Boom2Bust.com

U.S. Economy Headed Towards Doom And Gloom?

This morning I came across two pieces which were notable in that they painted a gloomy picture for the U.S. economy going forward. Jonathan Burton of MarketWatch talked about TCW Group’s Jeffrey Gundlach’s economic outlook, and wrote:

An influential investment strategist has a dire forecast for U.S. stocks, credit markets and the continued independence of some of the nation’s top financial institutions.

Jeffrey Gundlach, chief investment officer at Los Angeles-based mutual-fund company TCW Group Inc., told clients on a conference call late Wednesday that the crisis in credit and housing may not abate for several years and is actually getting worse.

In the deteriorating climate he sees unfolding, Gundlach said, the Standard & Poor’s 500 Index could fall another 30%, giant Citigroup could become an “AIG-sized debacle,” Morgan Stanley would merge with a banking company, Wachovia won’t be able to stand alone, default rates on even prime mortgages could soar, and European banks’ woes are just beginning.

“This is no market for old men,” said Gundlach, who also manages TCW’s flagship Total Return Bond Fund . “This is no market for old-school thinking.”

Gundlach based his assessment on a belief that housing prices still face several more years of decline, a protracted slump, he said, not seen since the Great Depression. Moreover, Gundlach said it’s possible that home prices could be sluggish until 2022.

“If it’s like the Depression experience — and it sure is shaping up that way — it could take several years. Maybe we won’t see a bottom in home prices until 2014,” he said.

Burton talked about Gundlach’s credentials for making such statements. He wrote:

As a forecaster, Gundlach didn’t just climb aboard the gloom-and-doom wagon. He was early to spot the cracks that subprime loans were making in the financial system, and among the first to warn that an era of easy money would come to a bad end.

The MarketWatch reporter noted:

Expect loan default rates to rise, Gundlach said, not just in the subprime market, but among the top-drawer prime borrowers as well. The prime default rate could approach 10% from a current 2% before the carnage is over, he said…

Accordingly, financial institutions may suffer write-offs that could surpass $1 trillion before conditions improve, he said…

The breakdown will take a further toll on U.S. stocks, Gundlach added. The S&P 500 will tumble below 800, he said, about 35% below its 1156 close on Wednesday.

Said Gundlach: “None of us have ever seen this, and it’s no market for old men, but risk aversion is the order of the day.”

Someone else who sees massive problems ahead for the American economy is Harvard economic professor and former chief economist of the International Monetary Fund Kenneth Rogoff. He wrote on the Financial Times (UK) website last night:

Were the financial crisis to end today, the costs would be painful but manageable, roughly equivalent to the cost of another year in Iraq. Unfortunately, however, the financial crisis is far from over, and it is hard to imagine how the US government is going to succeed in creating a firewall against further contagion without spending five to 10 times more than it has already, that is, an amount closer to $1,000bn to $2,000bn.

In other words, $1 to $2 trillion. Rogoff continued:

True, the US Treasury and the Federal Reserve have done an admirable job over the past week in forcing the private sector to bear a share of the burden. By forcing the fourth largest investment bank, Lehman Brothers, into bankruptcy and Merrill Lynch into a distressed sale to Bank of America, they helped to facilitate a badly needed consolidation in the financial services sector. However, at this juncture, there is every possibility that the credit crisis will radiate out into corporate, consumer and municipal debt. Regardless of the Fed and Treasury’s most determined efforts, the political pressures for a much larger bail-out, and pressures from the continued volatility in financial markets, are going to be irresistible…

The Ivy League professor talked about the potential fallout from allocating so much money to deal with the escalating financial crisis. He wrote:

It may prove to be possible to fix the system for far less than $1,000bn- $2,000bn. The tough stance taken by regulators this past weekend with the investment banks Lehman and Merrill Lynch certainly helps.

Yet I fear that the American political system will ultimately drive the cost of saving the financial system well up into that higher territory.

A large expansion in debt will impose enormous fiscal costs on the US, ultimately hitting growth through a combination of higher taxes and lower spending. It will certainly make it harder for the US to maintain its military dominance, which has been one of the linchpins of the dollar.

The shrinking financial system will also undermine another central foundation of the strength of the US economy. And it is hard to see how the central bank will be able to resist a period of allowing elevated levels of inflation, as this offers a convenient way for the US to deflate the mounting cost of its private and public debts.

It is a very good thing that the rest of the world retains such confidence in America’s ability to manage its problems, otherwise the financial crisis would be far worse.

Let us hope the US political and regulatory response continues to inspire this optimism. Otherwise, sharply rising interest rates and a rapidly declining dollar could put the US in a bind that many emerging markets are all too familiar with.

A new banana republic?

Sources:

“The worst is yet to come”
Jonathan Burton
MarketWatch, September 18, 2008

“America will need a $1,000bn bail-out”
Kenneth Rogoff
Financial Times (UK), September 17, 2008

Next Wave Of Mortgage Defaults Coming

Think the U.S. housing crisis is nearing an end? Think again, says Vikas Bajaj of the Paris-based International Herald Tribune. Bajaj wrote yesterday:

The first wave of Americans to default on their home mortgages appears to be cresting, but a second, far larger one is building with alarming speed.

After two years of upward spiraling defaults, the problems with mortgages made to people with weak, or subprime, credit are showing the first, tentative signs of leveling off.

But with the U.S. economy struggling, homeowners with better credit are now falling behind on their payments in growing numbers. The percentage of mortgages in arrears in the category of loans one rung above subprime, so-called alternative-A, or alt-A, mortgages, quadrupled to 12 percent in April from a year earlier. Delinquencies among prime loans, which account for most of the $12 trillion market, doubled to 2.7 percent in that time.

So, when should we expect this new tsunami of mortgage defaults to arrive? Bajaj wrote:

While it is difficult to draw precise parallels among various segments of the mortgage market, the arc of the crisis in subprime loans suggests that the problems in the broader market may not peak for another year or two, analysts said…

Bajaj said that prime and alt-A borrowers typically have a 5 to 7-year grace period before having to start making payments toward their principal. By contrast, subprime loan borrowers had a 2 to 3-year introductory period. David Watts, an analyst with CreditSights, told the Tribune that regarding alt-A mortgages:

More delinquencies look like they are on the horizon because so few of them have reset.

Delinquencies in prime and alt-A loans are worrisome for financial institutions because they have more of these types of loans on their books than they do subprime mortgages. Bajaj noted:

During a conference call with analysts last month, James Dimon, the chairman and chief executive of JPMorgan Chase, said he expected losses on prime loans at his bank to triple and described the outlook for them as “terrible.”

Madness, “One Step Beyond” (1980)
YouTube Video Link

Source:

“A second, far larger wave of U.S. mortgage defaults is building”
Vikas Bajaj
International Herald Tribune (France), August 4, 2008

Top Credit Analysts Say Housing Decline Could Amount To $4 Trillion In Lost Capital

So far, credit crunch talk has revolved mainly around losses in the billions of dollars. No more. Reuters’ Walden Siew wrote today:

No one knows when the credit crisis will end.

But when it does, U.S home prices may have lost a third of their value, high-yield bond valuations will hit levels close to those seen during the last recession, and what may amount to $1 trillion of Wall Street losses may translate into almost $4 trillion of lost access to capital.

That’s the view of top credit analysts, who say a U.S. housing decline, sparked last year by subprime mortgage debt defaults, will likely last another two years as a wider group of consumers, including prime borrowers, feel the pinch from a tightening of credit.

Siew interviewed Peter Acciavatti, a credit analyst and managing director at JP Morgan Securities Inc. The analyst informed him that:

• Wall Street write-downs and losses totaling at least $325 billion to date may ultimately mean $3.9 trillion in tighter credit conditions
• U.S. home prices may keep on falling until 2010, declining as much as 30% from their 2006 peak
• Further drops in subprime mortgage debt markets are expected
• High-yield corporate bond default rates, now at 0.75% from 0.34% at the beginning of 2008, may climb to 2.25% later this year and jump to 6.5% in 2009

Glenn Costello, a Fitch Ratings managing director, also said that there will be more defaults and delinquencies for U.S. home mortgages, with the highest default rates coming from mortgages originating in the last few years. The senior analyst warned:

There are a lot more mortgage defaults to come. We see an ongoing high level of default.

Source:

“Home price drop means $4 trillion in lost capital”
Walden Siew
Reuters, June 11, 2008

Charting A U.S. Financial Crisis

I came across some excellent Wall Street Journal charts this morning which show how the present financial crisis in the United States came to be. Like that old saying goes, “A picture is worth a thousand words.”

Sources: WSJ Market Data Group, Federal Reserve, Dealogic, Equifax, Moody’s Economy.com, National Association of Realtors, St. Louis Federal Reserve, Dow Jones Indexes

Article Source:

“U.S. Mulls Next Steps in Crisis”
Bob Davis, Greg Ip, and Damian Paletta
Wall Street Journal, March 18, 2008

A Detailed Look At The Causes Of Foreclosure

As I sit here at my computer waiting for news on the rescue plan for subprime mortgage borrowers, I thought I’d take a look at some of the reasons behind the growing foreclosures in the United States. Only this morning, MarketWatch reported that “the rate of loans entering the foreclosure process during the third quarter, as well as the percent of loans in the foreclosure process during that time, were at the highest levels in the history of the Mortgage Bankers Association’s quarterly delinquency survey.” According to The Peridot Capitalist, the following data came from a slide at Countrywide’s keynote presentation at the 37th Annual Bank of America Investment Conference in September:

Causes of Foreclosure (July 2007)
• 58.3% Curtailment of income
• 13.2% Illness/Medical
• 8.4% Divorce
• 6.1% Investment property/Unable to sell
• 5.5% Low regard for property ownership
• 3.6% Death
• 1.4% Payment adjustment
• 3.5% Other

Yesterday, a MarketBeat blog post from the Wall Street Journal said:

What’s striking about this, however, is that, at least through the summer, resetting rates weren’t the reason for the bulk of foreclosures…

In fact, income events account for 58% of foreclosures where the reason is known — payment adjustments account for just 1.4%…

This data, of course, runs only through July, and therefore does not include what’s happened since, but it’s worth watching.

So now that it looks like rates will be frozen on a number of adjustable-rate subprime mortgages, it’s possible that for some borrowers the difference between keeping or losing their homes depends on the U.S. job market holding up.

No Lifeline For Housing Investors?

According to a Money Magazine article posted on the CNN Money website yesterday, those who bought homes in the United States as an investment may not be helped by the proposed U.S. Treasury Department rescue plan to save the homes of subprime borrowers with adjustable-rate mortgages who cannot afford higher payments as their interest rates reset in coming months, but who otherwise could afford to stay in their homes. The article said:

It has also been reported that homes that were bought as investments - as opposed to for the purpose of living in - would be excluded.

More than 50% of the increase in delinquent mortgages are actually investor-related, said Wachovia senior economist Mark Vitner. “It’s hard to conceive how any people are actually going to meet this criteria. There’s nothing at all in there that addresses investors,” said Vitner, who added he doesn’t support an investor bailout.

Back on August 30, 2007, Doug Duncan, Mortgage Bankers Association (MBA) Chief Economist and Senior Vice President of Research and Business Development, had this to say about the spike in mortgage problems and its relation to U.S. housing investors:

Defaults are on the rise in most parts of the country, but it should be recognized that it is not always the case of a homeowner losing his or her home but is often the case of an investor gambling on a continued increase in home values and losing that gamble…

Nevada, Arizona and Florida were among the states with the fastest home price appreciation over the last five years. This rapid price appreciation attracted both speculators and home builders, a volatile combination that lead to an over-supply of homes that was beyond the capacity of the local populations to support. When this over-supply became apparent and prices began to fall, many of these investors simply walked away from their mortgages.

In a press release from the same day, the Mortgage Bankers Association said:

Defaults on mortgages where the owner does not live in the house are a major driver of the defaults in four of the states with the fastest rising rates of seriously delinquent loans, according to data released today by the Mortgage Bankers Association (MBA).

As of June 30, 32 percent of prime mortgage defaults in Nevada were on non-owner occupied properties, along with 24 percent of subprime loans. In Florida, the non-owner occupied shares were 25 percent for prime loans and 14 percent for subprime loans. Nevada and Florida are facing the fastest increases in delinquent loans in the country.

In Arizona, 26 percent of prime loan defaults were non-owner occupied and 18 percent of subprime loans. In California, the rate was 21 percent of prime defaults and 15 percent of subprime. Arizona and California are also among the states facing the fastest increases in delinquent loans in the country.

In contrast, in the rest of the country, non-owner occupied homes accounted for only 13 percent of prime defaults and 11 percent of subprime defaults.

Analyst Says U.S. Banking Crisis Has Begun

Earlier today, The Globe And Mail (Canada) reported that a major U.S. banking crisis is underway. Myles Zyblock, chief institutional strategist at RBC Dominion Securities Inc. (owned by Royal Bank of Canada), said that problems with the U.S. housing market have spilled over into the financial sector, setting off the third major banking crisis in the United States since the Great Depression. While Zyblock said he didn’t expect bank failures to be the “main problem” this time around, he wouldn’t discount the possibility “of a few sinking ships.”

According to The Globe And Mail:

In arguing his point about the likelihood of a major banking crisis, Mr. Zyblock trots out some disturbing statistics on the U.S. housing market and the fallout on the financials. He noted, for example, that more than 20 per cent of the value of U.S. mortgage loans made in 2005 and 2006 is linked directly to subprime situations, and another 19 per cent is linked to alt-A loan situations. Both are types of loans made to those who don’t qualify for prime mortgages.

And it is those loans that are running into trouble, as evidenced by the fact that 16 per cent of subprime mortgages are now past due. To make things worse, problems are starting to rise in the prime mortgage space as well as in the face of what he says is the worst case of national price deflation in the U.S. housing market in at least 40 years. And inventories of unsold houses are nearing multidecade highs with foreclosures adding to the supply.

Mr. Zyblock believes that the worst is probably still to come in terms of bank writedowns arising out of the real estate situation.

Zyblock said he “would not be surprised” if the U.S. government attempts some sort of bailout to deal with the situation.

Sunday Edition: November 11, 2007

The United States Of Debt
On November 6, the Denver Post talked about U.S. Comptroller General David M. Walker as he participates in the “Fiscal Wakeup Tour.” In an earlier post I spoke of tour, which is sponsored by the Concord Coalition and attempts to explain in plain terms why budget analysts of diverse perspectives are increasingly alarmed by the nation’s long-term fiscal outlook. Walker, who is the chief auditor of all federal programs and activities, is a political independent who is pleading with American voters to elect only presidential candidates who make budget reform a top priority. Why is he so concerned? According to the Post:

The federal budget is crumbling, he says. The nation continues to borrow at an alarming rate and to saddle today’s toddlers with exorbitant debt they may not ever be able to repay. The country can’t afford the Medicare and Social Security benefits it has promised. And politicians seemingly refuse to level with Americans about how much financial trouble the country faces if it sticks with the status quo much longer.

According to the nation’s auditor:

Let me tell it to you straight. The. Math. Politicians. Sell. Does. Not. Work. And if we don’t start dealing with the truth soon, this country could face dire consequences.

He adds:

Do not vote for anyone who is unwilling to make fiscal responsibility and intergenerational equity one of their top three priorities.

In response to those who insist that the United States can grow its economy enough to head off its impending trillion-dollar debt, Walker says his calculations show our annual economic growth must be at least 10% for the next 75 consecutive years for this to work (by the way, in the nineties the economy grew at an annual average of only 3.2%). Walker concludes, “We can’t grow our way out of this. Some very tough decisions must be made.”

Click here to watch the Denver Post’s presentation of “The United States Of Debt.” According to the Post, “This colorful video primer featuring Walker and some of the information he highlights when meeting with civic groups across the country will bring you up to speed in a hurry on one of the nation’s most pressing issues.”

Dissing The Dollar
I usually don’t pay attention to the antics of the in-crowd, but the following two are worth mentioning. On November 5, Bloomberg reported that Brazilian supermodel Gisele Bundchen wants to remain the world’s richest model and is insisting that she be paid in almost any currency but the U.S. dollar. Patricia Bundchen, the model’s twin sister and manager in Brazil, said in a telephone interview back in September that, “Contracts starting now are more attractive in euros because we don’t know what will happen to the dollar.”

Peter Schiff of Euro Pacific Capital had this to say about the greenback’s slide in the latest issue of his free newsletter The Global Investor:

The dollar’s fall is now so pervasive that the world is walking away from it en masse. The story has even been given some sizzle with the announcement from Brazilian supermodel Gisele Bundchen that she will no longer accept modeling contracts in dollars. Never seeing a cloud attached to any silver lining, knee-jerk bulls such as Larry Kudlow have suggested that Bundchen’s decision is a contrary indicator that the dollar has bottomed. In truth, the only notable bottom here belongs to Gisele herself.

On Friday, the Wall Street Journal reported that in the video for his new single “Blue Magic,” American rap artist Jay-Z is shown spending euros rather than dollars, “thus annointing the European currency as the rap world’s new bling,” according to the Boston Herald. Jim Cramer, host of CNBC’s “Mad Money, remarked, “But when things have gotten to the point that even people like Gisele and Jay-Z realize the dollar is too weak, things have gotten out of control.”

Parting Shot
Time magazine reported in its November 12 issue that some parents are skipping a mortgage payment so that they can get their hands on a ticket ($1,000 and up in some cases) for their child to attend a Hannah Montana concert. In case you didn’t know, Disney’s Hannah Montana is the number one show for kids and tweens on basic cable. The 54-city accompanying concert has sold out within minutes in every town.

On a side note, St. Louis-based radio station Y98 offered dads the chance to be their daughter’s hero- by putting on high heels and racing 50 yards to win 4 concert tickets.

According to Reuters, Mark Edwards, director of programming at Y98, said, “We got a couple of hundred phone calls from people asking questions about where to get high heeled shoes big enough for husbands and about 150 men turned up in high heels.”

By the way, the winner of the race didn’t give the tickets to his kids. He was competing on behalf of his boss who has a young daughter…

It’s good to be the king.

Have a wonderful week,

Christopher E. Hill
Editor
editor@boom2bust.com

And Homeowners Make Fun Of Renters?

As citizens of the United States, we’ve been brought up to believe in something called the “American Dream.” As part of this “dream,” we’ve been told that we should aspire to own the roof over our heads. At no other time was this more apparent than with the dawn of the new millennium. Back on December 16, 2003, President Bush declared:

This Administration will constantly strive to promote an ownership society in America. We want more people owning their own home. It is in our national interest that more people own their own home. After all, if you own your own home, you have a vital stake in the future of our country.

And so homeowners were held in the highest esteem throughout American society. But, there were still the renters, who were incapable of holding a mortgage (let alone a decent job). Those scum of the earth. Back in the glory days of the housing bubble, I read about a landlord here in Chicago who complained that she couldn’t find any decent tenants. What she really meant to say is that she couldn’t find any decent human beings to rent from her. And the cesspool was shrinking. Why was this? Well, there were some among the untouchables who aspired to become homeowners, and did just that, regardless of cost. I believe a lot of it had to do with the stigma attached to being a renter in American society. And the inevitable comparison to the Joneses (who are, if you haven’t figured it out by now, a commercial invention). The situation reminds me of an MTV commercial in the eighties where a teenage couple is talking, and the boy says, “Nobody likes me.” The girl reaches out for him and says, “I like you.” He whines back, “No. Nobody GOOD likes me.” Then silence (they don’t show her embedding her Doc Martens boot in his face).

Which brings us to the two million new homeowners (and falling as I type this) that were estimated to have been created by the housing boom. Mortgages were made available to these individuals so that they could leave the ranks of the houseless heathen and participate in the glory of the “ownership society.” And the aspiring Joneses diligently researched and familiarized themselves with the available mortgage products before signing on the dotted-line. Or did they? A recent study conducted by D.C.-based Peter D. Hart Research Associates discovered the following characteristics among borrowers:

• 51% say they are very informed about their mortgage’s terms and conditions
• 18% say they don’t know their current interest rate
• 25% say they don’t know when their lender will next be able to raise their rate
• 73% say they don’t know how much their monthly mortgage payment will increase the next time their rate goes up
• 40% say they don’t know whom to turn to for guidance if they have difficulty paying

Responsible borrowing? Hardly. It gets worse. On November 2, Brian Montgomery, Assistant Secretary for Housing with HUD, told a congressional hearing that more than 40% of delinquent borrowers do not respond to contact from their lenders until it is too late. Which is really quite sad, considering that industry sources say 50% of those who seek counseling or go to their lenders for help end up staying in their homes with new mortgage products.

As author Charles Simmons once said, “Ridicule is the first and last argument of fools.”