G
Gandalf Grey
Guest
Saint Joe and the Impending Global Financial Crisis
By Mike Whitney
Created Dec 10 2007 - 1:12pm
The wreckage in the housing market just keeps piling up. Sales of existing
homes in October dipped 23.5% from last year. Prices on new homes dropped
13% year over year. Third quarter foreclosures skyrocketed to 635,000, a 94%
increase over last October and an all-time high on the misery-meter. The
real estate market is in free-fall and the real trouble hasn't even begun
yet.
California, Nevada, Arizona and Florida are mired in a full-blown housing
depression. Inventory is off-the-chart. Presently, there's a 10.8 month
backlog and the numbers are steadily rising. If foreclosures continue at the
current pace, by the end of 2008, there'll be a 14 month inventory. That
means that every builder in the country could drop his tool-belt right now
and stop working FOR MORE THAN A YEAR before the market would clear.
Contractors would be filling out job-applications at Red Lobster or looking
for an empty street-corner with a tin cup.
We're now entering the crisis phase of the biggest housing bust in US
history; Greenspan's remake of Three Mile Island; only this time the whole
country will be vaporised by a subprime-radioactive cloud.
As bad as the housing market is now; it's going to get a whole lot worse.
Judith Levy sums it up in her article "ARM Resets to Hit Fan in 2008":
"In 2008 interest rates will be reset upward on $362 billion worth of
adjustable-rate subprime mortgages [ARMs] ....The 'real crest of the reset
wave' has yet to take place, which promises more pain for borrowers, lenders
and Wall Street.... In addition to the $362 billion of subprime ARMs, $152
billion of other adjustable-rate loans are scheduled to reset in 2008,
including jumbo mortgages and Alt-A loans. The Mortgage Bankers Association
estimates that 1.35 million homes will enter foreclosure in 2007 and another
1.44 million in 2008, up from 705,000 in 2005."
$514 billion in resets. 3.5 million foreclosures.
Did I say Three Mile Island? I meant Nagasaki.
California is bound to be the state that's hardest hit by the housing slump.
Homeowners can expect to see price depreciation that could rival the Great
Depression. As Broderick Perkins says,
"The California Association of Realtors reported the median price of an
existing, single-family, detached home in California dropped 9.9 percent in
October, compared to the same month a year ago. The decline was the largest
year-to-year decline in CAR's history books....
We believe that a downturn is imminent, with sales volumes down 52 percent
from the peak (in January 2005) and inventory (11.8 months) up 100 percent
since last year. House price depreciation and credit deterioration go
hand-in-hand. We anticipate residential mortgage credit deterioration to
follow house price declines in California. Presently, credit quality (in
absolute terms) is better in California versus the national average, but the
rate of deterioration is much worse. For instance, in the second quarter of
2007 delinquency rates for prime ARMs and subprime ARMs rose 92 percent and
73 percent year-on-year respectively in California, versus 53 percent and 38
percent nationally," Goldman Sachs reported."( Broderick Perkins, "Record
Home Price Declines Portend Extended Downturn", Seeking Alpha)
Wow. Home prices dropped 10% in a MONTH! Inventory is up 100%. Sales volumes
are down 52%. Its the trifecta!
Its getting so hard to sell a house in California, that people are resorting
to divine intervention. A number of websites have popped up on the Internet
promoting transcendental or occult techniques for attracting potential
buyers. Luckymojo.com recommends an old favorite; "burying a statue of Saint
Joseph upside down in the yard". The site even features its own "Real Estate
Spell Kit" which includes:
1 Dressed and Blessed Saint Joseph Candle
1 Statuette of Saint Joseph
1 Bottle Saint Joseph Oil
1 Saint Joseph Chromo Print
1 Saint Joseph Holy Card
Luckymojo even provides an optional prayer that can be recited during the
ceremonial burying of St. Joseph:
"Saint Joseph, I am going to place you
in a difficult position
with your head in darkness
and you will suffer as our Lord suffered,
until this [house/property] is sold.
Then, Saint Joseph, I swear
before the cross and God Almighty,
that I will redeem you
and you will receive my gratitude
and a place of honor in my home.
Amen."
Following the prayer, the supplicant takes the statue of Saint Joseph and
plugs him into the ground upside down and waits for the phone to start
ringing. Who needs a realtor anyway? "If there's no yard, then dig a hole in
a large potted plant." St. Joe won't mind. All of this can be done without
chanting, amulets, prostrations, or messy sacrificial animals.
It's worth a shot.
But sorcery won't work for everyone and the deteriorating housing market is
sending tremors through the broader economy. In fact, the accelerating rate
of foreclosures has put Washington in full panic-mode. Treasury Secretary
Henry Paulson has been frantically trying to put together a bail-out package
that will keep millions of homeowners from losing their homes. Here's
Paulson's statement from earlier in the week:
"As we are all aware, the housing and mortgage markets are working through a
period of turmoil, as are other credit markets, as risk is being reassessed
and re-priced. We expect that this turbulence will take some time to work
through, and we expect some penalty on our short-term economic growth.
To speed up the modification process, Treasury is working through the "HOPE
NOW" alliance with the American Securitization Forum to convene servicers
and investors so they can develop categories of borrowers eligible for
appropriate modifications and refinancings, and an industry-wide
solution....I am confident they will finalize these standards soon. And I
expect all servicers will implement them quickly, and create benchmarks to
measure their progress along the way. As a result, what was a fragmented,
cumbersome process can be a coordinated effort which more quickly helps able
homeowners."
Who does Paulson think he's kidding? He knows the plan is a non-starter. Why
would homeowners opt to make outrageous monthly payments on homes that are
quickly losing value, when they can just park the keys on the kitchen
counter and vamoose. There's no incentive for them to be shackled to a home
if prices are going down. They'd be better off loading up the U-Haul,
grabbing the dog, and letting the bank worry about it. That's who Paulson is
really worried about anyway. "Helping the homeowner" is is a red herring.
There are a number of glitches to Paulson's scheme. For example, if he
freezes monthly mortgage payments, then bondholders won't get what they
bargained for and the market for mortgage-backed securities (MBS) will dry
up. As Tom Deutsch, deputy executive director of the American Securitization
Forum, said, ``If they no longer invest in mortgage-backed securities,
you've cut off the credit available for refinancing, you cut off the
lifeblood of being able to give better loans." (Bloomberg)
That's right. If investors don't get the returns they were promised---or if
the government arbitrarily changes the terms of the deal-bondholders will
just take their money and put it somewhere else. It's as simple as that.
That would trigger a run on the MBS market and put the kibosh on Paulson's
plan.
One thing is certain, investors will not sit by quietly while their rights
are trampled and their profits are slashed so that people can stay in their
homes. That won't happen. Any viable bailout plan will have to be
evenhanded, so that everyone shoulders part of the burden. Besides, these
bonds are covered under contract law and the investors have rights. Paulson
seems to thinks he can just make up the rules as he goes along. But he's
wrong. If he tries to void or rewrite the contracts he'll be hit with
class-action lawsuits that will stop him in his tracks.
The best summary of Paulson's plan appeared in the Wall Street Journal:
"This whole scheme is an act of eminent domain, except the government isn't
formally seizing property rights, but emboldening private parties to do so.
Why is no one calling a spade a spade?"
It's ironic that the biggest boosters of free enterprise-like Paulson---are
the first to do an about-face at the first whiff of grapeshot. Whatever
happened to principles? Does Paulson really want to promote a scheme that
forces the revision of contracts as well as repeals basic property rights?
Needless to say, Paulson's metamorphosis into Leon Trotsky has not been
warmly received on Wall Street where he has been lambasted by friend and foe
alike.
The housing blowup is having dire effects on global financial markets. The
credit crunch has spread throughout Europe where lending standards are
tightening and industrial growth is threatened by the falling dollar.
Consumer confidence has plummeted in Europe just like in the US. Last week,
the Dow Jones slipped below its August low of 12,850 following the path of
the Transports. The stock market continues to lurch back and forth furiously
like an overloaded washing machine; soaring 100 points one day and then,
plunging 200 the next. The volatility is just another indication that we are
entering a primary bear market. Dow Theory suggests that the trajectory will
continue downward into recession.
The subprime debacle has cast doubt on whether the "structured finance"
model of securitizing debt will survive. On Monday, there were crucial new
developments in this story that will have profound effects on the future of
many the country's largest investment banks. E Trade Financial has been
forced to liquidate $3 billion of its mortgage-backed securities. Up to now,
the banks, hedge funds an other holders of these toxic MBS and CDOs have
been reluctant to sell, fearing that trillions of dollars in asset value
would be immediately wiped out (for similar investments) once a firm "market
price" is established.
Well, the Day of Reckoning arrived on Monday and the only thing missing was
the funereal dirge and the wreath of fresh lilies.
According to Reuters:
"Financial analysts on Friday said E Trade got anywhere from 11 cents to 27
cents on the dollar for its $3.1 billion portfolio of asset-backed
securities. The portfolio sale was part of a $2.5 billion capital infusion
from a group led by hedge fund Citadel investment Group.
"The portfolio sale, one of the few observable trades of such assets, has
very clear, generally negative, implications for the valuation of like
assets on brokers' balance sheets," Credit Suisse analyst Susan Roth Katzke
said."
$.27 on the dollar! Yikes. No doubt they'll be pulling a few weepy bankers
off the ledge before the week is out.
What is particularly distressing about the E Trade sale is that over 60% of
the $3 billion portfolio "WERE RATED DOUBLE-A OR HIGHER". That means that
even the best of these mortgage-backed bonds are pure, unalloyed garbage.
This is really the worst possible news for Wall Street. It means that
trillions of dollars of bonds which are currently held by banks, insurance
companies, retirement funds, foreign banks and hedge funds will be slashed
to $.27 on the dollar OR LOWER. Banks will have to hoard reserves to meet
the new capital requirements on the falling value of their assets, which
means that they'll have less money to loan to businesses and consumers. In
fact, this is already taking place, which is the real reason the Fed keeps
injecting money into the banking system. The E Trade "firesale" confirms
that the country--and perhaps the world---is now headed into a downward
deflationary spiral. The Fed will HAVE to cut interest rates 50 basis points
on December 11, just to keep the financial system from freezing up entirely.
That will, of course, further emasculate the dollar and send food and energy
prices through the roof.
There's really no way to overstate the importance of the E Trade sell-off.
It is the equivalent of a neutron bomb detonating in the heart of the
financial district. Yes, everyone is still milling around with their caramel
Macchiatos clutching their Blackberries just like before. But the game is
over. Trillions of dollars of market capitalization will be lost and some of
the biggest names in banking will be carted off to the boneyard. It will be
a miracle if the Fed's interest rate cuts are enough to keep the economy
sputtering along while the losses are written-down and the country recovers
its footing.
$.27 on the dollar should be inscribed on the headstone of every Wall Street
fraudster and every chiseling "financial innovator" who transformed the
world's most powerful and resilient markets into a carnival sideshow. It
should include every subprime "no doc--no down" homeowner who lied on his
loan application to goose the system and get another 50 grand for a jet-ski
and 42" liquid TV; every cheesy realtor who fudged the paperwork to put
unemployed busboys with bad credit in $550 McMasions in Loma Verde; every
ratings agency stooge who got carpal-tunnel from stamping each shaky
subprime loan with with AAA seal of approval; every lacquer-hair banker in a
two-toned shirt who bundled up garbage loans and dumped them on Wall Street;
every shabby hedge fund manager who used the subprime loans to beef-up his
own personal administrative fees by leveraging the MBSs and CDOs at rates of
10 to 1; every regulator who serenely looked the other way while the market
was dousing itself with jet-fuel and reaching for the matches; and, of
course--above all--the Federal Reserve, who initiated this whole boondoggle
by producing trillions of dollars of low interest credit which flooded the
system creating the greatest speculative frenzy in history. P.T.
Greenspan-the Ponzi Ringleader-- deserves the place of honor at the head of
the charlatans' conga-line as they are frog-marched to some remote black
site where they can pay for their transgressions.
The rest of us will have to stay put and endure the fallout from a
"completely avoidable" Great Depression. We're dead ducks.
Managing Director of Pimco Managed Funds, Bill Gross, summarized our present
conundrum in a recent article:
"What we are witnessing is essentially the BREAKDOWN OF OUR MODERN DAY
BANKING SYSTEM, a complex of levered lending so hard to understand that Fed
Chairman Ben Bernanke required a face-to-face refresher course from hedge
fund managers in mid-August. My PIMCO colleague, Paul McCulley, has labeled
it the "SHADOW BANKING SYSTEM" because it has lain hidden for
years-untouched by regulation-yet free to magically and mystically create
and then package subprime mortgages into a host of three-letter conduits
that only Wall Street wizards could explain." (Bill Gross, "The Shadow
Knows", Pimco Funds)
..
A few months ago, Gross's observations would have been dismissed as the
ravings of a doomsday nutcase. Not anymore. Now they are part of the
mainstream analysis. Gross is a realist. The financial markets are broken.
It's time to strap the patient to the gurney and wheel it in to I.C.U. No
more band aids, thank you. Time for major surgery.
Closing Thoughts
The President of the St. Louis Fed, William Poole, discussed many of these
issues in a speech last week. Poole insisted that it is not the Fed's
intention to "pump up the stock market" or to protect investors from losses
by easing rates. Rather, the rate cuts are supposed "to restore normal
market processes. He said, " An active financial market is central to the
process of economic growth and it is that growth, not prices in financial
markets per se, that the Fed cares about."
Fair enough.
He added, "One of the most reliable and predictable features of the Fed's
monetary policy is action to PREVENT SYSTEMIC FINANCIAL COLLAPSE. If this
regularity of policy is what is meant by the "Fed put," then so be it, but
the term seems to me to be extremely misleading. The Fed does not have the
desire or tools to prevent widespread losses in a particular sector but
should not sit by while a financial upset becomes a financial calamity
affecting the entire economy."
The Federal Reserve is now actively trying to forestall "a systemic
financial crisis". (Poole's words) The trillions of dollars that were loaned
to mortgage applicants--which ignored traditional criteria for
lending---have created the likelihood of a decades-long downturn in the
housing industry as well as a meltdown in the broader financial markets. The
bundling of dodgy subprime liabilities and selling them as valuable assets
to unsuspecting investors; is a scam that any competent regulator should
have spotted immediately. It doesn't take genius to see that offloading
sketchy MBSs and "marked to model" CDOs to gullible institutions is wrong
and a danger to the entire system.
Financial innovation has created a dilemma for which there is no easy
solution. The Genie cannot be put back in the lamp. Paulson's remedies have
no chance of succeeding. Mortgage-backed securities have been so chopped up
and spread throughout the system; it would be easier to to unravel a bowl of
spaghetti , separate each strand, one by one, and lie them next to each
other without touching. It can't be done. The bad debts will have to be
written down, banks will have to fail, and government will have to
investigate affordable housing alternatives for millions of defaulting
homeowners.
Deregulation has created a monster. The prevailing Reagan-era, "supply
side",
free market doctrine has removed tariffs, subsidies and other state-created
price-distortions, but it has also eliminated all oversight and
accountability. Government agencies no longer play an active role in
policing the markets and, as a result, US financial institutions have fallen
into disrepute.
This is, first of all, a credibility problem and it will require leaders
with a strong moral foundation, not evasive bureaucrats who're looking for a
painless way to "cut their losses" and and keep the wheels of industry
clanking along. Asset-backed commercial paper--a $2 trillion business--"is
hardly trading at all." The securitization of credit card debt, mortgages
and car loans has slowed to a crawl and is in danger of stopping altogether.
Many of the main engines for generating revenue for the banks-the
repackaging of debt and amplifying it through levered derivatives-has
vanished overnight. The financial markets have never been under such stress.
There's so much mortgage-backed gunk in the plumbing, institutional lending
has been reduced to a dribble. This is no the time for "business as usual"
"garbage in, garbage out". We need people who really understand what is
going on to step up to the plate and propose coherent "fiscal" policy
options that will steer the global economy away from the reef.
Forget about Paulson's "quick fix" snake oil. It's utter bunkum. The
credibility of the system is at at stake. It's time to get serious
_______
Mike Whitney
--
NOTICE: This post contains copyrighted material the use of which has not
always been authorized by the copyright owner. I am making such material
available to advance understanding of
political, human rights, democracy, scientific, and social justice issues. I
believe this constitutes a 'fair use' of such copyrighted material as
provided for in section 107 of the US Copyright
Law. In accordance with Title 17 U.S.C. Section 107
"A little patience and we shall see the reign of witches pass over, their
spells dissolve, and the people recovering their true sight, restore their
government to its true principles. It is true that in the meantime we are
suffering deeply in spirit,
and incurring the horrors of a war and long oppressions of enormous public
debt. But if the game runs sometimes against us at home we must have
patience till luck turns, and then we shall have an opportunity of winning
back the principles we have lost, for this is a game where principles are at
stake."
-Thomas Jefferson
By Mike Whitney
Created Dec 10 2007 - 1:12pm
The wreckage in the housing market just keeps piling up. Sales of existing
homes in October dipped 23.5% from last year. Prices on new homes dropped
13% year over year. Third quarter foreclosures skyrocketed to 635,000, a 94%
increase over last October and an all-time high on the misery-meter. The
real estate market is in free-fall and the real trouble hasn't even begun
yet.
California, Nevada, Arizona and Florida are mired in a full-blown housing
depression. Inventory is off-the-chart. Presently, there's a 10.8 month
backlog and the numbers are steadily rising. If foreclosures continue at the
current pace, by the end of 2008, there'll be a 14 month inventory. That
means that every builder in the country could drop his tool-belt right now
and stop working FOR MORE THAN A YEAR before the market would clear.
Contractors would be filling out job-applications at Red Lobster or looking
for an empty street-corner with a tin cup.
We're now entering the crisis phase of the biggest housing bust in US
history; Greenspan's remake of Three Mile Island; only this time the whole
country will be vaporised by a subprime-radioactive cloud.
As bad as the housing market is now; it's going to get a whole lot worse.
Judith Levy sums it up in her article "ARM Resets to Hit Fan in 2008":
"In 2008 interest rates will be reset upward on $362 billion worth of
adjustable-rate subprime mortgages [ARMs] ....The 'real crest of the reset
wave' has yet to take place, which promises more pain for borrowers, lenders
and Wall Street.... In addition to the $362 billion of subprime ARMs, $152
billion of other adjustable-rate loans are scheduled to reset in 2008,
including jumbo mortgages and Alt-A loans. The Mortgage Bankers Association
estimates that 1.35 million homes will enter foreclosure in 2007 and another
1.44 million in 2008, up from 705,000 in 2005."
$514 billion in resets. 3.5 million foreclosures.
Did I say Three Mile Island? I meant Nagasaki.
California is bound to be the state that's hardest hit by the housing slump.
Homeowners can expect to see price depreciation that could rival the Great
Depression. As Broderick Perkins says,
"The California Association of Realtors reported the median price of an
existing, single-family, detached home in California dropped 9.9 percent in
October, compared to the same month a year ago. The decline was the largest
year-to-year decline in CAR's history books....
We believe that a downturn is imminent, with sales volumes down 52 percent
from the peak (in January 2005) and inventory (11.8 months) up 100 percent
since last year. House price depreciation and credit deterioration go
hand-in-hand. We anticipate residential mortgage credit deterioration to
follow house price declines in California. Presently, credit quality (in
absolute terms) is better in California versus the national average, but the
rate of deterioration is much worse. For instance, in the second quarter of
2007 delinquency rates for prime ARMs and subprime ARMs rose 92 percent and
73 percent year-on-year respectively in California, versus 53 percent and 38
percent nationally," Goldman Sachs reported."( Broderick Perkins, "Record
Home Price Declines Portend Extended Downturn", Seeking Alpha)
Wow. Home prices dropped 10% in a MONTH! Inventory is up 100%. Sales volumes
are down 52%. Its the trifecta!
Its getting so hard to sell a house in California, that people are resorting
to divine intervention. A number of websites have popped up on the Internet
promoting transcendental or occult techniques for attracting potential
buyers. Luckymojo.com recommends an old favorite; "burying a statue of Saint
Joseph upside down in the yard". The site even features its own "Real Estate
Spell Kit" which includes:
1 Dressed and Blessed Saint Joseph Candle
1 Statuette of Saint Joseph
1 Bottle Saint Joseph Oil
1 Saint Joseph Chromo Print
1 Saint Joseph Holy Card
Luckymojo even provides an optional prayer that can be recited during the
ceremonial burying of St. Joseph:
"Saint Joseph, I am going to place you
in a difficult position
with your head in darkness
and you will suffer as our Lord suffered,
until this [house/property] is sold.
Then, Saint Joseph, I swear
before the cross and God Almighty,
that I will redeem you
and you will receive my gratitude
and a place of honor in my home.
Amen."
Following the prayer, the supplicant takes the statue of Saint Joseph and
plugs him into the ground upside down and waits for the phone to start
ringing. Who needs a realtor anyway? "If there's no yard, then dig a hole in
a large potted plant." St. Joe won't mind. All of this can be done without
chanting, amulets, prostrations, or messy sacrificial animals.
It's worth a shot.
But sorcery won't work for everyone and the deteriorating housing market is
sending tremors through the broader economy. In fact, the accelerating rate
of foreclosures has put Washington in full panic-mode. Treasury Secretary
Henry Paulson has been frantically trying to put together a bail-out package
that will keep millions of homeowners from losing their homes. Here's
Paulson's statement from earlier in the week:
"As we are all aware, the housing and mortgage markets are working through a
period of turmoil, as are other credit markets, as risk is being reassessed
and re-priced. We expect that this turbulence will take some time to work
through, and we expect some penalty on our short-term economic growth.
To speed up the modification process, Treasury is working through the "HOPE
NOW" alliance with the American Securitization Forum to convene servicers
and investors so they can develop categories of borrowers eligible for
appropriate modifications and refinancings, and an industry-wide
solution....I am confident they will finalize these standards soon. And I
expect all servicers will implement them quickly, and create benchmarks to
measure their progress along the way. As a result, what was a fragmented,
cumbersome process can be a coordinated effort which more quickly helps able
homeowners."
Who does Paulson think he's kidding? He knows the plan is a non-starter. Why
would homeowners opt to make outrageous monthly payments on homes that are
quickly losing value, when they can just park the keys on the kitchen
counter and vamoose. There's no incentive for them to be shackled to a home
if prices are going down. They'd be better off loading up the U-Haul,
grabbing the dog, and letting the bank worry about it. That's who Paulson is
really worried about anyway. "Helping the homeowner" is is a red herring.
There are a number of glitches to Paulson's scheme. For example, if he
freezes monthly mortgage payments, then bondholders won't get what they
bargained for and the market for mortgage-backed securities (MBS) will dry
up. As Tom Deutsch, deputy executive director of the American Securitization
Forum, said, ``If they no longer invest in mortgage-backed securities,
you've cut off the credit available for refinancing, you cut off the
lifeblood of being able to give better loans." (Bloomberg)
That's right. If investors don't get the returns they were promised---or if
the government arbitrarily changes the terms of the deal-bondholders will
just take their money and put it somewhere else. It's as simple as that.
That would trigger a run on the MBS market and put the kibosh on Paulson's
plan.
One thing is certain, investors will not sit by quietly while their rights
are trampled and their profits are slashed so that people can stay in their
homes. That won't happen. Any viable bailout plan will have to be
evenhanded, so that everyone shoulders part of the burden. Besides, these
bonds are covered under contract law and the investors have rights. Paulson
seems to thinks he can just make up the rules as he goes along. But he's
wrong. If he tries to void or rewrite the contracts he'll be hit with
class-action lawsuits that will stop him in his tracks.
The best summary of Paulson's plan appeared in the Wall Street Journal:
"This whole scheme is an act of eminent domain, except the government isn't
formally seizing property rights, but emboldening private parties to do so.
Why is no one calling a spade a spade?"
It's ironic that the biggest boosters of free enterprise-like Paulson---are
the first to do an about-face at the first whiff of grapeshot. Whatever
happened to principles? Does Paulson really want to promote a scheme that
forces the revision of contracts as well as repeals basic property rights?
Needless to say, Paulson's metamorphosis into Leon Trotsky has not been
warmly received on Wall Street where he has been lambasted by friend and foe
alike.
The housing blowup is having dire effects on global financial markets. The
credit crunch has spread throughout Europe where lending standards are
tightening and industrial growth is threatened by the falling dollar.
Consumer confidence has plummeted in Europe just like in the US. Last week,
the Dow Jones slipped below its August low of 12,850 following the path of
the Transports. The stock market continues to lurch back and forth furiously
like an overloaded washing machine; soaring 100 points one day and then,
plunging 200 the next. The volatility is just another indication that we are
entering a primary bear market. Dow Theory suggests that the trajectory will
continue downward into recession.
The subprime debacle has cast doubt on whether the "structured finance"
model of securitizing debt will survive. On Monday, there were crucial new
developments in this story that will have profound effects on the future of
many the country's largest investment banks. E Trade Financial has been
forced to liquidate $3 billion of its mortgage-backed securities. Up to now,
the banks, hedge funds an other holders of these toxic MBS and CDOs have
been reluctant to sell, fearing that trillions of dollars in asset value
would be immediately wiped out (for similar investments) once a firm "market
price" is established.
Well, the Day of Reckoning arrived on Monday and the only thing missing was
the funereal dirge and the wreath of fresh lilies.
According to Reuters:
"Financial analysts on Friday said E Trade got anywhere from 11 cents to 27
cents on the dollar for its $3.1 billion portfolio of asset-backed
securities. The portfolio sale was part of a $2.5 billion capital infusion
from a group led by hedge fund Citadel investment Group.
"The portfolio sale, one of the few observable trades of such assets, has
very clear, generally negative, implications for the valuation of like
assets on brokers' balance sheets," Credit Suisse analyst Susan Roth Katzke
said."
$.27 on the dollar! Yikes. No doubt they'll be pulling a few weepy bankers
off the ledge before the week is out.
What is particularly distressing about the E Trade sale is that over 60% of
the $3 billion portfolio "WERE RATED DOUBLE-A OR HIGHER". That means that
even the best of these mortgage-backed bonds are pure, unalloyed garbage.
This is really the worst possible news for Wall Street. It means that
trillions of dollars of bonds which are currently held by banks, insurance
companies, retirement funds, foreign banks and hedge funds will be slashed
to $.27 on the dollar OR LOWER. Banks will have to hoard reserves to meet
the new capital requirements on the falling value of their assets, which
means that they'll have less money to loan to businesses and consumers. In
fact, this is already taking place, which is the real reason the Fed keeps
injecting money into the banking system. The E Trade "firesale" confirms
that the country--and perhaps the world---is now headed into a downward
deflationary spiral. The Fed will HAVE to cut interest rates 50 basis points
on December 11, just to keep the financial system from freezing up entirely.
That will, of course, further emasculate the dollar and send food and energy
prices through the roof.
There's really no way to overstate the importance of the E Trade sell-off.
It is the equivalent of a neutron bomb detonating in the heart of the
financial district. Yes, everyone is still milling around with their caramel
Macchiatos clutching their Blackberries just like before. But the game is
over. Trillions of dollars of market capitalization will be lost and some of
the biggest names in banking will be carted off to the boneyard. It will be
a miracle if the Fed's interest rate cuts are enough to keep the economy
sputtering along while the losses are written-down and the country recovers
its footing.
$.27 on the dollar should be inscribed on the headstone of every Wall Street
fraudster and every chiseling "financial innovator" who transformed the
world's most powerful and resilient markets into a carnival sideshow. It
should include every subprime "no doc--no down" homeowner who lied on his
loan application to goose the system and get another 50 grand for a jet-ski
and 42" liquid TV; every cheesy realtor who fudged the paperwork to put
unemployed busboys with bad credit in $550 McMasions in Loma Verde; every
ratings agency stooge who got carpal-tunnel from stamping each shaky
subprime loan with with AAA seal of approval; every lacquer-hair banker in a
two-toned shirt who bundled up garbage loans and dumped them on Wall Street;
every shabby hedge fund manager who used the subprime loans to beef-up his
own personal administrative fees by leveraging the MBSs and CDOs at rates of
10 to 1; every regulator who serenely looked the other way while the market
was dousing itself with jet-fuel and reaching for the matches; and, of
course--above all--the Federal Reserve, who initiated this whole boondoggle
by producing trillions of dollars of low interest credit which flooded the
system creating the greatest speculative frenzy in history. P.T.
Greenspan-the Ponzi Ringleader-- deserves the place of honor at the head of
the charlatans' conga-line as they are frog-marched to some remote black
site where they can pay for their transgressions.
The rest of us will have to stay put and endure the fallout from a
"completely avoidable" Great Depression. We're dead ducks.
Managing Director of Pimco Managed Funds, Bill Gross, summarized our present
conundrum in a recent article:
"What we are witnessing is essentially the BREAKDOWN OF OUR MODERN DAY
BANKING SYSTEM, a complex of levered lending so hard to understand that Fed
Chairman Ben Bernanke required a face-to-face refresher course from hedge
fund managers in mid-August. My PIMCO colleague, Paul McCulley, has labeled
it the "SHADOW BANKING SYSTEM" because it has lain hidden for
years-untouched by regulation-yet free to magically and mystically create
and then package subprime mortgages into a host of three-letter conduits
that only Wall Street wizards could explain." (Bill Gross, "The Shadow
Knows", Pimco Funds)
..
A few months ago, Gross's observations would have been dismissed as the
ravings of a doomsday nutcase. Not anymore. Now they are part of the
mainstream analysis. Gross is a realist. The financial markets are broken.
It's time to strap the patient to the gurney and wheel it in to I.C.U. No
more band aids, thank you. Time for major surgery.
Closing Thoughts
The President of the St. Louis Fed, William Poole, discussed many of these
issues in a speech last week. Poole insisted that it is not the Fed's
intention to "pump up the stock market" or to protect investors from losses
by easing rates. Rather, the rate cuts are supposed "to restore normal
market processes. He said, " An active financial market is central to the
process of economic growth and it is that growth, not prices in financial
markets per se, that the Fed cares about."
Fair enough.
He added, "One of the most reliable and predictable features of the Fed's
monetary policy is action to PREVENT SYSTEMIC FINANCIAL COLLAPSE. If this
regularity of policy is what is meant by the "Fed put," then so be it, but
the term seems to me to be extremely misleading. The Fed does not have the
desire or tools to prevent widespread losses in a particular sector but
should not sit by while a financial upset becomes a financial calamity
affecting the entire economy."
The Federal Reserve is now actively trying to forestall "a systemic
financial crisis". (Poole's words) The trillions of dollars that were loaned
to mortgage applicants--which ignored traditional criteria for
lending---have created the likelihood of a decades-long downturn in the
housing industry as well as a meltdown in the broader financial markets. The
bundling of dodgy subprime liabilities and selling them as valuable assets
to unsuspecting investors; is a scam that any competent regulator should
have spotted immediately. It doesn't take genius to see that offloading
sketchy MBSs and "marked to model" CDOs to gullible institutions is wrong
and a danger to the entire system.
Financial innovation has created a dilemma for which there is no easy
solution. The Genie cannot be put back in the lamp. Paulson's remedies have
no chance of succeeding. Mortgage-backed securities have been so chopped up
and spread throughout the system; it would be easier to to unravel a bowl of
spaghetti , separate each strand, one by one, and lie them next to each
other without touching. It can't be done. The bad debts will have to be
written down, banks will have to fail, and government will have to
investigate affordable housing alternatives for millions of defaulting
homeowners.
Deregulation has created a monster. The prevailing Reagan-era, "supply
side",
free market doctrine has removed tariffs, subsidies and other state-created
price-distortions, but it has also eliminated all oversight and
accountability. Government agencies no longer play an active role in
policing the markets and, as a result, US financial institutions have fallen
into disrepute.
This is, first of all, a credibility problem and it will require leaders
with a strong moral foundation, not evasive bureaucrats who're looking for a
painless way to "cut their losses" and and keep the wheels of industry
clanking along. Asset-backed commercial paper--a $2 trillion business--"is
hardly trading at all." The securitization of credit card debt, mortgages
and car loans has slowed to a crawl and is in danger of stopping altogether.
Many of the main engines for generating revenue for the banks-the
repackaging of debt and amplifying it through levered derivatives-has
vanished overnight. The financial markets have never been under such stress.
There's so much mortgage-backed gunk in the plumbing, institutional lending
has been reduced to a dribble. This is no the time for "business as usual"
"garbage in, garbage out". We need people who really understand what is
going on to step up to the plate and propose coherent "fiscal" policy
options that will steer the global economy away from the reef.
Forget about Paulson's "quick fix" snake oil. It's utter bunkum. The
credibility of the system is at at stake. It's time to get serious
_______
Mike Whitney
--
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"A little patience and we shall see the reign of witches pass over, their
spells dissolve, and the people recovering their true sight, restore their
government to its true principles. It is true that in the meantime we are
suffering deeply in spirit,
and incurring the horrors of a war and long oppressions of enormous public
debt. But if the game runs sometimes against us at home we must have
patience till luck turns, and then we shall have an opportunity of winning
back the principles we have lost, for this is a game where principles are at
stake."
-Thomas Jefferson