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8:30 AM EST, Wednesday, August 15, 2007: This is where the money is being made at present -- shorting home mortgage lender stocks, like this one:

What was most interesting (entertaining?) is that yesterday's 47% drop in price (from $14.28) happened after five brokerage firms had downgraded the stock to "underperform." Before their downgrades, the stock had already dropped 48% (from $28). Wall Street analysts are, if anything, on the ball. (I don't make this stuff up.)

What's happening? Essentially, anyone lending money on homes has stopped lending. The reason: lenders don't hold their home loans any longer (like in my father's day). The loans are bundled and then sold to investors, like pension funds. The problem today is that nobody is buying loans. Hence the home lenders are fearful that if they lend money, they won't be able to sell the loans. Or if they ultimately do sell them, they might sell them at a loss. Hence, shut down until the mess clears -- hopefully soon. Thornburg (the one I've charted above) said it would not accept requests to lock in rates for four days. When you buy a house, you need to get a commitment (a lock) from your mortgage lender that they will lend you the money. Without a commitment, there's no sale.

Thornburg actually said it was being inundated with lock requests because few other lenders were honoring requests. What you're now seeing is a total shutdown (hopefully temporary) of the housing market, and to a lesser degree, the commercial real estate market (for the same reason).

There will be other Thornburgs doing a swan song. Last week, American Home Mortgage Investment Corp. filed Chapter 11 and said it would lay off 90% of its 7,000 employees. American Home Mortgage's 40 biggest creditors include virtually all of Wall Street. Its three biggest creditors are Deutsche Bank AG, Wilmington Trust Co., and JPMorgan Chase & Co.

This sub-prime contagion is spreading like an ebola virus -- fast and deadly.

Borrowing money is a hugely important part of our economy. It fuels jobs (think mortgage brokers). It builds houses. It provides sales to companies who make bathroom fixtures, floor boards, electrical wiring. All these suppliers will suffer as housing specifically and real estate in general shuts down.

This has all the makings of a recession and a much much larger plummet in world stockmarkets. Fear is driving stockmarkets at present. Raw fear. Yesterday the Dow fell 1.6%, Nasdaq 1.7%. Australia and Taiwan fell 3%. Japan and Hong Kong each fell more than 2%, Indonesia dropped more than 6%.

Japanese markets got a jolt when two of the country's biggest lenders, Mitsubishi UFJ Financial Group and Sumitomo Mitsui Financial Group reported losses on investments related to U.S. subprime loans, In Australia, hedge-fund manager Basis Capital, which was one of the first firms outside the U.S. to suffer from the subprime fallout, said losses at its Yield Alpha Fund may exceed 80%,

In Europe today (trading is continuing as I write this), London, Paris and Frankfurt all fell around 1% with financial shares dropping, with some help from Merrill Lynch downgrading Deutsche Bank.

What should you and I do now? Clearly we shouldn't be in financial stocks. I wrote that last week. Look what's happened to the mightiest of them.

We should be heavily in cash. And we shouldn't be in any of these stocks. For those with large kahonas, shorting or buying puts might be a good move:

Fannie Mae
Countrywide Financial
Capital Source Inc.
Gramercy Capital
MGIC Investment
Washington Mutual
Aegis
American Home Mortgage Investment
HomeBanc
Fannie Mae
Radian Group (Credit Protection to Lenders)
PMI Group

Catch a falling knife? How quickly the world changes. Earlier this week, I was waxing on the high dividend yields from fallen financials. A friend in the business turned me onto these four:

We called all. None have exposure to subprime. They all seemed to have assigned someone to say NO to the zillions of phone calls. Yesterday I assigned the task to my Dartmouth Bridge graduate summer intern, Michael Biblowit. "Give me your analysis." This is what he wrote:

As Harry mentioned in Monday's column, the recent drop in the stock market means that dividend yields are becoming appealingly high for a lot of companies. Four examples are Capital Trust (CT), Gramercy Capital Corporation (GKK), iStar Financial (SFI) and Centerline Holding Company (CHC). The first three are real estate investment trusts, while CHC is the parent of a full service mortgage finance operation. These stocks all sit slightly above their 52-week lows, having suffered along with the collapse in subprime mortgages. None of these companies, however, actually has any subprime exposure, according to their respective investor relations departments. So, although the problems of risky mortgages have had repercussions spreading throughout the credit markets, perhaps stocks like these are good candidates for recovery. As Harry put it, the saying goes that a rising tide lifts all boats. In this case, the receding tide of subprime borrowing is sinking all stocks. At some point, people might realize that certain firms have been punished a bit unfairly for the mistakes of others. The combination of attractive yields and value pricing could make for solid returns.

Out of this group, GKK and CT appeal to me for similar reasons. Their dividend yields are 11.15% and 9.45%, respectively. They have low P/E ratios of 8.41 and 7.91. They also have the lowest price/book ratios out of the four. These stocks have lost a lot of their market cap over the last few months and definitely appear to fit the profile of generous dividends and high yields that we're looking for. Also, at first glance at least, their management looks capable of weathering the current storm. Each has a history of beating earnings estimates and much better margins than the other firms in the industry. Finally, GKK in particular has continued to demonstrate strong growth, with EPS up 46% for the most recent quarter. CT managed 18.3%.

SFI does offer nice dividends, but is not as value-priced. Its yield is 9.57 while its P/E ratio is up at 13.17. SFI has tended to disappoint with its earnings reports. Another difference is that while GKK and CT have declined steadily over the past 3 months, SFI's drop has been concentrated in the last few weeks. Are GKK and CT thus closer to being "due" to recover? Finally, a point worth noting is that GKK is the riskiest of all these stocks. It has a beta value of 1.7, compared to 0.2, 0.3 and 0.4 for CT, CHC and SFI, respectively.

CHC, quite simply, has some very odd numbers. EPS is down 87.37% for the past four quarters. The P/E ratio is listed as 119.92. Huh? I'm not sure what to make of it and that tends to scare me away. More research into exactly what happened at the company is definitely required. Its yield is 11.68. However, while the other three have steadily increased dividends over the past few years, CHC boosted them significantly at the start of 2006 and has left them at the same level since. One last concern with CHC is that it already has seen some recovery. The stocks I've written about all hit their 52-week lows this August, but CHC has risen from a low of $10.35 back up to $13.29.

Follow up on Goldman's $3 billion "rescue" of its quant hedge fund: Goldman got $3 billion into the fund from itself and outside money. The terms? No 2% management fee, and no incentive fee until the fund is up 10%.

Tuck revisited. Everyone and their uncle sent yesterday's column on the Tuck Bridge Program to their friends with kids in their twenties. A flood of emails said the info on Tuck was this column's "best material" ever. To read it again, go here.

Thoughts for today's difficult times:
If you have a lot of tension and you get a headache, do what it says on the aspirin bottle: "Take two aspirin" and "Keep away from children."

"My Mom said she learned how to swim when someone took her out in the lake and threw her off the boat. I said, 'Mom, they weren't trying to teach you how to swim.'" --Paula Poundstone

"Why does Sea World have a seafood restaurant?? I'm halfway through my fish burger and I realize, Oh my God....I could be eating a slow learner." --Lynda Montgomery

"I think that's how Chicago got started. Bunch of people in New York said, 'Gee, I'm enjoying the crime and the poverty, but it just isn't cold enough. Let's go west.'" --Richard Jeni

"If life were fair, Elvis would be alive and all the impersonators would be dead." --Johnny Carson

This column is about my personal search for the perfect investment. I don't give investment advice. For that you have to be registered with regulatory authorities, which I am not. I am a reporter and an investor. I make my daily column -- Monday through Friday -- freely available for three reasons: Writing is good for sorting things out in my brain. Second, the column is research for a book I'm writing called "In Search of the Perfect Investment." Third, I encourage my readers to send me their ideas, concerns and experiences. That way we can all learn together. My email address is . You can't click on my email address. You have to re-type it . This protects me from software scanning the Internet for email addresses to spam. I have no role in choosing the Google ads. Thus I cannot endorse any, though some look mighty interesting. If you click on a link, Google may send me money. Please note I'm not suggesting you do. That money, if there is any, may help pay Claire's law school tuition. Read more about Google AdSense, click here and here.
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