Thursday, September 11, 2008

Behind the Wall

Let's take a look back at what's happened over the past year. The Federal Reserve has cut rates from a low 5.25% down to a ridiculous 2%. With inflation rates running higher than 2% it means that the real rate is actually negative and the money is free.

In December the Fed created the Term Auction Facility (TAF) that allows the banks to swap billions of dollars worth of mortgage securities for treasuries every month. This was supposed to be a temporary facility when created but has not yet stopped and the amount of money now lent every month has grown significantly.

In March the Fed engineered the bailout of Bear Stearns taking 30 Billion dollars worth of their bad debt on their books and placing the company in the hands of J.P. Morgan at a fire sale price.

In the spring United States citizens received checks in the mail to the tune of $168 Billion to try and stimulate spending in the economy.

As the housing decline accelerated and Fannie and Freddie began to topple the Treasury stepped in standing behind $6 Trillion worth of their guarantees on their real estate loans. The greatest bail out in the history of the world, shattering what America used to know as its former self, and creating a nation of communism for the rich only.

The Fed and Treasury have provided the market with the comfort that they will protect any major company that is troubled no matter what the cost.

After all these efforts throughout the year, we can turn and look proudly at where our economy currently stands:

-The stock market this year is down over 15%.
-Unemployment just hit a new multi-year high running over 6.1%.
-Inflation just hit a 17 year high with the government's understated numbers.
-Foreclosures are hitting record highs month after month and appear only to be getting started
-Home prices this year have fallen over 15% nationwide
-Credit card debt is surging and auto loans are starting to default at an escalating pace

So my question is? What would have happened if the government and the Fed had not taken these actions? What would have happened if they allowed the market to work itself out, can you imagine how bad things would be right now?

I try to think of it this way to help describe the state of our country. There is a dam at the bottom a stream that runs down a mountain. The dam protects a small village on the other side of the dam. Every few years the dam needs to be opened to clean the excess water out of the stream from the rain. If they let it build it would destroy the village because it would be too much water at one time. The dam opening is equal to a recession. The homes that were built strong will survive, and the ones that were not are wiped out so newer and stronger ones can be built.

The last time our gates were allowed to be opened was in 1991 and the water has been building every year since. It should have been allowed to open in 1997 but Greenspan would not allow it. It definitely should have been opened in 2001 but Greenspan refused. He wanted the villages to have uninterrupted prosperity forever. And here we are in 2008, and the the gates have still not been opened. The amount of water now built up on the otherside will absolutely destroy the village when it gets through.

The only problem is the dam is starting to break because of the amount of water pressing on the other side. There are small holes starting to crack and water is starting to seep through. Helicopter Ben Bernanke and Hank Paulson are frantically running around trying to plug every single hole as it cracks. They do this so the villagers don't see the water and realize what is happening. If they knew how much trouble they were in there would be a panicked evacuation from the city.

There is no stopping this water from getting through eventually, and at this point the government will do anything it can to prolong it from happening so it doesn't happen on their watch. Will it pour through by the end of the year or will it come on McCain/Obama's term? I don't know. I only can try and protect myself and the people I love in the village and try to position myself to take advantage of the opportunities that will be presented when the flood breaks through. There will be mass panic unlike anything you've ever seen.

The people in the village carry on with their day and talk about how much Sarah Palin loves her kids and the wonderful health care that Obama will bring into their lives over the next few years. This is more important than discussing the dam that is trembling over their heads above.

Interesting interview from the famous Jim Cramer today as he discusses why all these banks need to be saved. Why all these holes must continue to be plugged. He is probably one of the most bullish analysts on Wall Street but he understands what is happening and says that if everyone is not protected we will immediately be faced with Great Depression number 2. (The flood)

It's going to come at some point and every time a hold is plugged and the problem is postponed the water builds, and builds, and builds.......

Wednesday, September 10, 2008

WaMu Trembles

Uh oh.....Looks like the Fed may get to add Washington Mutual's debt to its toxic mortgage balance sheet as well.

At least the Fed can always turn to the FDIC with its strong balance sheet. It has about $50 billion available to guarantee $4.3 Trillion in bank deposits. (That's your money at the bank) They'll probably be busy dealing with some problems so the Fed better leave them alone.

So, it's back to the treasury. Maybe good old Hank Paulson won't mind picking up Washington Mutual and Lehman and just merging them with Fannie and Freddie.

Auto's on Deck

Well, now that we have a nationalized government mortgage company lending 75% of the mortgages in this country, we can now move on to step two which is autos.

It appears the government is deciding on how much to provide auto manufacturers to bail them out of their current troubles. The numbers being heard most are $25-$50 billion. This will just be a first direct investment, as they will need more indirectly to help deal with all the auto loans that have been securitized over the past few years that Americans cannot afford to pay. The losses will pour onto balance sheets just as the home loans are now.

But why are those losses not coming in right now? Great question. It's because Americans are paying their bills with their shiny new credit cards. There has been a surge in credit card use over the past few months, and the media has gushed over the "profits" that credit card companies will be receiving from this new "business."

Americans cannot afford to pay back this new credit card debt they are running up, and this is the last gasp that is the American consumer, which also happens to be 70% of GDP.

There is no limit to what the government will do now that they have been allowed to take over Fannie and Freddie. Perhaps by next year we will have a government mortgage business, auto business, and credit card service. These will run along side the post office.

Of course there is no money to pay for these new government programs, and the new money will be printed and taxed to the American public in the form of inflation, the hidden tax that they do not yet understand but will before it's all over.,0,4565657.story

Tuesday, September 9, 2008

Lehman Shakes

Here we go again. Lehman Brother's shares dropped 47% this afternoon shaking the stock market and bringing it down close to 300 points. There were talks over the weekend with a Korean bank to take over the faltering former giant of the mortgage industry. Those talks dissipated by this morning and the big question now is, why?

Did they find something on their books that scared them off? Did the Korean government, which is crossing headlines now, tell them to back away? Or did Lehman walk away because they felt they were worth more than what was being asked?

We'll find out as early as tomorrow morning. They have decided to release their numbers early to postpone a run on their assets, a la Bear Stearns. Why does an American bank not step in and buy them at their very low stock price, which was beaten down 47% today to around $6. Ah, now that's a better question.

Maybe the banks now understand that if Lehman were to stumble the Federal Reserve would immediately step in and purchase a significant portion of their debt and allow another bank to buy the remaining shares at a fire sale price. It's always more comfortable going into a merger with the Federal Reserve than go it alone.

So here in lies the great moral dilemma that you keep hearing about. Everyone sees that both the Fed and the Treasury have now played their hand. They will step in every step along the way and bail everyone out. We'll see what happens, but my guess is that helicopter Ben is working the phones tonight just as frantically as Lehman's CEO.

Good article written today about Fannie and Freddie from someone who predicted their failure years ago based on his strong understanding of finances and economics.

Sunday, September 7, 2008

Banking Update

Let's put Freddie and Fannie aside for a second and talk about the state of our banking and credit markets.

Up to now worldwide the financial institutions have written off $514 billion, and they have raised an additional $364 in new capital. Conservative estimates now show that these institutions will have total writeoffs in the neighborhood of $2,000,000,000. That's $2 Trillion. This means we are about one fourth of the way through the credit crisis in terms of losses.

Along with these writedowns, the financial institutions have been swapping hundreds of billions of dollars worth of toxic mortgages with the Fed in order to stay solvent. The Fed up to this point has said this is a short term loan and the banks will have to take this debt back on their balance sheet when the smoke clears. The big banks have also done some Enron style financial trickery, extending their loan loss grace period from 120 days to 180 days on home equity lines, thus pushing those losses to future quarters.

In addition to all this the banks have another enormous financial storm cloud looming in the not so distant future. In order to stay solvent the banks have taken on short term debt obligations in order to borrow at a lower cost. There is currently $900 Billion in debt coming due by the end of this year.

Let me use a simple example to help explain this. Imagine that you decided to buy a house in November, 2007 and you used an interest only mortgage at 4% that adjusts after the first year to whatever the market interest rate is going for. (This loan exists in real life, it is called an adjustable rate mortgage.) You gladly take the loan at 4% because it is the only way you can afford the expensive home that you really want. Then in November of 2007, you merrily walk into the bank to find out what happens next now that your loan will adjust the following month. Your loan officer let's you know that mortgage debt is currently trading at a 40% yield in the open market and your loan starting in December will now be 40% instead of 4%.

You then have three options.

You can refinance and try to find an interest rate a little lower. You then find out the best you can do is 36%, meaning your loan payment will now be $35,100 per month, instead of the $3,500 that you have been paying. You will be bankrupt after the first month with that scenario since you have no savings and only credit card debt.

The second option is to pay the loan off in full to avoid the higher payment. It will be difficult to quickly come up with $800,000 since you have no savings and massive credit card debt.

The third option is to call Benjamin Bernanke at the Federal Reserve and ask him if he will swap your debt for treasuries which are currently running at 2%. Unfortunately, he only takes calls from the major banks.

Does this seem like a silly scenario? Let's take a look at that $900 Billion adjusting by the end of the year for the big banks, instead of the $800,000 for your home. The current yield in the open market right now for Washington Mutual debt is 40%. Does that sound familiar? When they go to roll the debt over this fall they will have to pay the going rate, or they will have to come up with the cash to cover what they borrowed. Since all the banks are currently insolvent and on life support, it's going to be tough to do this.

We are on the precipice of a financial storm unlike anything we've seen since the great depression. The credit crisis will probably be at the heart of it's destruction during the 3rd quarter of 2009, just as the country is realizing that the oil "bubble" is actually a very serious supply problem that we have no answer for.

Fannie and Freddie Nationalized

Unbelievable. Much, much, more to come discussing this American catastrophe. Stay tuned.