Saturday, September 6, 2008

Shady Accounting Pressed the Treasury to Take Action

I am going to roll this stuff out to you this weekend as I find it. This is unbelievable. It looks like both GSE's were using borderline fraudulent accounting to hide losses. Geez...Where are the cops?

This story has just begun to be unfold folks. This is from the New York Times. Is this Enron part 2? You decide. Here is the link:

"The government’s planned takeover of Fannie Mae and Freddie Mac, expected to be announced as early as this weekend, came together hurriedly after advisers poring over the companies’ books for the Treasury Department concluded that Freddie’s accounting methods had overstated its capital cushion, according to regulatory officials briefed on the matter.

The proposal to place both mortgage giants, which own or back $5.3 trillion in mortgages, into a government-run conservatorship also grew out of deep concern among foreign investors that the companies’ debt might not be repaid. Falling home prices, which are expected to lead to more defaults among the mortgages held or guaranteed by Fannie and Freddie, contributed to the urgency, regulators said.

The accounting issues that brought so much urgency to the bailout appear to center on Freddie Mac’s capital cushion, the assets that regulators require them to keep on hand to cover losses.
The methods used to bolster that cushion have caused serious concerns among the companies’ regulator, outside auditors and some investors. For example, while Freddie Mac’s portfolio contains many securities backed by subprime loans, made to the riskiest borrowers, and alt-A loans, one step up on the risk ladder, the company has not written down the value of many of those loans to reflect current market prices.

Executives have said that they intend to hold the loans to maturity, meaning they will be worth more, and they need not write down their value. But other financial institutions have written down similar securities, to comply with “mark-to-market” accounting rules. Freddie Mac holds roughly twice as many of those securities as Fannie Mae.

Freddie Mac and Fannie Mae have also inflated their financial positions by relying on deferred-tax assets — credits accumulated over the years that can be used to offset future profits. Fannie maintains that its worth is increased by $36 billion through such credits, and Freddie argues that it has a $28 billion benefit.

But such credits have no value unless the companies generate profits. They have failed to do so over the last four quarters and seem increasingly unlikely to the next year. Moreover, even when the companies had soaring profits, such credits often could not be used. That is because the companies were already able to offset taxes with other credits for affordable housing.
Most financial institutions are not allowed to count such credits as assets. The credits cannot be sold and would disappear in a receivership. Removing those credits from assets would probably push both companies’ capital below the regulatory requirements.

Regulators are also said to be scrutinizing whether the companies were trying to manage their earnings by waiting to add to their reserves. Both companies have gradually increased their reserves for loan losses — Fannie’s reserves today stand at $8.9 billion, and Freddie’s at $5.8 billion.

Other companies, like private mortgage insurers, have been quicker to identify large losses and have set aside much greater amounts. Fannie and Freddie have dribbled out bad news with each quarterly announcement, suggesting they may be trying to manage this process.

Finally, regulators are concerned that the companies may have mischaracterized their financial health by relaxing their accounting policies on losses, according to people familiar with the review. For years, both companies have effectively recognized losses whenever payments on a loan are 90 days past due. But, in recent months, the companies said they would wait until payments were two years late. As a result, tens of thousands of loans have not been marked down in value.

The companies have injected their own capital into pools of securities containing these loans, arguing that their new policies are helping more borrowers.
Under conservative accounting methods, changing these policies would not have any impact on the companies’ books. However, people briefed on the accounting inquiry said that Freddie Mac may have delayed losses with the change.

“We have just had to nationalize the two largest financial institutions in the world because of policy makers’ inaction,” said Josh Rosner, an analyst at Graham Fisher, an independent research firm in New York, and a longtime critic of the government-sponsored enterprises. “Since 2003, when these companies’ accounting came under question, policy makers have done nothing. Even though they had every reason to know that the housing market’s problems would not be contained to subprime and would bring down the houses of Fannie and Freddie.”

Bailout Likely to be Announced Sunday

Good Afternoon!

Ok folks, I have spent the entire afternoon sorting through everything. The New York Times says one thing and the Washington Post says another. The differences between the two are described in a Bloomberg article. Here is the first Bloomberg story from today:

"The Washington Post reported that the government would make quarterly injections of funds as the companies' losses warranted, avoiding a large up-front taxpayer cost, citing sources it didn't name. Debt and preferred shares would be protected, and common stock would be diluted while not wiped out, the Post said.

The New York Times said most or all of both the common and preferred shares would be worth little or nothing"

Bloomberg Updated

There is a lot more updated and detailed info here so I will use this article to explain whats going on.

It looks like the CEO is out and analysts are speculating that all $5.2 trillion dollars will be guaranteed:

"Sept. 6 (Bloomberg) -- Treasury Secretary Henry Paulson will use his authority to rescue Fannie Mae and Freddie Mac, likely placing the beleaguered mortgage-finance companies under government control as early as this weekend.

Paulson informed House Financial Services Committee Chairman Barney Frank that the Treasury intends to use the powers that Congress provided last month to ensure the ``stable functioning'' of Fannie and Freddie, according to a statement today from the lawmaker. The government would make periodic injections of funds by buying either convertible preferred shares or warrants in the companies as needed, avoiding a large up-front taxpayer cost, according to a person briefed on the plan.

Holders of the companies' corporate debt and preferred shares would probably be protected, while the chief executive officers won't, said the person, who declined to be identified. Paulson met with Fannie Mae CEO Daniel Mudd and Freddie Mac CEO Richard Syron yesterday to tell them of the decision to put the companies into conservatorship, and remove the executives from their jobs, according to two people briefed on the discussions.

Shareholders' Fates

Analysts have speculated that the Treasury would wipe out common shareholders, while seeking to shield preferred stockowners from total loss. Fannie and Freddie preferred shares are typically owned by banks and insurance companies. Their $5.2 trillion of debt outstanding is held by investors including Asian central banks, and would probably be guaranteed, analysts said.

Mudd was accompanied in his meetings at FHFA yesterday by Fannie General Counsel Beth Wilkinson and Chairman Stephen Ashley. Last week, he shook up the company's management in an effort to restore investor confidence, replacing three top deputies."

My Take:

There is a lot to digest here. We still don't know what the details are so this is all pure speculation. It appears that this is going to be rolled out tomorrow before the Asian markets open. How dare they do this on the first day of football season!!!

Here is the key question: Will they just pump liquidity in as its needed and not guarantee the $5.2 trillion in debt or do they inject liquidity and guarantee the $5.2 trillion in trash?

If the $5.2 trillion gets the guaranteed, then the bond market is going to go apesh*t. Yields will go through the roof. Spreads on Fannie debt will narrow because its guaranteed. The government hopes this narrowing will lower mortgage rates and get housing moving again.

The problem the Treasury/government has here is the bond market is going to take long term rates higher because we will have just doubled our national debt overnight by taking over these two bloated pigs. They have no power to stop the bond market folks. ZERO, ZILCH,NADA.

Bottom Line

This is the best update I can give you right now. I will have much more insight tomorrow if they announce the details. I wouldn't want to be a Fannie/Freddie common shareholder right now. It looks like they get wiped out here.

I really don't have a clue as to how the market will take this. They tend to cheer bailouts so I wouldn't be surprised to see a bounce. If the bond market vigilantes send the 10 year to the moon then the bullish sentiment on Wall St. will be short lived.

Friday, September 5, 2008

WSJ: Treasury Close to Fannie/Freddie Bailout

This is hitting the wires everywhere.

Get ready folks, here come the fireworks. Word is the bailout could be announced as soon as tomorrow. Here is the news from Bloomberg:

"Sept. 5 (Bloomberg) -- Treasuries fell amid speculation the U.S. is close to reaching a plan to help troubled mortgage finance companies Fannie Mae and Freddie Mac, easing the haven appeal of government debt.

Yields climbed after the Wall Street Journal reported that the Treasury Department could announce a plan as early as tomorrow. Bonds rallied earlier as a government report showed the economy lost jobs for an eighth consecutive month in August, increasing speculation the Federal Reserve will cut rather than raise interest rates.

``We are seeing some selling of Treasuries off of this because it creates a safer environment,'' said Glen Capelo, a Treasury trader at RBS Greenwich Capital in Greenwich, Connecticut, one of 19 primary dealers required to bid at government debt sales.

The yield on the benchmark 10-year note rose 7 basis points to 3.69 percent at 4:42 p.m. in New York, according to bond broker BGCantor Market Data. It reached 3.55 percent earlier today, the lowest since April 15. The 4 percent security due August 2018 fell 17/32, or $5.31 per $1,000 face amount, to 102 18/32.

Ten-year note yields touched the lowest in almost five months before paring gains as stocks rebounded from the worst week since May. Futures show that traders see a 9 percent chance central bankers will reduce borrowing costs by year-end, compared with 43 percent odds for an increase a month ago.

Payrolls fell by 84,000, and revisions added another 58,000 to job losses for the prior two months, the Labor Department said today in Washington. The median forecast in a Bloomberg News survey of 76 economists was for a loss of 75,000. The jobless rate jumped to 6.1 percent, matching a high reached in September 2003, from 5.7 percent the prior month."

Quick Take:

Well it looks like the bailout is going down this weekend. Monday will be interesting. You could potentially see a wicked rally on the announcement. It all comes down to the language and what they plan on doing.

There are many questions that I have here regarding this announcement. Do the common shareholders get wiped out? What about the preferred? How does the bond market react to this. How high do the yields on the 10-year go if a bailout is announced?

It looks like yields rose just on the rumor that this was going down this weekend. This explains the big rally this afternoon on Wall St. There is not much else to say here until we see the details.

Bottom Line:

Whatever the Treasury decides to do, it does not change the fundamental problems in the housing market and the economy. Any bounce we get on this news becomes the shorting opportunity of a lifetime IMO.

This is the last big stick save! The Treasury better get it right. "Moral Hazard" is in play here folks. Next week will be historic.


Fannie/Freddie now plummeting after hours according to CNBC after initially bouncing. It looks like the common shareholders might get wiped out.

Hold on tight folks. Its gonna be a wild ride!

Unemployment rises to 6.1%

Good afternoon everyone

Just a quick update here on the data this morning. The jobs number was terrible. Here it is from Bloomberg:

"Sept. 5 (Bloomberg) -- The U.S. lost more jobs than forecast in August and the unemployment rate climbed to a five- year high of 6.1 percent, a sign that the economic slowdown is worsening two months before Americans elect their next president.

Payrolls fell by 84,000 in August, and revisions added another 58,000 to job losses for the prior two months, the Labor Department said today in Washington. The increase in the jobless rate sent the misery index, which adds unemployment to inflation, to 11.7 percent, the highest level since 1991.

The deteriorating labor market raises the likelihood the Federal Reserve will postpone any increase in interest rates until next year, futures trading shows. Today's figures increase the risk that President George W. Bush will become the first president since Richard Nixon to oversee two recessions, and may hurt fellow Republican John McCain's campaign to succeed him.

``It certainly increases the probability that we really are in a recession,'' William Poole, former president of the Federal Reserve Bank of St. Louis"

Quick Take:

Analysts had projected that the unemployment rate would stay at 5.7%. Nice call! NOT. My friends, things are worsening at an alarming rate. The market is trying to rally from this morning lows but I doubt it holds. I wouldn't surprised to see us pull back again this afternoon. There is simply no catalyst out there to rally equities. All of these rallies are turning out to be nothing but bounces as we slide deeper into the abyss.

Many are trying to play a bounce on the short term theory that we are oversold at these levels.

Hideous Mortgage Update

The Mortgage Bankers Association released new foreclosure numbers today. Overdue loans reached 6.41% which was an all time high:

"Sept. 5 (Bloomberg) -- Foreclosures accelerated to the fastest pace in almost three decades during the second quarter as interest rates increased and home values fell, prompting more Americans to walk away from homes they couldn't refinance or sell.

New foreclosures increased to 1.19 percent, rising above 1 percent for the first time in the survey's 29 years, the Mortgage Bankers Association said in a report today. The total inventory of homes in foreclosure reached 2.75 percent, almost tripling since the five-year housing boom ended in 2005. The share of loans with one or more payments overdue rose to a seasonally adjusted 6.41 percent of all mortgages, an all-time high, from 6.35 percent in the first quarter.

Prime Mortgages

The share of new foreclosures on prime ARMs was 1.82 percent, triple the 0.58 percent in the year-earlier quarter, and the total foreclosure inventory was 4.33 percent, up from 1.29 percent, the report said. The share of seriously delinquent prime ARMs was 6.78 percent, rising from 2.02 percent a year ago."

Final Take:

I don't know what to say here folks. I am speechless. these numbers are atrocious. The fact that prime borrowers are starting to roll over means death to Wall St. if this trend continues. Prime borrowers are not supposed to fail folks! They are now getting foreclosed on at triple the ratefrom a year ago.

This tells me that prime borrowers were as stupid as the subprime borrowers. They can't afford what they bought and now they are starting to lose their jobs.

Bottom Line:

I really don't know how this story ends folks. Things are deteriorating at a much faster rate than I expected. Foreclosure inventory is exploding which is going to continue to push home prices down.

This is looking more and more like a death spiral to me until houses fall all the way back to levels where people can buy them using the current lending standards. I am guessing in the bubble areas this may be a 50% decline peak to trough.

Some areas like Miami might see even bigger declines. I read a piece yesterday explaining that Miami now has a 5 year inventory of condos based on current sales levels.

Someone needs to start finding solutions to this crisis. We are getting close to the point where any reform is going to be too late to stop this train wreck. The government must end the smoke and mirror game on Wall St. immediately, and come up with a solution to this crisis.

A collapse is imminent if something isn't done. I hate to say it but Bill Gross is right in some aspects of his financial tsunami predictions.

I am concerned about the financial system folks. We may end up having to rebuild it from scratch.

Lets hope we find away out of this.

Thursday, September 4, 2008

Ouch! That's Gonna Leave a Mark!

Good evening everybody!

I swear every time I travel we have a big sell off. I apologize for not getting anything up earlier today as the market rolled over.

I really don't know where to start. Lets take a look the the news. This blog would be 10 pages long if I listed all of the bad news that hit today, so lets just stick with the Bloomberg summary of the meltdown today:

"Sept. 4 (Bloomberg) -- U.S. stocks tumbled, sending the Standard & Poor's 500 Index to the longest stretch of losses since January, after rising jobless claims heightened concern the economic slump is worsening and a decline in oil pushed energy producers lower.

Caterpillar Inc., Boeing Co. and United Technologies Corp. retreated as much as 5.6 percent after higher unemployment spurred concern about tomorrow's monthly jobs report. Exxon Mobil Corp. dragged energy shares in the S&P 500 to the lowest level since February. Banks and brokerages fell 4.7 percent after bond investor Bill Gross warned of a ``financial tsunami.''

My Take:

Where are those bottom callers? Are we there yet? Today's free fall was not a surprise to me. However, the events that triggered it were. Bill Gross's comments really slammed the door on the bulls today. He essentially came out and said he is not buying any more Fannie/Freddie paper until the Treasury decides on how they are going to fix the GSE disaster.

Folks, this is baaaad. Bill Gross put 61% of his fund mainly into Fannie/Freddie debt. He's getting nervous because Mr. Paulson hasn't come out and announced he will backstop this paper and bailout Fannie/Freddie. As a result, Bill Gross is on strike until he hears from the Treasury.

This puts the spotlight on Paulson. He is now forced to make a decision that he doesn't want to make right now. If there are no buyers of Fannie/Freddie debt, there is no mortgage market thus no housing market.

The risk of losing all of his buyers is very real because Bill Gross has the reputation of being one of the smartest guys on Wall St. If he ain't buying, you can assume that China and Russia aren't either. You can be sure that this news raised an eyebrow or two in Moscow and Beijing.

If the big players start to bail on buying our housing debt than the game is over. Gross knows this, and he is basically pressuring the Fed to back his investment. He placed a calculated trade on this paper knowing that when push came to shove, the US Treasury would be forced to back stop the paper.

If the Fannie housing debt isn't backed, the government guarantee means nothing. If this is the case, then why would you trust our "guarantee" on treasuries?. Remember folks, its the foreigners that fund our ridiculous spending habits by gobbling up our treasury debt.

IMO, these risks are too great for the Fed and Bill Gross knows it.. As a result, expect to hear from the Treasury soon on how they plan to bail out Fannie/Freddie.

Now I must ask a question here: Is placing a big bet on mortgage paper and then hanging your country out to dry piggish behaviour by Bill Gross? Yes! This is why they are called pigmen! All Gross cares about is making money here, and if he has to grab the Treasury by the throat in order to do so then so be it.

Pretty disgusting isn't it? Its also pretty damn brilliant in a greedy sort of way. Gross will get his way in the end. If he doesn't, his fund is probably toast after betting more than half of its assets on mortgage debt.

Now lets think about that for a second: Would Bill Gross ever bet "the house" without knowing that the Treasury was going to most likely bail us out this mess? Uhhh NO! Hell, I bet the Treasury has come to him and asked for his opinion on how to fix it!

Its criminal when you think about how this is all going down. Talk about inside information on a trade! Nevertheless, betting against Gross here would just be plain stupid.

So what do we face after the bailout?

You think you saw selling today, wait until the Treasury bailout is announced. The bond market will hate the fact that we doubled our national debt to $10 trillion by back stopping the GSE's. Interest rates will go through the roof as a result. 14% mortgage rates anyone? Don't kid yourself, it will happen when this bailout goes down. It might not happen immediately, but it will down the road.

Equities will then tank as massive deflation follows the bailout. Why? Because the cost of borrowing will go through the roof as fear grips the bond market. Risk will be the new buzzword on Wall St.

As a result, assets will free fall in value because no one will be able to afford to borrow as much money at the new higher interest rates.

Bottom Line:

The bailout is coming folks. Like it or not. The bankers are all in bed with one another and Gross's announcement today is just part of the playbook on how we get out of this mess. Does Gross really know what the Fed will do? Probably not, but I bet he is about 95% sure what their next move is. You can be sure that they have had discussions with one another about what "might" happen.

You can't bet against a GSE bailout after today folks. Bill Gross gave you the answer on the bailout on a silver platter today.

Bailouts are disgusting and should have nothing to do with capitalism. No one ever learns any lessons from them and it increases the likely hood that the pigmen will repeat the same mistakes.

Regardless,you gotta invest based off of the tape on Wall St., and the tape says bailout . You play the hand you are given! My advice and thesis remains the same: Stay in treasuries/CD's because cash is slowly becoming king. Surging US dollar anyone?

If you decide to dabble in equities, keep your positions small, and at least hold some shorts if you decide to bottom feed here on the long side.

I am currently very short in my trading account. Let me reiterate what I have said in the past: My trading account is a very small portion of my investment portfolio. Most of it is in cash.

If the jobs number is really bad tomorrow, equities are extremely vulnerable to another sell off. There is nowhere to hide in the current market. In the past, investors could always run into commodities when equities tanked. This is no longer an option as gold and oil continue to free fall. Expect many a hedge fund to go belly up as a result. There is a big rumor that the $14 billion Atticus hedge fund is liquidating.

Warning! These liquidations can kill your portfolio, especially if they invested in the same stocks as you did. Strong hedge funds are now out there shorting stocks that weak hedge funds own, betting that they will be forced to liquidate and sell all of their shares which then destroys the stocks price.

You gotta love the brutal creativity of the pigmen. Wall St. is such a pleasant place isn't it?

Wednesday, September 3, 2008

Fed Beige Book Reveals Economy Still Slowing

Good Afternoon!

The markets have been pretty quiet today. Stocks are down mildly since the Fed beige book came out. This is the most recent data that the Fed has on the economy. The report showed that the economy continues to suffer:

"Sept. 3 (Bloomberg) -- Business across most of the U.S. was ``slow'' last month, while almost all Federal Reserve districts reported pressure to raise prices because of higher commodity costs, the central bank said in its regional economic survey.

Consumer spending was ``slow'' in most of the 12 Fed districts as the housing market ``weakened or remained soft,'' the Fed said in its Beige Book report, published two weeks before policy makers meet to decide on interest rates. A ``general pullback in hiring'' helped keep wage increases ``moderate,'' the Fed said today.

With the economy weakening under the impact of the yearlong financial crisis and housing recession, and consumer prices rising, most investors anticipate the Fed will keep interest rates unchanged through December. Policy makers have lowered the rate 3.25 percentage points over the past year.

``The pace of economic activity has been slow in most districts,'' the report said. ``Wage pressures were characterized as moderate by most districts amid a general pullback in hiring.''
While prices of energy and other commodities have declined recently, the Fed said companies in the San Francisco district, the largest region, reported that ``upward price pressure remained significant,'' while ``price levels remained high'' in three other districts. Philadelphia-area retailers saw ``rising wholesale costs,'' the Fed said."

My Take:

This is a pretty gloomy beige book. Prices are up, wages are down, and consumer spending continues to be slow.

One of the Fed presidents was on earlier today discussing unemployment. He expects the jobless rate to rise over 6% later this year.

The market seems very jittery and nervous right now. Investors have been flying into treasuries over the last few weeks. Take a look at the 10-year yield below:

Yields on the 10 year and other treasuries have been plummeting as investors fly out of stocks and into treasuries. We are starting to inch back to where we were in March when Bear Stearns blew up. Fear continues to grip the markets as the credit crunch refuses to abate.

The good news here is mortgage rates should drop slightly as long as the demand for treasuries is high because many mortgage rates are based of the 10-year.

Now don't get too excited over lower rates! The banks seem to be setting their own interest rates due to fear and insolvent balance sheets! However, some of this relief in the 10-year should still get passed on.

Bottom Line:

Today was a pretty ho-hum day in the markets.

There are two sectors to keep an eye on. Tech is sharply reversing so I would watch any investments you have in this sector.

The big sector story over the last few weeks has been commodities . There is another rumor going around that a second commodity hedge fund blew up.

Some of the recent high flying commodity plays like Potash(POT) have been getting creamed:

This is what can happen when the bottom falls out in commodities. Hedge funds get stuck on the long side and go bust or decide to close up. Two things can happen here: Either they try to stay alive and sell their commodites and attempt to rotate, or they go belly up and are forced to sell all of their assets via liquidation. Either scenario floods the marketplace with excess supply which then destoys prices.

So going forward keep the following in mind:

As these commodity hedge funds start blowing up, you can expect to see violent drops in things like oil, gold, and commodity related stocks. Stay away from this sector unless you are shorting it!

Fear and uncertianty continue to build in the stock market. I expect to start seeing a rise in the VIX shortly.

Any major negative market moving event could create a sever market correction in my opinion. Things are very fragile right now.

Stay nimble.

Tuesday, September 2, 2008

The Surge of the US Dollar

Good evening folks!

I wanted to talk about the US dollar tonight. Take a look at the chart below:

As you can see, the dollar has soared over the past month. Now one would think this would be a good thing for our economy right? Wrong.

Now don't misunderstand me, I think its very important that the USA has a strong currency. Its good for our country and great when you want to travel abroad!

However, what we need to look at during when we look at this recent surge in the dollar is why is it happening? Normally you see the dollar strengthen when the Fed raises interest rates. Now we all know that that isn't the case today as the Fed has sharply cut rates since the end of last summer.

Notice up above how the value of our dollar started to weaken in Sept. as the Fed started slashing rates. Now we all know the Fed has kept rates low so the question then becomes why have we had this huge surge in the dollar over the past month?

The reason for the surge is traders are now beginning to see that the Eurozone and Japanese economies are starting to fall apart. The belief going forward is you will start seeing rate cuts overseas just like we saw over here last summer.

Certian countries like Spain and the UK have worse housing bubbles than we do! Australia dropped their rates yesterday for the first time in 7 years.

Traders are starting to realize that many countries are in worse shape than we are economically and we will see a global slowdown. I guess now itbecomes a race to the bottom economically for all of us! Some are guessing that we will be the first ones out of the global slowdown because we were the first ones in.

The bulls say this is why you should be buying US equities. Get in now because we will recover first. I say BULL****. I believe we are in just as bad a shape as these other countries, and we will all have to wallow in this together for years before we can start working our way out of it.

So beware people! The strong US dollar is a huge warning sign that the whole world is slowing down. Throughout history, countries always flock to the US whenever things get bad globally. Why do you think countries fall all over each other to buy our treasuries? We are still considered to be the safest haven in the world. If I was a FCB I sure as hell would be buying UStreasuries.

Bottom Line

The strengthening of the dollar is an ominous sign that the world is slowing down. If this is the case, the whole global growth story goes out the window. Combine weak global growth with our crippled consumers and banks and you build a strong case to stay the heck away from US equities.

I mean think about it. How can our multinational companies going to grow when imports have become 30-40% of their earnings? There growth in the US is anemic so the only conclusion you can make is its going to be very difficult to grow earnings in this environment.

The strengthening dollar should not be perceived as positive at this point of the economic cycle. The 10-year plummeted today because money was soaring into treasuries not equities. Follow the smart money.

Sadly, treasuries are slowly becoming the only place to be as an investor.

Market Instability is a Huge Warning Sign

A quick update this morning folks.

Stocks shot out of the gates like a rocket this morning, but I don't buy it for a second. We had major market dislocations last night and this morning.

Stocks are up today because Gustav did basically zero damage to the oil rigs. Oil plunged as a result. Its down almost $9 a barrel on the Gustav news. Gold then followed suit dropping a whopping $35 to fall below $800 an ounce. These are huge moves folks.

The third jolt to stocks is the continued rumor that Lehman is close to a deal on new financing from a private Korean bank. Adding to the bullish sentiment on Wall St. was the fact that Australia cut rates and Great Britian came out with their own stimulus plan on real estate taxes.

So what did the traders do in reaction to all of this news? They piled right into equities and boom we are off to the races.

Here is the problem for the bulls

Bloomberg reported today that stocks are now at 25.8 times profit. Socks haven't bee this expensive since 2002. The last time this happened, the S&P dropped 38%. Here is the piece from Bloomberg:

Sept. 2 (Bloomberg) -- The best already may be over for the U.S. stock market this year.
The Standard & Poor's 500 Index, which had the worst first half since 2002, added 0.2 percent this quarter, the only gain among the world's 10 biggest markets in dollar terms. Shares in the benchmark index for American equity climbed to an average 25.8 times reported profits, the highest valuation in five years. The last time that happened, the S&P 500 fell 38 percent.

Money managers at Federated Investors Inc., Russell Investments and Morgan Asset Management, which oversee a combined $600 billion, said the gains won't last because corporate profits will fail to meet analysts' estimates. Wall Street forecasters, who were too optimistic about earnings for the past four quarters, predict income at America's biggest companies will grow by a record 62 percent in the final three months of 2008, according to data compiled by S&P.

``The market is pricing in the expectation of a good quarter, but we just don't see it,'' said Philip Orlando, who helps manage $350 billion as chief equity market strategist at Federated in New York. ``The fundamentals are going to be poor, earnings are going to be bad, and there are going to be more huge writedowns. We think stocks probably need to work 5 to 10 percent lower over the next month or two.''

Final Take:

Don't be fooled by this bounce. The bears were whacked over the head with a perfect storm of bullish news. Stocks are NOT cheap at these levels. This is a Gustav/oil relief rally. It will flame out shortly once the attention is focused back to the credit crunch.

I see desperation in the bulls eyes as they pump this bounce. I had to turn off bubblevision. It was simply too disgusting to watch the pump monkeys pump stocks based on zero fundamentals. The market is not rational right now people. Gold should not be dropping $35 in one day. There are major market dislocations out there.

Speculators are taking on huge risk and placing huge bets in commodities markets long or short. This will eventually end ugly. The instability I am seeing in the markets is of great concern to me.

Buyer beware. Lets see where we end up at the end of the day.

Monday, September 1, 2008

California Home Prices Plummet

Wanna see a bursting bubble?

The housing correction in California has been astonishing. As you ca see above, prices are down almost 50% from the peak in 2007.

The California home price correction is getting close to the bottom. I still think its too early to be buying here because interest rates keep rising. Catching a falling knife is never a smart thing to do, and prices look to be continuing to fall faster than Michael Phelps in the 200 meter freestyle.

I would wait until the Fannie/Freddie situation plays out and you see housing prices stabilizing. If we backstop the $5trillion in mortgage debt, the bond market vigilantes might take interest rates higher. California home prices should continue to fall as a result because mortgage rates will rise.

Patience is a virtue guys and gals. Knife catching can be painful!

Sunday, August 31, 2008

Mortgage rates are expected to continue to rise

Good afternoon!

I gotta hand it to my local paper The Baltimore Sun. They kinda tell it like it is when it comes to real estate. I want to share a couple articles from them today.

The first article discusses why mortgage rates continue to rise even though the 10-year Treasury yields have been dropping. They do a nice job explaining why. Risk is back:

"Mortgage rates aren't what they used to be - and not just because they're higher.

You can normally predict the going rate for a 30-year fixed mortgage by looking at the yield on 10-year Treasury notes. If the yield is 3.8 percent, as it was in the middle of this month, you'd expect mortgage rates would be a bit less than 5 percent. Instead, they were hovering around 6 percent.

As Treasury yields dropped earlier in the summer, in fact, mortgage rates stayed steady or even rose. Joseph Bell, a Wonk reader who's thinking of buying a house, wonders: "Is there any reason for this?"


Keith T. Gumbinger, a vice president at financial publisher HSH Associates, sums it up like this: "Risk means higher rates."

Lots of people wanted to invest in mortgages back when home prices were rising faster than a helium balloon. Now, with prices falling and delinquencies multiplying, investors still willing to inject their money into the mortgage markets want a better return to make up for the risk.

Concerns about the health of Fannie Mae and Freddie Mac, the big buyers of mortgages, are also driving up rates. So are the additional fees Fannie and Freddie have been levying.

The difference between mortgage rates and the 10-year Treasuries isn't the biggest it has ever been. But "it is unusually wide," says Greg McBride, senior financial analyst at

Mortgage rates tend to move in concert with 10-year Treasury yields because "T-Notes" are a benchmark for the cost of borrowing, Gumbinger says. Treasuries, the government's primary method of borrowing, are guaranteed to be paid back, so mortgage rates are set higher to account for the added element of risk. (Most homeowners refi or sell long before 30 years, hence the use of the 10-year note.)

What about the Federal Reserve, which sets the rate banks charge each other for overnight loans? Well ... its effect on mortgages is complicated.

The Fed raises rates to combat inflation and lowers them to avoid recession, but it's now faced with rising inflation and a slow economy. Since April it's kept its rate steady - potentially adding to inflation. And when the cost of living rises, so do mortgage rates because investors don't want to lose ground, Gumbinger says.

All this means borrowers are more likely to see rates go up than down for the rest of the year, both Gumbinger and McBride say. Gumbinger thinks rates could go as high as a half-percentage point above where they are now.

But McBride says buyers shouldn't panic.

"With home prices still sliding, that removes some of the urgency for borrowers that would otherwise be laser-focused on the movements of mortgage rates," he says. "Buy a house when you're ready."

Quick Take:

Rates could end up being 1/2 a point higher from here according to Gumblinger. That would put rates on a 30 year fixed close to 7%. I think they could go higher depending on how the Fannie/Freddie debt disaster is handled.

Risk is back folks, and the banks refuse to lend like they have in the past. The conclusion here is obvious. Prices on houses will continue to drop as rates rise because buyers need to be able to qualify in order to buy. Higher rates mean the amount they can qualify to borrow is smaller.

Don't be fooled by the recent pull back in the 10-year Treasury yield. Rates are going up because of fear and risk not the 10-year. This will only further pressure the housing market. It also takes the Fed out of the equation. Lower Fed rates no longer push down lending rates.

Look at what mortgage rates have done since the Fed started slashing rates. They have gone up! The lower Fed rates have done two things: Increased inflation and helped the banks. When is the Fed going to start helping us instead of hurting us via inflation and a cheap dollar? Ahh I get infuriated everytime I think about this!

Mortgage Fraud:

I would have thought with all of the investigations around mortgage fraud would have forced lenders to clean up their act. Apparently this is not the case. In fact fraud is up 42% from last year.:

"Tough market spurs fraud

Kenneth Harney -- Nation's Housing
By Ken Harney
August 31, 2008

You might assume that, with home purchases and new mortgage volume off by 30 percent or more in many markets in the past year, loan fraud would also be down.

Wrong. A benchmark quarterly study released Aug. 25 by the mortgage industry's principal compiler of fraud reports, the Mortgage Asset Research Institute (MARI), found that the number of cases jumped by 42 percent between the second quarter of 2007 and the same period this year.

They ranged from hoked-up income verifications and credit reports to falsified employment records, financial assets illegally "rented" to buyers to beef up loan applications, inflated appraisals, straw-buyer scams and a wide variety of sellers' and purchasers' schemes designed to fool lenders. The highest second-quarter numbers of fraud reports were in Florida, California, Maryland, Illinois and Michigan"

Bottom Line:

My advice? Stay the hell away from buying a house and this industry as a whole until they clean this mess up. It appears the desperation following the ongoing housing collapse is forcing people to commit fraud on an unprecedented scale in order to try and survive.

Walking into a realtor or mortgage office is the equivalent to swimming into a shark tank IMO. Housing prices are doing nothing but dropping so sit back, relax, and watch the destruction.

Be afraid, be very afraid.