Saturday, May 3, 2008

The Fed and Moral Hazard/Being Superman has reprocussions

As Wall Street cheers the Fed's new image of being Superman and saving any damaged financial company, everyone that's in trouble is beginning to believe they can get a free handout.

This is the moral hazard that Wall St. never addressed as they decided to become the Superman of Wall St. As a result, everyone is starting to come to the Fed wanting their piece of the financial pie.

Criticism is starting to mount from the guru's because the rules of who would be helped and where the Fed would draw the line were never established.

Bloomberg addressed this today:

"May 2 (Bloomberg) -- A month after the Federal Reserve rescued Bear Stearns Cos. from bankruptcy, Chairman Ben S. Bernanke got an S.O.S. from Congress.

There is a potential crisis in th "student-loan market'' requiring ``similar bold action,'' Chairman Christopher Dodd of Connecticut and six other Democrats wrote Bernanke. They want the Fed to swap Treasury notes for bonds backed by student loans. In a separate letter, Pennsylvania Democratic Representative Paul Kanjorski and 31 House members said they want Bernanke to channel money directly to education-finance firms.

Former Fed officials and other Fed-watchers say that Bernanke's actions in saving Bear Stearns will expose the central bank to continuing pressure to use its $889 billion balance sheet to prop up companies or entire industries deemed important by politicians. The Fed satisfied Dodd's request today, expanding the swaps to include securities backed by student debt."

Criticism is mounting over the Feds new handout policy:

``It is appalling where we are right now,'' former St. Louis Fed President William Poole, who retired in March, said in an interview. The Fed has introduced ``a backstop for the entire financial system.''
Critics argue that the result will be to foster greater risk-taking among investors emboldened by the belief that the government will bail them out of bad decisions.

The Fed's loans to Bear Stearns were ``a rogue operation,'' said Anna Schwartz, who co-wrote ``A Monetary History of the United States'' with the late Nobel laureate Milton Friedman.
`No Business'
``To me, it is an open and shut case,'' she said in an interview from her office in New York. ``The Fed had no business intervening there.''
There are already indications that investors perceive the safety net to be widening as a result of the actions by Bernanke, 54, and New York Fed President Timothy Geithner. The Bear Stearns bailout and an emergency facility to loan directly to government bond dealers triggered a decline in measures of credit risk for investment banks and for Fannie Mae, the Washington-based, government-chartered company that is the nation's largest source of funds for home mortgages.

It is very hard in the middle of a crisis to know where to draw lines,'' said Harvard University professor Kenneth Rogoff, a former research director at the International Monetary Fund. ``They reduced the immediate risk of a crisis, but upped the ante of raising the possibility of a bigger crisis down the road.''

The facility now includes all AAA rated asset-backed investments, including bonds backed by student loans. Former Fed officials say it is risky for the central bank to use its portfolio to address specific markets and satisfy Congress without saying where it will stop.
``If there is a public purpose in lending to investment banks, and taking dodgy mortgage securities as collateral, then it is a question of degree about other potential lending,'' Vincent Reinhart, former director of the Fed board's Division of Monetary Affairs, said in an interview. ``That's the consequence of crossing a line that had been well established for three- quarters of a century.''

My Take:

What former Fed officials are starting to ask is: Where does the Fed draw the line? Almost every area of Wall St. is hurting right now. The Fed has already used up $500 billion of the $800 billion it has in its reserves. They are running out of bullets folks.

They can probably get as much money as they want from the treasury once they run out, but this will have consequences like inflation and a reaction from the bond market. The risk here is the moral hazard. The Fed cannot bailout everyone.

As I warned you yesterday, the Countrywide deal is falling apart because BofA has announced they want no part of $38 billion in crappy loans that Countrywide has on its books.
Who knows how much more bad debt Countrywide has. This will be the next big test for the Fed. Do they bail this $38 billion out as well?

If they do bail out Countrywide then won't every other bank want their subprime loans bailed out as well? This is where not drawing the line gets you in trouble and moral hazard becomes a huge risk.

If the Fed agrees to bailout the 38 billion from Countrywide then expect a violent reaction from the bond market. They may tell the Fed to go pound sand because Countrywide preferred shareholders will take a bath.

Remember, the Fed gets killed if these loans from Countrywide go under because the Fed probably owns much of this due to accepting these garbage MBS's at the discount window as collateral.

There is nothing they can do about it either if these AAA Mortgage backed securities are worthless. Zero is zero and they can't change this. So expect the Fed to take a bath on the $38 billion in bad Countrywide loans. Countrywide probably has more to dump that haven't even been announced.

Bottom line:

So what does the Fed do? Do they turn into a garbage dump and take on every ones garbage which forces a bond market collapse, or do they let the financials that made mistakes go under and make them take the losses?

Kind of a lose/lose situation isn't? The Fed has backed itself into a corner and there is no way out. The bond market will be the kryptonite to this new Superman.

Peter Schiff: Unless its 50% off, now is not the time to buy a house

Here is a great answer on why now is not the time to buy a house. I have put Peter Schiff up here before. He is the head of Euro Pacific Capital and called the housing bust long before most other economists. You can catch him on The Fox Buiness channel and other media outlets.

Unless your paying half, his recomendation is to pass on buying a house right now. Its simply too early in the cycle to be buying. I hope you find this to be helpful.

I hope everyone is enjoying their weekend.

Friday, May 2, 2008

Bank Capital Drive Looks Good?/Economy Crossroads

The market is mixed today as Wall St. tries to figure out which direction the economy is heading. In my opinion, Wall St. now believes we are at a large crossroads. Earnings came in better than expected and the jobs report today was bad, but better than expected. So now the market is asking itself "where do we go from here?".

The big crossroads that the market is pondering is this: Are we in the early stages of a recovery or are we just keeping our head above water for now before we head into a deep recession?

I of course believe the latter and believe this rally will fade in time as the data continues to get worse. The market is rising on weak data and this often turns out to be a suckers rally. In fact, over half of the largest one day rallies in the stock market happen during bear markets.

There were many huge rallies during the Great Depression. Many of these were due to new ideas and legislation that failed to materialize into any long term recovery. I see a lot of parallels like this today. It seems almost daily that the government has a new idea to save housing and the banking system.

The problem like I said yesterday is this massive debt bubble will eventually suffocate us.

Here is a good example of the pressure the banks are under:

The banks have raised $125 billion through these hybrid security sales. This makes for a great headline when new capital is being raised by a bank. The problem is the banks have to pay an arm and a leg to get this capital. From the article posted above:

``The fact that the market has continued to provide as much capital and liquidity to the large financial institutions as they have is pretty impressive,'' Merli said. ``That's the half-full version. The half-empty version is it's become increasingly more attractive from the buy-side's perspective and increasingly more expensive from the issuer side.''

Hybrids typically allow issuers to defer interest payments without defaulting and rank behind senior bonds for repayment in a bankruptcy. The securities may have no maturity and credit- rating companies usually give the securities equity credit, meaning only a portion of the money raised is counted as debt on an issuer's balance sheet."

So in other words, yeah this is capital but its expensive capital. If things in the housing market continue to deteriorate, this capital could turn into a liability because of the interest rate payments and whatever other terms these desperate banks agreed to.

S&P and Moody's both see thtough this and Moody's is coming out with new guidelines. Same article:

"Banks and brokers may be too reliant on this form of capital, said Tanya Azarchs, an analyst at S&P in New York.
``It's a lesser-quality form of capital than straight equity is and so we don't like to see more than a certain amount of each type of instrument in there,'' Azarchs said. ``A lot of it that's been recently raised we're not counting.''

Moody's Limits

Citigroup has about $47 billion of preferred and hybrid capital and only gets equity credit from S&P for $28.5 billion of it, she said. S&P assigns varying amounts of equity credit to different types of hybrids. Issuers may have as much as half of their equity in mandatory convertible preferred shares and as much as 33 percent in perpetual preferred securities, she said.

Moody's said in March it was limiting the amount of equity credit granted to hybrids to 25 percent of a company's total equity. Merrill, which issued $2.55 billion of perpetual preferred shares this month, has too much hybrid capital and must raise common equity to bolster its ratios, Moody's said in a report this month. Moody's is reviewing New York-based Merrill's A1 rating for a downgrade.

"The whole issue with hybrid securities is the banks can elect to stop payments in times of stress without precipitating a default,'' Azarchs said. ``Banks are very reluctant to do that. They'll pay the preferred dividend even when they can't cover it with current earnings and it's usually at a regulator's encouragement that they stop payment on a preferred and at that point they're already in trouble.''

My Take:

Well the way I see it, these capital raising's will turn up the pressure on the banks because they will feel tremendous pressure to pay the interest payments they agreed to on the new capital they raised(See the last paragraph above) Some have agreed to 8% interest rates and higher.

Banks like Citi will pay these dividends even if they are near insolvency in order to look like they are in a strong capital position. Remember folks, its all about confidence. This new capital could someday be one of the catalysts that could take down a bank.

This gets back to my point about the debt bubble being to large to sustain. The banks are so desperate right now that they are willing to accept all this guido capital at horrible interest rates and othet terms so they can cover all of the bad debt that they are holding on their books.

The capital raising's are desperate attempts to stay solvent. With the housing downturn accelerating, there will come a point where the banks simply get to the point where they are insolvent due to all of the bad debt on their books combined with attempting to fulfill all of their obligations to all of the investors that are involved in this new capital.

These raising's have looked great in the news and financial stock prices have moved considerably higher based on the fact that these banks look much healthier. When you dig into the numbers, you see how desperate these banks really are for cash.

The pressure on the banks going forward will be enormous. Another big leg down in housing and its good night Irene for some of these institutions.

Bottom Line:

Be careful out there in the investing world. Cash is king in my opinion right now. This rally looks tired and stocks are reversing from a big rally early in the morning.

The jobs report was still minus 20,000 jobs in April and wages increased only .1%. That doesn't help you much when inflation is soaring. We are getting poorer by the minute as long as wages stay flat and prices continue to rise.

I hope everyone has a great Friday.

Thursday, May 1, 2008

So how much debt have we ran up as a nation versus GDP?

Please click on this to enlarge the picture.
Well the bulls took us to the moon today. I wanted to put this up to show you why we should all be afraid of what is happening in our economy. This is how bad our debt bubble has gotten versus GDP. Right now it sits at 330% of our Gross Domestic Product!

Folks, you can't keep borrowing when you are not bringing in enough to pay off your debts. Eventually what happens is you cannot afford to pay the interest on the debt and it ends up going KABOOM.

At some point we will be forced to dip into a severe recession or depression as the debt either gets payed off or defaulted on.

As you can see, the only debt bubble that's even close to the one that we are in now was the Great Depression. In 1929 the credit debt was 170% of GDP before peaking at around 260% of GDP when we were in the middle of the Great Depression.

What the Fed is trying to do now is throw massive amounts of liquidity into our system so that we can keep servicing the debt. They want us to keep borrowing like drunken sailors so that the party can keep going.

The problem is like any other bubble, its simply unsustainable. The government is pulling out all the stops in order to keep this sucker inflated. Everyone thinks that the Fed saved us when we bailed out Bear Stearns.

The problem they face now is people don't have the incomes to keep borrowing. They have borrowed as much as they possibly can. Now throw inflation into the fire and you further tighten our ability to borrow in order to keep the bubble going. The Fed cannot force us to continue to borrow, and this will eventually lead to the bubble bursting.

Bottom Line:

The market is in rally mode because everyone thinks the bottom is in and the party is back on. This will be a temporary fix. How long can they keep the bubble inflated? That I can't answer.

The Fed has already shown you it will try everything in its power to keep this debt bubble from popping. They may have a few more tricks in the bag that keeps the debt party rolling for a short time.

I don't think there is a person on the planet that can predict what the market is going to do in the short term these days. The market has been all over the place. I have never seen a market in such dislocation from reality. Rome is now burning, and when you look at the market, you would think that we just won a world war and were ready to head into an era of prosperity.

When this bubble pops, and it will, we are going to see the worst economic downturn since the Great Depression. The scary thing is we ran this debt bubble up to 330% of GDP versus 260% in the 1930's.

How this ends is any ones guess but I can tell you one thing, any rise in the markets will be a temporary one.

Could it last another 6 months? I doubt it but who knows? It depends how bad the Fed fights it. In the end they will lose. All bubbles pop because they are unsustainable. We will be forced to either pay this debt down or default on it. When this happens its going to be ugly

The violent moves up and down in the market tell you we are heading towards some type of tipping point. When the debt bubble popped in 1929 you saw what happened. Lets hope the result is different this time.

Stocks move higher on promises promises promises

Well the market is higher today as the Fed and the government went into full pump mode. The Fed tried to do a little damage control from their weak statement by saying the Fed will most likely stay at 2%. Here is the piece from Bloomberg.

I will believe that when I see it. The economic data continues to slow, and the Fed has shown that they have no backbone when it comes to holding rates when the economy is weak.

The dollar bounced on the Fed news which hurt commodities. Paulson was also out their blabbering that the worst of the credit crisis is behind us.

There is also talk of a new bailout plan(how many of these have we seen). See the Paulson article. Here is how it would work:

"FDIC Proposal
Federal Deposit Insurance Committee Chairman Sheila Bair today said Congress should authorize the Treasury to make home loans to help pay down as much as 20 percent of the principal on mortgages.

Under the FDIC plan, borrowers would be responsible for paying back the loan and the restructured mortgage. Participation would be restricted to Americans in owner-occupied homes with mortgages obtained between January 2003 and June 2007 whose monthly payments exceed 40 percent of household income."

My Take:

Another stupid proposal. These 2003-2007 borrowers simply can't afford the house and bought at the top. This would be a mess if it got approved. How would these loans be structured?

The proposal calls for the treasury part of the loan to start getting paid back 5 years after the new loan was structured. Like all of the other bailout plans, all this will do is postpone the inevitable outcome of foreclosure. This proposal will fail like all of the others. You don't hear much about 'Hope Now' anymore now do you?

This plan also would also do nothing for speculators and condo buyers because they can't qualify.

I've got a brilliant idea. How about we let housing prices fall back to affordable levels and let the housing market naturally correct itself?

Housing cannot be saved at unaffordable levels!!! It does nothing but destroy the housing market going forward because no one will be able to afford to qualify for a loan. I still say any serious government plan will only happen after prices are at or near the bottom. Consider this government hype nothing but lip service.

The sad part about all of these promises is it brings false hope back to the stock market which is soaring as I write to you right now. The "buy the bottom mania" continues when the Fed and government come out and make promises they know they can't keep.

Here is your "reality check" on the data released today:

Here is what is really going on in the economy. Manufacturing shrunk for a third straight month and the jobless claims report for the week came in higher than expected at 380,000. There are now 3 million Americans out of work which is the highest number since 2004. Here it is from Bloomberg:

"Manufacturing in the U.S. shrank for a third month and rising prices eroded consumers' buying power as the six-year economic expansion ground to a halt.

The factory index compiled by the Tempe, Arizona-based Institute for Supply Management was unchanged at 48.6 in April. The Commerce Department said consumer spending rose 0.4 percent in March. Stripping out the effect of inflation, purchases were up 0.1 percent after stagnating the previous month.

The ISM report indicated no sign of improvement from the first quarter, when only a jump in inventories prevented the economy from shrinking. Consumers and manufacturers are struggling with rising prices and the worst housing slump in a quarter century.

The Labor Department reported separately that first-time claims for unemployment insurance rose more than forecast last week, to 380,000. The total number of Americans receiving benefits climbed to 3.019 million, the highest level since April 2004.

``Consumers are struggling,'' said Ryan Sweet, an economist at Moody's in West Chester, Pennsylvania. ``Their finances are being squeezed on two fronts: they're getting pressure from higher energy prices and slower income and job growth.''

The spending report, which also showed incomes increased a smaller-than-forecast 0.3 percent, indicated households spent mainly on services such as medical care and utilities, and bought fewer big-ticket items such as cars and furniture.

The inflation measure tracked by the Fed, which strips out food and fuel prices, increased 0.2 percent after a 0.1 percent gain the previous month. It rose 2.1 percent from March 2007, compared with a median estimate of 2 percent."

Final Take:

Quite a difference between what the government is saying versus what the economic data shows isn't it? The numbers above speak for themselves. They are terrible and people are starting to really struggle.

So who are you going to believe? The lip service from the Paulson and the Fed, or the hard data showing how the housing slowdown, inflation, and the higher unemployment is killing the consumer.

I will take the data over lip service any day of the week.

Wednesday, April 30, 2008

The Fed made a big mistake/Market Rally Fades on cut

What a roller coaster today. In my opinion, the Fed made a major blunder today. The .25 cut was understandable because it was already baked in the cake. Here is the news on the rate cut.

What was disappointing to me was the statement. Traders were looking for a cut followed by a firm statement from the Fed that they would pause here because inflation was a concern. When they didn't get any tough talk defending the dollar, the DOW went from being up 160 points to down 12 for the day.

What you heard instead from the Fed was they saw some weakness in inflation in the CPI, and they are predicting that inflation concerns will lighten as the economy weakens based on less demand for goods. Why are they looking at the CPI!! This does not include food and energy, and this is where the inflation is!!!

If anything, my bet is that the next move by the Fed will be further cuts because the economy keeps weakening. The dollar weakened significantly after the news of the cuts and the weak wishy washy statement from the Fed.

Ladies and gentleman we are in a real bad position. My guess is the data on the economy was so bad that they decided to come out with a tame statement knowing they have 2 months until there next meeting which gives them some time.

So going forward we will have a crumbling economy combined with soaring inflation. If the Fed is betting that inflation will be contained with 2% interest rates then they are making a huge mistake. The dollar is just going to continue to slide.

Oil and food will then continue to move higher. If inflation wasn't contained at 2-1/4% rates then how will it be contained at 2%? Betting that lower demand will tame inflation is a stupid bet. How can you think in this way when you have massive emerging economies with new middle classes numbering in the billions gobbling up commodities?

There are now food riots based on our weak dollar. Whats going to happen to these poor people as we continue to cut rates?

I hope they realize these risks. IMO the economy is so bad, they are willing to risk the inflation to save the economy. This is a big mistake. The consumer is in no shape to handle much more inflation.

The dumbest thing of all is the fact that cutting rates is not addressing the problem!!!
The bond market and Libor set mortgage rates. Rates have hardly dropped since the Fed started cutting. The only thing these cuts are doing is propping up dead insolvent banks and fueling inflation.

The pigmen need help because they got blinded by greed, and the Fed is giving it to them on a silver platter at the expense of the middle class who is stuck with higher prices on everything.

How dead are the banks and Wall St.?

Take a look at what some of the biggest names on Wall St. had to say in a poll realeased by Reuters:

A few quotes:

"On Wall Street, however, the road back to health will take much longer.
"It is the Great Depression on Wall Street. It sure isn't on Main Street," Ken Griffin, chief executive of hedge fund Citadel Investment Group, said during a panel at the Milken Institute Global Conference in Beverly Hills, California.

According to Griffin and other top U.S. investors at the conference, the credit and housing crises that led to hundreds of billions of dollars in losses for Wall Street firms will take those investment banks years to claw back from.

"Until you see Wall Street put on their party hats again and get on the tables and start dancing is going to be years," said Ken Moelis, a former UBS banker who now runs his own investment firm, Moelis & Company.

"It will be a long time for Wall Street to come back to where it was." Leon Black, billionaire investor and founding partner of hedge fund Apollo Advisors, said the banking system has been "broken" since last summer and has fostered a credit crisis "the likes of which I've never seen in the 30 years I've been in the business."

My Take:

Well there you have it. The best and the brightest are calling for a Wall St. depression. Leon Black said its the worst he has ever seen in 30 years. Think about that. That means its worse than 1987, or the 1980-82 period where interest rates ended up in double digits.

Expect housing to go right down the tubes with Wall St. They were tied together like husband and wife during this bubble, and they will go down in flames together as well.

I think history will show that the Fed made a mistake today as they continued on the path of rate cutting that the Fed has been famous for over the last 20 years. What is different this time is inflation, and insolvent banks who refuse to lend in order to get the party started again.

Like the billionaires explained above, its going to take years to fix this. There will be no catalysts for stocks for a long time. Tomorrow, the unemployment report comes out followed by the manufacturing data. Expect these to look horrible.

With the Fed hopefully done cutting, and Wall St. on its knees, expect stocks to start trading on the news and fundamentals versus hope. Expect the news to get worse by the month and investors will come to realize that there will be no second half recovery in 2008.

The easy money party is over and now its time to clean up the mess. Its going to be a long summer for the market.

Quiet Morning is we await the Fed

The market was very quiet for the most part this morning. The action should pick up later in the day after the Fed makes its statement and we see where rates are going to be heading going forward. A .25 cut seems to be the most common prediction on what they do with the FF rate.

One quick thing I wanted to talk about that might pressure the Fed with its decision today is the increase in food prices that are causing riots all over the world. The Wall St. Journal reported yesterday that our low rate monetary policy causing many of these issues with the rising costs in food.

The reason for this is because commodities are dollar based. As our dollar decreases in value it increases the cost of food for poorer nations. Food is a much larger part of an average workers budget in countries like China and India. When you see stories like this from Bloomberg, you realize this is a large issue and prices are still rising.

So now we have the Fed being pressured to cut rates by Wall St to save the banks, and they are getting pressure from the rest of the world to do the opposite so people don't starve.

Its a very difficult spot for the Fed to be in and it will be interesting to see what they decide to say today.

The data was pretty solid today on the economic front. GDP was reported at .6 for the first quarter and earnings weren't too bad from several companies. Much more later as we see the markets reaction to the Fed and what they decide on rates.

Have a great day.

Tuesday, April 29, 2008

Bill Gross/Foreclosures/Consumer confidence

Stocks fell slightly today as the news flow continues to show that the economy is contracting in a major way. Before I get into some news the following news on Citi just hit the wires:

"April 29 (Bloomberg) -- Citigroup Inc., the U.S. bank hit with writedowns on subprime mortgages and bonds, is selling $3 billion of stock two weeks after reporting its second straight quarterly loss.

``This was extremely disappointing,'' William Fitzpatrick, an equity analyst at Optique Capital Management in Racine, Wisconsin, said in a Bloomberg Television interview. ``I would say this is probably it, but I have said that before.''

How many more times does Citi plan on doing this? The stock is free falling in after hours trading. I wonder what price they are selling their shares at? It must be low if the stock is tanking. I thought the financials had bottomed?..Yeah right. Why anyone would want to own financials right now is beyond me.

As the foreclosures add up, expect many banks to continue to be forced to raise capital by diluting their shares or borrowing at guido interest rates.

This is going to happen over and over and over again everybody. The banks keep lying to investors saying they don't need to raise anymore capital. This sucks in more investors, and they get rewarded by getting sucker punched when banks like Citi announce this crap.

Do not trust the financials right now. They are sitting on billions of bad debt and will continue to pull these dilution stunts. You know what will happen if people decide to stop buying these shares after getting suckered one too many times? The bank will go POOF. Now is not the time to own financials.

Why does this keep happening?

Because the housing crisis is deepening. The news is getting really bad out there folks. Take a look at the foreclosure data released today.

"April 29 (Bloomberg) -- U.S. foreclosure filings more than doubled in the first quarter as payments rose for subprime adjustable mortgages and falling home prices left property owners unable to sell or refinance without losing money.

Almost 650,000 properties were in some stage of foreclosure during the quarter, or 1 in every 194 U.S. households, Irvine, California-based RealtyTrac Inc., a seller of foreclosure data, said today in a statement. The number was 112 percent above a year ago. Nevada, California andArizona had the highest rates."

``This country needs a cleansing,'' billionaire real estate investor Sam Zell, chairman of Equity Group Investments LLC, said yesterday at the Milken Institute Global Conference in Los Angeles. ``We need to clean out all those people who never should have bought in the first place, and not give them sympathy.''

My Take:

Sam Zell is right. That 112% jump in foreclosures is flat out frightening. When this cleansing is done the stock market is going to be in shambles. This second half recovery talk is a joke. Analysts are already starting to backtrack on this recovery talk as the data gets worse and worse.

One of them was quoted on CNBC warning that if stocks hit the expected earnings growth of 14% in the second half, it would be the quickest rebound in the stock market in over 30 years. Anyone thinking this is going to happen without housing and the financials participating is smoking crack.

Consumer confidence Data:

So how is the consumer feeling?

"April 29 (Bloomberg) -- Confidence among Americans fell to a five-year low this month after home prices dropped by the most since at least 2001, signaling a deepening threat to consumer spending.
The Conference Board's confidence index fell to 62.3 in April, posting its biggest three-month slide since the last recession in 2001, the New York-based research group said today. House prices in 20 U.S. metropolitan areas dropped 12.7 percent in February from a year earlier, more than forecast and the most since S&P/Case-Shiller's records began seven years ago.
Treasuries rallied and stocks fell after the figures indicated no end in sight to the housing slump"

"Home prices will probably keep sliding as foreclosures push even more properties onto the market just as stricter lending rules limit the number of qualified buyers.
``This is just one more strain for consumers, in addition to high energy prices and tight credit,'' said
Michelle Meyer, an economist at Lehman Brothers Holdings Inc. in New York. ``Prices are going to continue to fall, probably through the end of next year.''

Uhhhh not very good. The consumer represents almost 70% of the economy. I think these numbers speak for themselves. I think Michelle is about right. I expect this recession to last well into next year.

Bill Gross today: ``Lower Fed Funds? They would, in Pimco's opinion, likely do more damage than good from this point forward,''

Uh oh. How will the stock market go up without rate cuts? This has been the main driver for stocks since the data has been so bad. Lets buy because the worst is over! The bottom is in! What a joke. We are in the second inning of this mess.

Here is what else Bill Gross said today:

``Lower Fed Funds? They would, in Pimco's opinion, likely do more damage than good from this point forward,'' Gross said in commentary on Pimco's Web site. ``Foreign and domestic investors are being fleeced with negative real interest rates, and the weak dollar, stratospheric commodity prices and steadily rising import inflation are the result.''

``The better alternative is to initiate a limited mark-to- market write-down of private mortgage debt as envisioned in the Dodd-Frank Congressional proposal combined with government- subsidized loans at below market rates,'' Gross wrote. ``Surely Republicans, Democrats and Wall Street mortgage holders (Pimco included) can recognize that stability as opposed to freefall market clearing is the better alternative, especially if the pain is shared by all parties.''

Final take:

Pay attention to Bill Gross. Many think he is one of the smartest guys on the street. Now Bill Gross will talk his book so you need to be careful. He has placed huge trades betting that the government will eventually bail out housing.

Even with a housing bailout, Gross agrees that there needs to be a controlled reset on prices. I believe he will get what he wants, but at the rate housing is self destructing, it will be too late because the legislation would have to be approved by congress which will take time. The damage in housing will be mainly over with by the time the government gets a chance to step in.

As it was explained to me earlier today by an insider, its better for the government to step in when prices are way down because it will be cheaper to bail out.

Save your rebate checks for your down payment! The rate at which housing is crashing is stunning.

The bottom might be closer than I anticipated. Its still definately not the time to buy, but the panic stage of this crash is getting close and you need to be ready.

Case/Shiller Index: Record price drops. No end in sight

The Case/Shiller US home price index hit record lows today as prices dropped 12.7% in February versus a year ago. This was the biggest drop in prices in the history of the current index which dates back to 2001.

The older Case/Shiller 10 city report showed a 13.7% drop in prices which was the the largest drop since the report was introduced in 1987.

Prices have now fallen every month since January of 2007. That's 14 consecutive months! There were zero indications that we are near a bottom. I watched some commentary on CNBC about the results of the report, and even bubble TV failed to find one positve in the report. Here are the the results from Bloomberg:

"April 29 (Bloomberg) -- Home prices in 20 U.S. metropolitan areas fell in February by the most on record, pointing to an imbalance between supply and demand that shows no sign of ending.

The S&P/Case-Shiller home-price index dropped 12.7 percent from a year earlier, more than forecast and the most since the figures were first published in 2001. The gauge has fallen every month since January 2007.

``This is just one more strain for consumers, in addition to high energy prices and tight credit,'' said Michelle Meyer, an economist at Lehman Brothers Holdings Inc. in New York, which forecast a price decline of 12.4 percent. ``Prices are going to continue to fall, probably through the end of next year.''

Nineteen of the 20 cities in the index showed a year-over- year decrease in prices for February, led by a 23 percent slump in Las Vegas and a 22 percent decline in Miami. Charlotte was the only area showing a gain with a 1.5 percent increase. "

My Take:

Well I guess if you need to buy a house then you better move to Charlotte. These numbers are obviously hideous and there seems to be no end in sight. The numbers from Vegas and Miami are stunning. We are now seeing price drops that are worse then the 1990 housing slump according to the 10 city report which hit an all time low.

Imagine buying a home for $500,000 in Las Vegas last year, and learning that your house is now worth $100,000+ less. The impact of this realization will result in a major pullback in consumer spending habits.

When people feel less wealthy they spend less. If I was $100,000 in the hole living in Vegas I wouldn't want to spend a dime above what I had to.

People will be walking away in record numbers as housing prices continue to plummet. All of this talk about the government stepping in and stabilizing the housing market is nothing but lip service.

When I asked one of the Wall St. players in the real estate market about government intervention, he responded to me by asking a question. Jeff, Why would the government step in and try to stabilize prices at a level where no one can afford them?

Quite a good question don't you think? Expect housing prices to get slaughtered before the government comes in with any sort of substantial bailout. Sweden waited until housing prices dropped 50% before their government intervened to stabilize their housing bubble.

The bailout will eventually happen, but it will be after housing prices have corrected to affordable levels.

Monday, April 28, 2008

Legendary Builder Eli Broad expects an additional 20% drop in home prices

Legendary Eli Broad, co-founder of KB homes, told Bloomberg today that he expects home prices to drop an additional 20% due to unsold inventory. Here are some of his comments from Bloomberg:

"Eli Broad, a philanthropist and co- founder of KB Home, the fifth-largest U.S. homebuilder by revenue, said he expects home prices to drop another 20 percent.

``I don't think we're anywhere near a bottom in housing,'' Broad told Bloomberg TV at the Milken Institute Conference in Beverly Hills, California. ``We're going to have a big inventory of unsold, unoccupied homes that's going to take three or four years to clear out.''

"``People were using their home equity as really an ATM machine,'' Broad said, referring to an automated teller machine. ``They were spending more money than they were earning by taking equity out of their home. That couldn't go on indefinitely. We're now paying a price for that.''

My Take:

Well I don't know of a guy that knows the housing market better than Eli Broad. He has built homes through several selling cycles and made billions doing it. Consider him the T. Boone Pickens of the housing world.

His expectations of a 20% drop did not surprise me. I have personally figured the number nationally would be right around there and worse in the bubble areas.

What shocked me was how long its going to take to sell off this inventory. 3-4 YEARS!!!! Prices will continue to fall as long as there is excess inventory. Anyone not selling a home thinking the market will come back is crazy.

Don't forget, there will be years of flat prices after the inventory is sold off because so many people will have gotten burned. It will take time for people to shake off the pain of their losses. It will also take time for them to get their credit back to buy a new house!

Japan is going on 20 years after their housing bubble crashed and they still haven't seen any serious appreciation in their housing market.

Bottom Line:

Eli Broad is a guy you should pay attention to. If its going to take 4 years to sell off this inventory then I have some advice for sellers and buyers.

Anyone who owns a home in a bubble area and is holding out thinking the market will come back needs to rethink their position. If you live in an area where there was not a lot of appreciation and your house is affordable for the income in the area then you can be more patient. By affordable I mean 3-4 x income.

If you live in a bubble area my advice is to get out now as fast as you can. Lower the price to where you start seeing traffic then sell it. The longer you wait the lower prices are going to go if we have 4 years of inventory.

If this means you have to short sell it at a small loss then you better do it now before it becomes a big loss later in the cycle. If you can't afford to short sell it then I would suggest you go talk to a bankruptcy attorney and take a look at your options.

Now some advice for the buyers. We have a long way down to go. 20% in Eli's opinion. I will trust him over the NAR any day of the week. As long as inventories stay high, prices will keep dropping.

Don't try to catch a falling knife. I am always a fan of industry experts who no longer are in business because they tend to tell you the truth versus talking their book. Eli gives his fortune away for a living now as a philanthropist. He has no agenda due to any business ties when he speaks his mind.

If he thinks we go down 20% from here then expect it.

Case/Shiller price index comes out tomorrow. Stay tuned!

Forum Announcement

I wanted like to announce the launch of a new forum section of The Housing Time Bomb. Here is the link:

The Housing Time Bomb Forum

You can also find this link on the upper right side of the blog right above the housing bear.

Everyone is invited to participate.

Many sellers/buyers are struggling to find there way through this challenging environment and I thought having a meeting place where people could share their experiences would be helpful.

There is also a section for people that just want to talk stocks.

Grab a screen name and have some fun.

I will be on later for an update on today's housing and market action. It was a busy day.


Interest Rates: Get out your Polyester the 1970's are Back!

Well this week will be all about the Fed and what they do with the FF rate. I predict they will cut another .25 down to 2% and warn that this may be it because of inflation. They will then cross their fingers and pray that they can sit here for awhile and allow the banks to recover and hope going forward, higher inflation will be somewhat modest.

Speaking of inflation, there was an article in the Washington Post this weekend that says world food prices are up 80% since 2005. No wonder we are having food riots all over the world.

There was an interesting article in Bloomberg discussing interest rates and where we might be heading. From Bloomberg:

"Reserve Chairman Ben S. Bernanke may have to start talking and acting more like Paul Volcker if he wants to avoid being remembered as another Arthur Burns.

With oil and food prices surging, Volcker told the Economic Club of New York on April 9 that ``there are some resemblances between the present situation and the period in the early 1970s,'' when then-Fed Chairman Burns let an inflation psychology take hold. ``There was some fear of recession, the oil price went skyrocketing up, the dollar was very weak.''

It took Volcker's effort as Fed chief to push the overnight lending rate to 20 percent in 1980 and drive the economy into its deepest decline since the Depression to break the inflation he inherited. To avoid squandering the gains Volcker made, Bernanke may need to stop his all-out effort to prop up the weakening economy and start paying more attention to countering price pressures."

So what are the economists predicting going forward?

``It's most likely that they'll cut by a quarter point,'' says David Jones, author of four books on the central bank and chief executive officer of DMJ Advisors LLC in Denver. ``But I wouldn't be shocked if they don't cut rates at all.''

Fisher's Concern

``I'm concerned that we might be on a path of higher inflation than we would otherwise have had,'' Fisher said in a Fox Business Network interview aired April 22.
Since the start of the year, oil prices have risen 23 percent, while corn has climbed 27 percent and rice has jumped 76 percent.

``The economy in the '70s had a tremendous inflationary bias; the recession slowed inflation but didn't stop it,'' says Wyatt Wells, a professor at Auburn University and author of a biography of Burns.
``The lesson of the '70s is that, more than anything else, the Fed has to keep inflation expectations anchored,'' DMJ Advisors' Jones says. ``Bernanke is about to get hit right between the eyes with that reality"

My Take:

Expect another .25 because the market has priced it in. I think this it it though folks. Equities will be fighting the Fed going forward. Bernanke may end up having to do what Volker did at some point. Inflation is out of control. Can you imagine the fed funds rate at 20% instead of the 2.25% we have now?

Higher rates going forward are a must going forward in order to cool inflation. Expect this to do a number on housing. Just think you go to a mortgage boker and he quotes you a rate of 15%? You wouldn't be able to qualify to buy a closet at current prices.

Wall St. is going to have a fit as rates rise because it will not be good for stocks if the consumer gets crushed.

Sometimes you just need to take your medicine. We are already heading back to the 1970's. If Bernanke doesn't watch his step it could be worse. I wonder if there are any disco songs that I can download on I-Tunes. The seventies are back.

Quick newswire alert from DowJones on the financials:

JP Morgan says sell the financial rally:

Morgan Stanley Says Sell Financials' Rally, Risk Not Over Yet0 minutes ago - Dow Jones NewsBy Ed Welsch Of DOW JONES NEWSWIRES Sell the rally in financial stocks, analysts at Morgan Stanley told clients Monday, saying more capital raising, dividend cuts and deleveraging are coming across the sector. Financial stocks rose in last week's trading as momentum investors rotated out of securities seen as safer, such as commodities and U.S. Treasury securities, and into investments that had been shunned, like corporate bonds and financial stocks. Financial stocks in the Standard & Poor's 500 index are up more than 15% from their lows on the March 17 bailout of Bear Stearns Cos. (BSC). The tentative movement back into risker investments shows that some investors are willing to test the idea that things are looking up for battered financial companies. But Morgan Stanley analysts Betsy Graseck, Cheryl Pate and Justin Kwong aren't convinced. They believe the difficulties in the credit markets are only in their "3rd inning," and that the situation will be worse than the recessionary environment of 1990 and 1991. "We think it's a mistake to chase this rally," they wrote. "The risk is much greater that credit deterioration will accelerate and banks will raise more dilutive equity and cut dividends [more] than expected."

Sunday, April 27, 2008

The Libor panic: Homeowners scramble to get out of Libor Based Loans

Bloomberg reported today that the soaring Libor rate is putting even more pressure on homeowners that have a Libor based adjustable rate ARMs. The Libor rate has risen so high, its forcing Libor based homeowners to refinance into a treasury based 30 year fixed that has a higher .61% rate than the Libor ARM.

The reason these homeowners are jumping into 30 year fixed mortgages before their loan resets is because many Libor based mortgages don't have a yearly 2% per year cap like treasury indexed loans. So the payment can change before the loan resets.

As a result, their payments could double before the ARM even resets because the rate on the loan fluctuates based on the Libor rate.

Here are a few nuggets from the article followed by my take:

"Property owners are abandoning adjustable-rate mortgages, or ARMs, to ward off the prospect of higher payments. About 6 million U.S. homeowners, or 59 percent of the ARM market, have Libor-indexed loans, according to data compiled by Santa Ana, California-based First American CoreLogic Inc. The 12-month U.K. benchmark Libor rate rose more than two-thirds of a percentage point in the past month, according to Bankrate Inc. in North Palm Beach, Florida.

``Any ability people might have had to convince themselves that adjustable-rate mortgages don't have risk has completely evaporated,'' said
Edward Glaeser, a professor of economics at Harvard University in Cambridge, Massachusetts, and editor of Quarterly Journal of Economics.

Almost all U.S. subprime loans and 41 percent of prime adjustable loans are linked to Libor, or the London interbank offered rate, First American CoreLogic said. Many Libor-indexed mortgages don't have the 2 percent cap on adjustments that are typical for Treasury-indexed loans, meaning homeowners could see their monthly payments double.
Sleepless Nights

``Like a lot of people I've been awake some nights worrying about what the Libor is going to do,'' said Marc Sherman, 51, of Manhattan Beach, California, who has a $440,000 adjustable loan linked to the U.K. benchmark rate that will reset next March. ``I may be switching to a fixed-rate loan.''

``If you're stepping up to a higher interest rate and, on top of that, paying loan fees, it means you are making a commitment to stay put long enough to make those costs worth it,'' Gumbinger said.

Homeowners with Libor-indexed loans who are refinancing are finding that the cost of fixed loans isn't much higher than adjustables, said Patrick Newport, an economist at Lexington, Massachusetts-based research firm Global Insight Inc.

The spread, or difference between the average U.S. fixed rate and the average adjustable rate for a 30-year mortgage, was 0.61 percent in the first quarter, the closest since the fourth quarter of 2000, data compiled by Freddie Mac show."

My Take:

What a disaster. So all of the subprime loans are based off of Libor. The foreclosure rate is already 25% on these loans and rising. So how do these homeowners react? They jump into a 30 year fixed loan at a higher rate. Can you say nightmare?

This will send foreclosure rates even higher on these loans because the owner now has to pay more for a house that they already can't afford!!!

Bottom Line:

The Libor scandal has forced another explosion in the housing market. I think now we realize why these banks were desperate enough to lie about the lending rates between each other in order to keep the Libor rate lower. They realized it would force more foreclosures costing them billions of dollars that they can't afford to lose right now.

Libor has gone through the roof because the banks now have to tell the truth about lending rates.

The fraud involved in this housing debacle is on a scale I have never seen before. Many of the people involved in this need to be thrown in jail so this never happens again.

Its amazing what greed will do to people. Stay the heck away from buying a house until this disaster plays out.

It just keeps getting worse folks. The housing time bomb took another step towards going KABOOM.