investment/capital goods – then tech goods, today housing glut, consumer durable and auto glut – the demand for such goods becomes interest rate insensitive. So the Fed will try but will not be able to rescue the economy.

Consensus View #9: The world will happily decouple from a US hard landing

Ugly Reality #9: Decoupling of growth for Europe, Asia and emerging markets will occur only if the US has a soft landing. If the US experiences a hard landing there will be no decoupling whatsoever.

Consensus View #10: The recent financial markets turmoil is a temporary blip; the financial party will happily continue.

Ugly Reality #10: Previous market corrections were temporary blips and market opportunities because macro fundamentals were sound. The spring 2006 “inflation scare” turned out to be a “scare” without basis; thus markets recovered after a brief turmoil. Today we do not have a “growth scare”; we have US growth fundamentals that are severely weakening and leading to the risk of a hard landing. In that scenario the market will not have a brief correction; instead all sorts of risky assets – equities, commodities, corporate credit risks, emerging market assets – will have a severe downturn once sucker rallies following expectations of a Fed ease will run out of steam when the reality of a hard landing sinks in.