In Search of: The Next ‘New Subprime’

Ever since the bursting of the subprime bubble, a parlor game of sorts has emerged: What's the next subprime?

From commodities to U.S. muni bonds, various markets have been cited as having the ability to torpedo the financial system and trigger another 2008-type contagion.

In the accompanying video, I discuss the leading contenders with Josh Brown, VP at Fusion Analytics and author of the blog, The Reformed Broker.

Commodities: U.S. banks reportedly have $400 billion of exposure to commodities and European banks have made big bets too, which makes Brown —and a lot of other people nervous. "Not all banks are taking on too much risk but…it is necessary for them to be speculating in commodities?"

Brown is quick to note that not all banks are leveraged long commodities — JP Morgan, for example, was reportedly short silver before its big recent swoon. "Because this is the case, we are free to worry about their exposure should the commodity rout persist, but the evidence of their participation in these markets - and on what side of the trade they may be - has yet to give me cause to freak out," he writes.

Sovereign Debt: Back in late 2009, I wrote a piece entitled Is Sovereign Debt the New Subprime? Two-plus years later and we're still braced for a debt default by Greece, or a handful of other European nations.

"This is the slowest motion car crash," Brown says. "It's not good but I don't think it's the next subprime per se" because of the political stakes in Europe and the relatively limited exposure of U.S. banks to European debt.

Muni Bonds: Ever since 60 Minutes featured Meredith Whitney's dire warnings about U.S. muni bonds, fear of state and local government defaults has hung over the market. But a number of muni bond experts have refuted Whitney's call, state tax revenues are on the rise as Dan Gross details, and the National Muni Bond ETF (MUB) recently hit a new high.

"We know what the issues are: This is not pleasant stuff but it's too well known and there's too many levers that can be pulled for us to say 'this is going to spiral out of hand'," Brown says.

Potpourri: Other "new subprime" candidates include China, the dollar and U.S. student loans. Brown isn't sanguine any of these issues but believes there's generally less risk of contagion today vs. back in 2008.

"The real danger of subprime heading into the crash was its having been bundled into so many collateralized securities along with higher-rated pools of assets. Its ability to contaminate was a function of its ubiquity where it didn't belong," he writes. "So-called double and triple-A fixed income securities were packed with junk in such a way that the value of everything became suspect. As far as I can tell, there aren't many products being sold to insurance companies or banks with a hidden silver [or Greek debt] component right now."

Of course, the operative words in that sentence are "as far as I can tell."

The very fact people are already worried about the "known knowns" mentioned above suggest it's unlikely any will take down the system. But it's usually the stuff you don't worry about — like the impact of Lehman's bankruptcy on money market funds — that really causes a problem. The financial markets remain far too opaque and derivatives transactions far too commonplace for anyone to say with absolute certainty the system is "safe."