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Economy Heading For The Cliff(ZT)

(2007-08-01 08:36:37) 下一个
Economy Heading For The Cliff
Wednesday, 01 August 2007 Written by Garrett Johnson
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Got Gravity?
Thereis a famous moment in Looney Tunes cartoons after Wile E. runs off acliff, but before he looks down, when he starts to suspect thatsomething might be wrong.

The American economy had one of those moments yesterday.

The news was something only an economics junky could truly appreciate.
On Wall Street, Bear Stearns Cos., Lehman Brothers Holdings Inc.,Merrill Lynch & Co. and Goldman Sachs Group Inc., are as good asjunk.
If you don't know what this means, let me try toexplain in the simplest way possible: Wall Street professionalsconsider the odds of the three largest investment banks in the world topay off their debts equal to the odds of a subprime, house-flipperstaying out of bankruptcy.

The credit rating of these huge investment banks are now several levels below investment grade, just like Ford and GM.

If that doesn't sound scary enough to you then I would like to referyou to some economic history, when large financial houses went bankrupt- Panic of 1893, Panic of 1873, Panic of 1907, and of course, the 1929 Stock Market Panic.

From the Panic of 1837up to today, every economic recession/depression in this country'shistory has been triggered by either a banking crisis or an energycrisis. For the first time since 1974, we are set up to be hit by bothat the exact same time. On top of that, we have the very realchance of also getting hit by a currency crisis, the first this countryhas experienced since the Continental Congress was issuing promissory notes it couldn't cash during the revolution.

But I'm not making this diary to rehash economic history. Instead Iwant to examine where we are and what we can expect.


Super-Size that Subprime


While the bursting of the real estate bubble is not the original causeof the current economic distress, it is certainly the trigger.

Foreclosure rates


While the implosion of the subprime market has been getting lots ofheadlines, the Alt-A market (the level between subprime and prime)deserves a lot more attention.
The ratings company said today its expectations for losses on Alt Amortgages will increase by 10 percent to 100 percent, depending in parton how many mortgages in a loan pool were extended to borrowers withlow credit scores and little money for down payments.
Whyis that important? Keep in mind that most subprime and Alt-A mortgageswere bought on a 2/28 or 3/27 mortgage (a low, two-year or three-year"teaser" rate, before resetting to much higher market rates). Now lookat the rate resetting schedule from the start of this year.



The peak of the subprime resets doesn't happen until October of thisyear. Will the real estate market bottom then? Not even close. You haveto add another 3 to 6 months before the homes go from default toforeclosure. Then factor in the fact that the worst credit quality ofsubprime loans happened late in this real estate bubble (i.e. 2006).Then take another look at the chart and notice a second peak in 2011,nearly as large as the first, where the Alt-A mortgages will beresetting.

Discouraged? We've barely even started.


Contagion


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The subprime disaster has caused 105 mortgage lenders to go bankrupt so far. Only last month the high and outside guesses for potential losses from this financial disaster was $250 Billion. Now a month later that guess looks rather realistic.
Subprime mortgage securities make up about $100 billion of the $375billion of CDOs sold in the U.S. in 2006, according to data fromMoody's and Morgan Stanley.

On average, as with all CDOs, more than 90 percent of the value in them is rated investment grade.

TheCenter for Responsible Lending estimates that 2.2 million borrowers whogot subprime loans since 1998 either have lost or will lose their homesthrough foreclosure over the next few years. This includes one of everyfive borrowers who got subprime loans in 2005-06, a default rateunmatched in the history of the modern mortgage market.
Another way of looking at this is to see what homeowners have done during the recent real estate boom.

So even while home prices shot up, the percentage of the homes theowners actually owned dropped. Why? Because they used their homes likeATM machines. And once the price of a home drops, suddenly thehomeowner is upside-down on their mortgage, owing more than the home isworth. Can you imagine how many more foreclosures there would be if theusury credit agencies hadn't shoved through the new bankruptcy lawin 2005 that requires "means testing" before walking away from a home?It's almost enough to make someone think that the mortgage lenders knewthis was coming several years ago, and planned to profit from it.

But don't worry. The subprime debacle is "contained". That's the word that the financial media keeps using. The damage isn't going to spread, you can count on that.

Except that if you understand how the mortgage market works today, theidea that the damage won't spread is absurd. Those mortgages arepackaged up and resold as CDO's all over the world (usually as AAArated bonds). That's why Moody's recently called the bust in U.S. subprime loans gives "serious reasons to worry" and is a "reality check."

Bear Sterns certainly has reason to worry, as a third hedge fund went bustyesterday. Bear Sterns losses now total in the billions and are stillclimbing. Quite probably the most disturbing fact from the Bear Sternsimplosion is that when they tried to liquidate their hedge fund assets,they couldn't find buyers even when they tried to sell at 11 cents on the dollar.They stopped the sale and simply ate the losses rather than reveal justhow overpriced the subprime CDO's really are. I'm sure the rest of thesecondary mortgage market doesn't want to know either.

And speaking of hedge funds, there are at least two other American hedge funds, and three other foreign hedge funds that invested in American CDO's that have gone under in the past few months.

These huge borrowing and speculating institutions move trillions ofdollars around the globe every year. Some are predicting that half of these monsters will go bust in the next five years. 717 did go bust last year, but that still leaves nearly 10,000 in business.

If those predictions are anywhere close to being true, then the financial fallout could be devastating.

All this "contained" subprime fallout is spilling over to othermarkets. Notice what has happened to credit spreads of late.



Simply put, borrowing costs for companies is rising. Once the borrowingcosts rise enough it becomes known as a "credit crunch". And a creditcrunch, in a country as deeply in debt as we are today, will certainlylead to a recession.

Some would say that we've already entered a credit crunch.
Wall Street's corporate-debt machine has helped to finance theincreasingly exotic takeover deals of the buyout boom and to shore upsome of the nation's ailing industries with cheap loans and bonds. Now,that machine is sputtering.

[...]

"For all practical purposes the markets are closed right now," said Chad Leat, co-head of Global Credit Markets at Citigroup.



An Oily Problem


The financial media has largely ignored how oil prices are now justpennies anyway from setting a new, all-time high.



But I bet you noticed. You noticed every time you filled up your gas tank. Now here's the bad news: worldwide oil production is falling.



It's falling even though global demand is rising. It doesn't take aneconomist to understand what that means for future oil prices.


"Deficits don't matter"


America borrows $2 Billion from foreigners every day, 365 days a year,just to maintain its lifestyle. Those foreigners, often using recycledtrade surplus dollars, usually buy our bonds (aka our debt). Not justour treasury bonds, but also our mortgage bonds.

If youbought a home in the last few years, there is a good chance thatsomeone in east Asia actually owns your mortgage. So if you default onyour mortgage, those foreign investors take a loss. So the question is:at what point do those foreign investors get tired of losing money andstop buying our debt?

Some are suggesting that this day is almost upon us.



The value of the dollar has been falling for years as country aftercountry has diversified away from the dollar in their currencyreserves. Private foreign investors have long since stopped buyingdollar assets except as very short-term speculative purchases.

Recently the Euro passed the dollar as the leading world reserve currency. This was years before it was supposed to happen.

Even more damaging, OPEC countries (that generally peg their currency to the dollar) are complainingabout the lack of purchasing power of the dollar. When you include thefact that Kuwait, one of our strongest allies in OPEC, has dropped their dollar currency peg recently, those complaints are ominous.

Right now the dollar index is hanging on long-term support. If thatsupport fails there is no longer any guidance you can gleam from thecharts. In other words, we enter unknown waters.

One day someone will want us to repay for all that borrowing.

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