Subprimes: A Steal or a Bust?

Much has been made of the subprime lenders lately, especially on CNBC and in the Wall Street Journal. I started watching two of these mortgage gambles about two weeks ago: New Century (NEW) and Accredited Home (LEND). They're both incredibly cheap, with P/E ratios below 5, which means these potential timebombs could also become acquisition targets for big investment banks with the means to hedge out the risk.

Acquisition isn't the only route to a payout, as these companies may be able to recover on their own. I met with Dr. Ed Yardeni last week, who pointed out that housing busts are traditionally caused by low employment and high interest rates, not negative or stagnant housing prices. Employment numbers are currently fine, and interest rates have dropped to a fourteen month low. This sentiment has been echoed by the always-outspoken Madman of Wall Street, Jim Cramer, over the past week. On both CNBC and his thestreet.com website, Cramer has been adamantly downplaying the doom scenario in the subprime space since the media hype began last week.

Hedge fund manager Doug Kass, a regular contributor to Cramer's The Street website, appeared on CNBC midday today, predicting a hard landing in housing and a bust for subprime lenders. He cited slowdowns in the economy and the markets as just one trigger that could send housing defaults into turbo mode. Just ten minutes later, Cramer was back on the air for his Stop Trading segment. Not only did Cramer disagree with Kass, but he also endorsed LEND. I believe this is the first time Cramer has publicly endorsed any name in the subprime genre. Cramer finished off his prediction in typical fashion with an extremely bullish call: Fed Funds to 2.5%, Dow to 16,000 (although he neglected to give a timeline).

Kass's reversal is completely plausible, with December's market performance showing a weakening in the bullish convictions that have dominated since July. But it's hard to call a housing market crash when we've already witnessed a slowdown and have now seen an increase in mortgage applications. Continued strong employment numbers and the lowering of rates could breathe life back into the housing sector, giving subprimes a chance at market cap redemption. I like these names in a gambling sort of way. I wouldn't put next month's mortgage payment on them - and I wouldn't move in on them for a while - but I'd have no problem allocating one week's worth of lottery tickets on them.

Unnecessary Disclosure: I currently have no position in the names mentioned above.