Housing Bubble Bursting?

[Cigar]

Terrel:

I've got another Arkansas true story. In the early 90s I exported airplanes to Australia as a sideline since I love flying. Our environmental regulations make stripping the paint off airplanes very expensive, you can't use chemicals or sandblast. There is (was?) a place in Mena Arkansas where everyone took their airplanes to be repainted and reupholstered where they did excellent work for a fraction of the price it could be done here. Once I reversed the process, found a "Rice Rocket" (MU2) in Australia which was nearing it's engine life service limits (we have much looser requirements as to air-frame and engine life) so I bought it cheap and had my ferry pilot fly it to Mena and wait for it to be repainted and reupholstered. He stayed there and watched the whole process, I asked him how they did it so cheaply, he said they chemically stripped it and the waste products flushed down a stream, something you would go to jail for here. He also said he fraternized with other pilots ferrying drugs in from South America at the airport. About the same time Bill Clinton was running for President, citing the "Miracle that was Arkansas" and inferring he would do the same for the rest of America when elected president. BTW, about the same time a painting contractor I used had a 55 gallon drum with left-over lead-based paint from an old ship painting project which was now illegal to dispose of without taking it to an expensive recycling center, two minority guys came by wanting to know if he needed any junk hauled away, he said yes and they took a truck load of junk away including the 55 gallon drum. They dumped the drum in the Bay and it washed ashore, complete with the painting company's name stenciled on the side. Ge got 18 months in jail, got out in 6 months for good behavior.

BTW, I understand that Arkansas is an absolutely beautiful place, a friend vacationed there and said there were gorgeous "mansions" with yards and lawns so big you had to have a riding mower to keep them clipped, for the price of a tract house here, makes you wonder why more people don't move to places like Arkansas?

Sorry to hijack this thread, I love to come to it everyday and read Randolph's and Moh's posts among others, but I think maybe it needed a little break but back to business now.

 

[Terrel L. Shields]

http://www.whatreallyhappened.com/RANCHO/POLITICS/MENA/crimes_of_mena.html

You mean this Mena

You mean this little country home (4,500 SF) on 40 ac.? $750,000

or a little larger one (20,000 SF) on just a couple acres? $2,000,000 or so

 

[Randolph Kinney]

Banks under capitalized - losses could top $242 billion

Banks will need new capital; losses may top $240 bln: analysts

SAN FRANCISCO (MarketWatch) -- Banks could lose as much as $242 billion from the mortgage crisis, leaving the industry in need of more capital, analysts at Friedman, Billings, Ramsey & Co. warned on Monday.

Since subprime mortgage problems erupted in August, banks, thrifts and brokerage firms around the world have written down the value of mortgage-related assets by more than $94 billion, FBR estimated.

Banks could suffer another $59 billion to $148 billion of such losses over the next few years, partly depending on how fast house prices in the U.S. fall, the analysts forecast.

That would leave total losses at between $153 billion and $242 billion, forcing the banking industry to raise more capital, they added.

"The industry is undercapitalized," Paul Miller and his colleagues at FBR wrote in a note to clients. "With $59 billion to $148 billion of losses expected in the banks' mortgage portfolios, on top of the $94 billion of losses already recognized, banks will have to continue to raise new capital to replace these losses."

Investors shouldn't buy shares of mortgage-related companies right now, because when the firms raise new equity, current shareholders will be diluted, they added.

I wonder how many banks will fail?

 

[Tim The Enchanter]

Geez. A few Billion here and a few Billion Dollars there, and pretty soon you're talking real money.

 

[Randolph Kinney]

Geez. A few Billion here and a few Billion Dollars there, and pretty soon you're talking real money.

Yeah, the problem with mortgages and banking, the value of the paper is not known until you try to sell it.

Some additional information from the article:

The loss estimates are based partly on the $3.3 trillion of whole loans that banks and thrifts hold on their balance sheets. But another $2.2 trillion of non-agency mortgage securities are held by brokerage firms, hedge funds, overseas investors and off-balance sheet entities like structured investment vehicles (SIVs), the analysts said.

Market value losses on that $2.2 trillion of securities could reach $301 billion, the analysts estimated.

Most of the $94 billion of write-downs and other charges already announced by the banking industry came from these non-agency securities. This reflects lack of liquidity in the mortgage market, rather than credit losses, the analysts said.

Foreclosure losses are not included or known yet.

 

[Greg Bell]

Arnold the debtonator.California is broke due to 40% increase in spending
since Rambo took over.Quick , buy some beans and ammo..

 

[Austin]

The Fed can print money but they can't print capital. All those things mentioned above like states going into huge deficits, banks with shortages of capital etc., add up to one thing-interest rates going through the roof. Fannie Mae led the way when they covered their capital problem with 7.5% preferred stock. That is where I think we are headed.

 

[Riick]

Real Problem - Credit Default Swaps

The Fed can print money but they can't print capital. All those things mentioned above like states going into huge deficits, banks with shortages of capital etc., add up to one thing-interest rates going through the roof. Fannie Mae led the way when they covered their capital problem with 7.5% preferred stock. That is where I think we are headed.

Who's Got My Credit Default Swap Back?
My middle son is an online gamer, typically playing combat games with teams
formed by players from around the world.
To advance in the rankings, you have to work together. "I've got your back" is a
frequently heard term in my house.
If no one has your back in the gaming world, you can be pretty sure that the enemy will soon be there and you will be a statistic.

The "back" for the mortgage investment business seems to be particularly absent.
As in the online gaming world, it could get ugly really quick.
And a lot uglier than I thought just a few weeks ago.

In a brilliant article in the Wall Street Journal, Carrick Mollenkamp and Serena Ng
detailed the rise and fall of a collateral debt obligation (CDO) called Norma,
ushered into existence by Merrill Lynch.
This is a $1.5 billion CDO created in March of 2007 with over 90% of its paper rating
"A" or better, and $1.125 billion rated AAA.
In November 2007, the entire CDO was downgraded to junk.

That is not particularly news, as there are a lot of subprime CDOs that are being downgraded.
What caught my eye was how this CDO was created.
Quoting (and emphasis mine): "For Norma, [the manager] assembled $1.5 billion
in investments. Most were not actual securities, but derivatives linked to
triple-B-rated mortgage securities. Called credit default swaps, these derivatives
worked like insurance policies on subprime residential mortgage-backed
securities or on the CDOs that held them.
Norma, acting as the insurer, would receive a regular premium payment, which it
would pass on to its investors.
The buyer protection, which was initially Merrill Lynch, would receive payouts from
Norma if the insured securities were hurt by losses. It is unclear whether Merrill
retained the insurance, or resold it to other investors who were hedging their
subprime exposure or betting on a meltdown.

"Many investment banks favored CDOs that contain these credit default
swaps, because they didn't require the purchase of securities, a process that
typically took months. With credit default swaps, a billion-dollar CDO could be assembled in weeks.

"UBS Investment Research estimates that CEOs sold credit protection on around three times the actual face value off triple-B-rated subprime bonds.
'The use of derivatives "multiplied the risk," says Greg Medcraft, chairman of the
American Securitization Forum, an industry association.
'The subprime mortgage crisis is far greater in terms of potential losses than anyone
expected, because it's not just physical loans that are defaulting.'"

The article goes on to detail how the entire CDO world is one large daisy chain of credit default swaps.

Who's got your back? And who's got the back of the guy who has your back?
And .... you better hope it is not ACA.
Never heard of the company? You will.
ACA has dropped 95%, from $16.55 to $0.86 today. Why?
Because the company sold credit insurance on CDOs.
"If now junk rated ACA can't come up with an additional $1.7 billion in capital by
January 18, it will be insolvent and the $69 billion in credit default swaps on CDOs it
underwrote will be worthless." (Shilling)
$69 billion? That is huge. Think that won't hurt balance sheets all over the world?

Counterparty Risk is the Real Sleeper Issue

There is never just one cockroach. Write this down.
Counterparty risk in the credit default swap market will be a huge story in 2008.
Losses are going to mount far higher than estimates from just a few months ago.
I believe that many financial institutions will be taking large losses every quarter for the next few quarters.
At the end of each quarter, investors will hope that this is finally the end.
"Surely this time they have gotten it all out in the open."
It won't be, because banks can't write down loans until the counterparty risk problem is solved.
Who's got your back?

Between more massive subprime-related losses, being forced to bring SIVs back
onto their balance sheets, and deteriorating credit quality in other bank lines (like
credit cards and auto loans, as well as commercial real estate), banks are going to
be forced to raise capital and tighten lending standards.
This is not something that is going to happen in one quarter.
It may take the better part of the year for all of this to flush out of the system.

This tightening stance will also contribute to a slower than usual recovery.
Even if the Fed cuts rates again and again, the banks still have to raise capital
and become more prudent lenders.
And that means the cost of borrowing is going up.

The Fed: Too Little, Too Late

There are those who hope that the Fed will ride to the rescue with more rate cuts.
I believe they will, but it is a case of "too little, too late."
I think we will see a Fed rate below 3% by the end of the summer, if not before.
But they are likely to initially take it slow, until it is clear we are in a recession, and/or
inflation pressures have abated.
While rate cuts will help in general, the problem is that rate cuts won't help the credit
crisis, won't solve the problem of credit default swaps, and won't bring back the subprime market.
These are problems we simply have to work our way through, and it is going to take time.

Investment banks and the financial services industry made a great deal of money on securitizing all manner of risk. In general, that is a very good thing, except when the
risk is fraudulent subprime mortgages.

That source of income is drying up.
You can bet the banks are working overtime on creating new forms of securitization that will allow for transparency and increased investor protection.
There is a market for risk properly packaged and understood.
Profits at investment banks are going to be under pressure until these new structures
are developed and accepted by the marketplace. They have the incentive to get this done quickly and done right.

So let's get to the predictions.
I think that we are in a recession for most of the first half of this year, and that we begin a slow recovery in the second half.
It will be a Muddle Through Economy for at least another year after that.
That would suggest that most companies will come under serious earnings pressure.
If history is any indicator, that means we should see a bear market in the first half of this year.
How deep will depend on how fast the Fed cuts, but I don't think we are looking at anything close to the bear market of 2000-2001.
Still, I wouldn't want to stand in front of a bear market train.

Consumer spending is going to slow, and it will be slower to rebound, for reasons outlined above.
That will also make the recovery in the stock market a little slower.
But I expect to become bullish on the market sometime this summer, if not before.
I'm looking forward to it.

It also follows that bonds are a good buy at this point.
It would not surprise me to see the 10-year bond fall to 3.5%.

I think the United Kingdom follows the United States into a mild recession, and European growth will come under pressure.
Nearly every central bank in the developed world outside of Japan will be cutting rates by the beginning of summer.
China will not have a hard landing this year.

I've been bearish on the dollar since early 2002.
Sometime in the first half of this year I think we see the dollar bottom out against the euro and the British pound.
When the Bank of England and the ECB start cutting their rates, the dollar will start rising.
The US will recover faster than its European counterparts, and that will help drive the dollar higher.
The dollar is massively undervalued against those currencies.
I think the dollar ends up higher by the end of the year, maybe by 10% or more.
As I have written before, I expect the dollar to be at $1.20 against the euro once again, and sometime next decade it will be at parity.
But not against Asian currencies.
I expect the dollar to continue to drop against the Chinese yuan, the Japanese yen, and other major Asian currencies.

This will be a challenge to gold, and we could be in a period of price consolidation for the yellow metal.
But at current prices, gold stocks are attractive.

There will still be significant growth in emerging markets, which will therefore increase demand for oil and energy,
offsetting potentially weaker demand in the developed world.
Six months from now energy inflation will begin to subside, if only because the year-over-year comparisons become easier.
I believe oil is going higher, but maybe not this year, barring a crisis of some type.
I am still a believer in natural resource stocks and alternative energy for the long run.
.

 

[Randolph Kinney]

NAR data - whoops!

Pending U.S. home sales fall more steeply than forecast in November

WASHINGTON (MarketWatch) - Sales contracts on previously owned U.S. homes fell by 2.6% in November, a sign that home sales will continue to decline. The pending home sales index, based on contracts signed but not closed in November, fell 2.6% in November and was down 19.2% in the past year, the National Association of Realtors reported Tuesday. The index, which is considered a leading indicator of existing home sales, had risen in September and October. Existing-home sales for December (representing closings on contracts signed in October and November) will be reported on Jan. 24. Exiting-home sales have dropped 20% in the past year.

I really don't believe the September and October data since NAR does not correct for pendings that fall out of escrow or come back in escrow again having fallen out previously.

Over time, anyone can see the need to make corrections to past data and statistics published by NAR.

 

[Marcia Langley]

The mainstream media I read have stopped even trying to give any credence to Nar's press releases. They report it, in one sentence, then follow up with all the "buts".

I don't think real economists are listening to NAR at all.