Contagion!

Good evening!

Today was an interesting day in the markets. We had another triple digit move today on the DOW today. Stocks quietly dropped about 140 points. It seems like anything under a 200 point move almost seems like a flat day the way the markets have been trading lately doesn't it?

The market badly wants to move higher as the dollar strengthens, commodities drop, and Europe starts to falter. This bullish sentiment is further fueled by the idea that the US will be the first country to recover from the global slowdown.

As a result, the bottom callers have been screaming that we have seen the market lows based on these data points.

As the bulls were reminded today, there is one big problem that refuses to die and continues to put a drag on the markets: Housing! The bursting housing bubble refuses to dissapear no matter how much the bulls try to put it behind them! Its like that little dog that refuses to let go of your pant leg no matter how hard you shake.

The news on the housing front was frightening today. Bloomberg reported that 1/3 of the buyers that bought homes within the last five years now owe more on their loan than their house is worth:

"Aug. 12 (Bloomberg) -- Almost one-third of U.S. homeowners who bought in the last five years now owe more on their mortgages than their properties are worth, according to Zillow.com, an Internet provider of home valuations.

Second-quarter home prices fell 9.9 percent from a year earlier, giving 29 percent of owners negative equity, said Zillow, the Seattle-based service that offers values for more than 80 million homes. For those who bought at the 2006 peak of the housing market, 45 percent are now underwater, Zillow said.

``For homeowners who need to sell, this is a gravely serious situation,'' Humphries said in an interview. ``It can also be harmful to communities where the number of unsold homes adds more to inventory and puts downward pressure on prices.''

The highest percentages of homeowners with negative equity were located in California. In four of the state's metropolitan areas -- Stockton, Modesto, Merced and Vallejo-Fairfield -- the number of homeowners whose mortgage debts exceeded the values of their properties topped 90 percent, Zillow said."

Quick Take:

I thought housing prices always go up? Ha! Obviously this is a nightmare scenario for anyone trying to sell a home. Very few homeowners have the cash to cover a short sale. This will eventually increase the number of foreclosures as buyers run out of options when they have to move or can't afford to pay the mortgage.

This will continue to weigh heavily on the financial stocks. They got creamed today by the way.

Contagion:

This is the biggest problem that the bulls face. The news today provided more evidence that this credit collapse is spreading into all asset types as the debt bubble bursts. Prime loans are even starting to become affected. From CNN:

"The next wave of mortgage defaults
More borrowers with good credit are defaulting on their home loans, and that's going to make it even harder for the staggering housing market to recover.

NEW YORK (CNNMoney.com ) -- Prime mortgages are starting to default at disturbingly high rates - a development that threatens to slow any potential housing recovery.

The delinquency rate for prime mortgages worth less than $417,000 was 2.44% in May, compared with 1.38% a year earlier, according to LoanPerformance, a unit of First American (FAF, Fortune 500) CoreLogic that compiles and analyzes residential mortgage statistics.

Delinquencies jumped even more for prime loans of more than $417,000, so-called jumbo loans. They rose to 4.03% of outstanding loans in May, compared with 1.11% a year earlier.

And prime loans issued in 2007 are performing the worst of all, failing at a rate nearly triple that of prime loans issued in 2006, according to LoanPerformance.

"The extent of how bad these loans are doing is very troubling," said Pat Newport, real estate economist with Global Insight, a forecasting firm.

Washington Mutual (WM, Fortune 500) CEO Kerry Killinger said last month that the bank's prime loan delinquencies are on the rise. As of June 30, 2.19% of the prime loans issued by WaMu in 2007 were already delinquent, compared with 1.40% of prime loans issued in 2005.
Also last month, JP Morgan Chase (JPM, Fortune 500) CEO Jaime Dimon called prime mortgage performance "terrible" and suggested that losses connected to prime may triple. For the second quarter, the bank reported net charges of $104 million for prime rate delinquencies, more than double the $50 million recorded three months earlier."

Further Evidence:

The contagion into prime loans isn't the only area of contagion as seen here from Bloomberg:


"Aug. 12 (Bloomberg) -- Banks' losses from the U.S. subprime crisis and the ensuing credit crunch crossed the $500 billion mark as writedowns spread to more asset types.

The writedowns and credit losses at more than 100 of the world's biggest banks and securities firms rose after UBS AG reported second-quarter earnings today, which included $6 billion of charges on subprime-related assets.

``It just keeps spreading from one asset to another, so it's hard to know when these writedowns will stop,'' said Makeem Asif, an analyst at KBC Financial Products in London. ``The U.S. economy needs to stabilize first. But even then, Europe could lag and recover later. There's still a lot more downside.''

Banks and brokers have raised $353 billion of capital to cope with the writedowns, according to data compiled by Bloomberg. The gap between losses and capital infusions, which now stands at $148 billion, has regularly narrowed to about $80 billion as capital raising follows writedown announcements."

Final Take:

The evidence of contagion is becoming overwhelming. The data on prime loans is flat out frightening. Notice that the delinquency rates on loans over $417,000 were almost double the rate of homes under $417,000.

The jumbo prime loans are supposed to be the loans of the rich and were considered to be safe. Now the data is showing that they have almost double the delinquency rates of the average middle income "subprime" homebuyer!

I have one question to ask. If the wealthy can't pay off their loans than who in the hell can? The answer is these jumbo loan buyers made the same stupid mistakes that the subprime low income buyers did. They bought houses that they couldn't afford!!

It appears that wealthy were even bigger morons when it came down to buying houses than their "subprime" counterparts based on these delinquency rates.

This is why contagion is setting in folks. The rich and the poor are both in deep trouble. Houses for the wealthy became just as unaffordable as houses for the middle class.

As a result, this economic mess is spreading into all types of loans. Cars, boats, student loans, you name it. The worst part about this is its coming at a time when the banks can least afford it.

This is going to force the banks to tighten their lending standards and raise interest rates which will push housing prices down even further.

Bottom Line:

I wouldn't touch financials with a ten foot pole here. The total losses from this debacle are expected to be about $2 trillion dollars according to economists like Dr. Roubini. The financials have currently written down about $500 billion.

I am no math major but this tells me we are about 25% through the writedowns that need to be taken by the financials.

The market woke up today and realized that this credit crisis is going strong. Waves of bad news from JP Morgan, Goldman, and UBS forced the markets to take a reality check.

The bulls will continue to ignore this glaring problem as they try to shake that pesky little dog off their leg.

Smart investors will realize that this little dog bites like a Tyrannosaurus Rex.