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Subprime Lending. What exactly happened to take this subject from a word unrecognized by Microsoft Word to the cornerstone of every financial discussion? It is simple really; the current bubble has been rolling through the U.S. economy since the late 1990s. It started with the tremendous run-up for technology stocks that ended around 2000. A bubble clearly formed as many stock prices reached levels that even the most optimistic observer had to find somewhat ridiculous. Then that bubble burst.

Investors pulled money from stocks and flocked back to traditional savings methods. The Fed was forced to lower interest rates to a low at one point of just 1%. Flush with cash for new depositors and the wide-open Fed window, banks were looking for places to invest and earn a return on all these dollars. As a result, they aggressively pushed mortgage loans and demand for real estate. Just as investors surged to less-than-quality stocks at the end of the tech wreck, they began lending money to those who really couldn't afford it and invented new loans that required housing prices to go up in order for buyers to be able to repay them. When a segment of the economy is in a bubble, it is almost impossible to believe that prices can stop going up at such a fast rate–but reality can be painful.

Subprime mortgages are usually defined as those extended to people with less-than-perfect credit. The United States Treasury Department's official definition of subprime lending is a loan to a borrower who has weakened credit histories including payment delinquencies and more severe problems such as charge-offs, judgments and bankruptcies. Why on earth would banks lend money to these borrowers? Simple: They can charge whatever rate they want as often the borrower has no other choice but to pay it. The banks and mortgage lenders believed that rising real estate prices made the loans less risky than they actually were. Boy, were they wrong.

How the trouble started

These subprime loans then got sold to Wall Street, the big firms and the hedge funds. That's where the problem started. The banks and funds traded these toxic, high-yielding scraps back and forth, usually using borrowed money. When, as happened in 2007, housing prices flattened or dropped, a game of musical chairs ensued. Because these traders used borrowed money to buy the loans, they had to sell them at any price. And as prices moved down, the selling spread en masse across Wall Street, and prices plummeted. Soon, the music stopped, and lots of people were left standing.

A specific example was when Citigroup (C) and Merrill Lynch (MER) as well as dozens of other banks, brokers and hedge funds announced billion dollar mortgage-related write-downs. These tremendous losses were devastating, and many people believe that this crisis has threatened the underpinnings of the US financial markets. But I do not think that's the case. The real estate market was causing terrific inflation and needed to pop eventually. So it did. Plus, while most financial stocks are taking a justified beating and experiencing incredible selling pressure, they still have strong cash flows and are unlikely to be in danger of failing. The worst thing that can happen is big institutional investors will shift their money out of the batterred financial-loaded value stocks and move it to a safer home: Growth stocks. And that's where we benefit.

In fact, the only good news about the subprime mortgage debacle is that we absolutely zero subprime exposure in either of our Emerging Growth or Blue Chip Growth portfolios. We're actually benefiting from the subprime fallout, twofold:

First, the Fed now needs to continue cutting short-term rates, which will help spur economic growth. There are billion of dollars of subprime loans that were set at adjustable rates, and many will reset this year. So to prevent catastrophe, the Fed must keep cutting rates to get the markets moving again. And when the market rallies, businesses will create jobs, and the folks who are in danger of losing their homes due to the adjustable rate mortgages will be able to keep them. That is great news for all of us.

Second, I am a growth stock investor, plain and simple. My analysts and I look for the companies that have new innovative products and services and can sustain their growth quarter after quarter, and year after year. And to be a successful investor in today's market environment, you must steer clear from the financial stocks that were hit by the credit crisis. They're ticking time bombs. Instead, you need to be overweighted in key industries such as  agriculture, aviation, multinational and oil service companies–to name just a few. It should come as no surprise that we're already heavily invested in these industry groups, and we increased our exposure to these sectors as the financial mess got messier. As a result, we were able to beat the market nearly $6-to-$1 in 2007, and we've already started 2008 off on a very strong foot.

Bottom Line: While a bubble sounds like a bad thing, it is not–if you know how to play it. Since I concentrate on stocks with superior fundamentals, fast growth in sales and earnings as well as showing buying pressure, we are well-positioned to see more profits as the subprime mortgage bubble bursts and all the mutual funds and value-based investors seek a safer shelter. Join us now risk free to get in on the growth stocks on our Blue Chip Growth and Emerging Growth Buy Lists.

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