What exactly is the connection between the subprime mortgage market and weakness
in earnings at Goldman Sachs and Bear Stearns? Both the Wall
Street Journal and the New
York Times think that the subprime exposure at both companies is so important
that it’s worth putting in the headline of the story about the banks’ earnings
reports. And Bear Stearns certainly has a hedge fund which seems to have been
hard by subprime weakness in April. But losses at the fund will have very
little direct impact on Bear’s earnings, since the bank has only a small stake
in the fund.
That said, Bear has historically made a lot of money from securitizing subprime
mortgages, and as the flow of such business has dried up, its fixed-income revenues
have fallen. But according to Bear’s earnings press
release, there might be more to things than just that:
Mortgage-related revenues reflected both industry-wide declines
in residential mortgage origination and securitization volumes and
challenging market conditions in the sub-prime and Alt-A mortgage sectors.
(Emphasis added.)
Does this mean that Bear Stearns itself is long mortgages, and that it marks
those mortgages to market, resulting in losses when the value of the mortgages
falls? It’s not entirely clear. But it’s clearer than the Goldman press
release:
Net revenues in Fixed Income, Currency and Commodities (FICC) were $3.37
billion, 24% lower than the second quarter of 2006, primarily reflecting lower
net revenues in commodities and weak results in mortgages, principally attributable
to continued weakness in the subprime sector.
I thought that banks were meant to make money from volatility, which is what
we’ve seen in mortgages. Instead, it looks as though they’ve been making money
simply by being long credit, and making mark-to-market profits as the market
has risen. When the market turns south, they start losing money. In other words,
they’re behaving more like mutual funds than like traders, who should be able
to make as much money in down markets as they do in up markets.
But there are lots of unanswered questions here. For one thing, why is the
subprime weakness hitting these banks now? Their second quarters cover the period
from March to May, while the big collapse in subprime mortgage prices happened
in the previous quarter, from December to February.
And for another thing, why is Goldman’s press release in the form of a non-searchable
PDF file, which shows us images of words rather than the words themselves? Is
there a good reason why neither of these banks have put their press release
out on the web for the world to easily see? Both releases are in PDF form only,
although at least the Bear release is searchable and can be copied and pasted.