On March 13, the Mortgage Bankers Association reported that 13% of subprime borrowers were behind on their payments.

That same day American Home Mortgage’s preferred A shares plummeted 33%.

That fall capped off a three-day 41% plunge.

Funny… Only seven days prior, AHM reported that only 1.3% of its loans held for investment and 7.3% of its loans held for sale had FICO credit scores below 620.

Those credit profiles hardly typify excessive subprime waters.

Therefore, it seems to me, lenders like AHM were taken to the whipping post as nothing more than collateral damage for the reckless indiscretion these ravenous B-rate chop shops pushing “self-certification” loans kept practicing at the expense of unqualified borrowers.

But it’s not like we didn’t see this coming.

For months now, pundits and analysts like myself have been calling for the inevitable end to the champagne party otherwise known as the subprime lending market. But what purpose did these provident calls actually serve?

Anyone competent enough to color between the lines could have seen the market for “no document” lending coming to a catastrophic end.

It didn’t matter. Greed triumphed reason. Companies like Countrywide Financial kept lending. Meanwhile, cash-strapped Americans kept borrowing…and the cycle continued.

But a gambler’s good fortune can’t last forever. The deck eventually turns cold. It’s not luck…it’s math.

Unfortunately, everyone plays believing that they’ll be the one who escapes before the cell door slams shut. This attempt is futile and childish, grossly naive in its fundamental premise. Most try, but few succeed.

You see, market bubbles and blackjack tables are quite similar.

In both cases, the odds are stacked against you. Rationalize all you want. Drink a beer. Finagle some numbers. Do whatever it takes to put your mind at ease.

The truth remains: Predicting the precise moment to collect your chips is no different than predicting the precise moment a dark cloud will start to make you wet.

Your guess is no better than mine.

You can count cards and spew statistics until you’re blue in the face, but no one really knows the tangible tipping point.

All market bubbles eventually come to an end. There’s no telling what triggers the retraction.

In the case for subprime lending, a simple statistic shifted the tide. All of a sudden, we rubbed our glassy eyes to find that roughly 30 of America’s subprime lenders had closed their doors in the last three months.

And some argue the worst is yet to come. The Economist reports that subprime borrowers now account for 10% of the $10 trillion mortgage debt market.

But let’s not start heaving ourselves from the tops of buildings quite yet.

Those who were fearful when others were greedy avoided the recent meltdown. They still have a roof over their heads.

More importantly, those savvy enough to be greedy when others were fearful would have snatched up AHM’s preferred shares on that gloomy Tuesday afternoon. By day’s end, the preferred A’s were trading 40% below par, yielding 16.2%.

So before we usher in the cruelest month, I’m happy to report that the preferred shares have rebounded 69% in less than two weeks. Not a bad return considering AHM offered a 16% yield to boot.

Despite what Johnny Day Trader may tell you, value investing doesn’t necessarily require the patience of a tree farmer specializing in Californian redwoods. On many occasions, wild days in the market produce incredible values. March 13 was one of those days.

We all knew the subprime market would eventually implode. So instead of risking your assets by riding the wave of momentum toward the rocky shore, you could have saved your time and money.

You could have researched something other than finance and patiently awaited the inevitable.

In every market bubble, whether it be in Dutch tulips, dot-coms or subprime lending, people always tend to overreact or underreact to news. And when they do, there is hardly a better time to buy.

So I offer you this.

If you want another company I feel may be unjustifiably punished in the subprime nuclear meltdown, take a look at the small-cap building supplier Monarch Cement. This $100 million company trades just above book, with enough assets to cover total liabilities two times over.

And my gut tells me that those assets exclude the market price for 5,000 acres of prime Kansas farmland anchored around grade-A railroad access.

Assuming this land could fetch a mere $5,000 an acre, you’re talking about roughly 20% of the market cap right there.

So far, it’s looking good.

I think it’s worth a look. But if you’d rather spend your time researching something other than finance, I’ll be happy to share my complete thoughts on Monarch Cement next week.

Until next time,
Christopher Hancock
March 30, 2007

P.S.: Get Ready for the Worst Property-Led Recession of the Last 76 Years. Nobody’s money is safe. The “Second Wave” housing tsunami of 2007-2011 is about to hit, and smart investors are already battening down the hatches.

Christopher Hancock

Christopher Hancock lives and breathes emerging markets. He travels extensively and utilizes his contacts across the globe to recommend the best international investments in the world. After working with Citigroup in Hong Kong on the challenges and opportunities associated with the forthcoming RBM flotation reform, Christopher left many of his friends behind and decided to return to the States to pursue a career in equity research. Special Report: Imagine Getting Rich as Ignored Stocks Soar- How you could turn $200 into $1.2 million!

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