Britannia Radio

Wednesday, June 3, 2009 A look back at the beginning of the meltdown... Your humble DR meteorologists offer their economic forecast... A laughable assessment of government's role in the economy... Doug Hornig on the unstoppable second mortgage crisis...and more! ----------------------- Special Offer ------------------------- Only 63 People Know Why These Six Tiny Companies Will Change the World... You're #64 - and you're about to become Ultra-Wealthy. This will go down in history as the "story of our era..." - and you'll be rich because you took decisive action in 2009. See the full report right here. --------------------------------------------------------------- The Eye of the Economic Hurricane by Bill Bonner London, England Yesterday was beautiful in London. We wandered along the banks of the Thames and crossed Waterloo Bridge over to Covent Garden. Everywhere, people were sitting out on the grass...standing outside pubs...walking hand in hand. Everyone had the same idea - to take advantage of the nice weather before it goes away. Last year, London had a beautiful summer too. But we were gone that week and missed it. Alas, many of the best things in life are fleeting. And thankfully, so are the worst things. What put us in such a reflective mood were yesterday's news reports. The Dow rose again - up 19 points this time. Gold edged closer to the $1,000 mark - at $984. Oil traded at $68. And the dollar fell to only $1.43 against the euro. These trends - not to mention the broad rise in commodities and stocks worldwide - lead many investors to think that the fair weather is back, permanently. Asset prices are rising. Investors are less afraid of risk. Hallelujah - a dove with a sprig of green in its beak! Of course, it may be true. But our advice, dear reader, is to take an umbrella with you anyway. As far as we can tell, nothing has happened to disturb the major weather pattern that began developing two years ago. Anyone could see it coming years in advance. "You gotta expect trouble when the average house is more expensive than the average person can afford," we kept saying. But it was only when high winds hit the housing market that the newspapers took notice. Then, for 40 days and 40 nights the rain came down. First, the house flippers were caught off guard. They were in the middle of flipping condos when all of a sudden the wind shifted and sent their contracts aloft. Mortgage rates were rising and buyers disappeared. The flippers lost their deposits and walked away from empty buildings. Then, resets and higher rates blew the roof off the subprime market. Then, the whole housing sector was getting knocked down - builders, suppliers, and financers. Next came the credit crunch...when major lenders and investment banks realized that they were in heavy seas. Their ships were swamped with mortgage-backed debt and derivatives...and their captains were morons. Lehman went down. Wall Street abandoned ship. And the feds sent out rescue planes. By late in 2008, everyone was taking shelter. Businesses were cutting payrolls. Banks were squeezing their reserves. Consumers were staying at home. And GM was hiring bankruptcy lawyers. Everything was falling in price - houses, office buildings, stocks, commodities...practically everything except the US dollar, US bonds, and gold... These three were seen as the only safe refuges for storm- tossed investors. But on March 9, 2009, came a lull. Reluctantly, investors came out of their storm shelters. The skies lightened...the sun shined. Oil has gone up 53% since then. Stocks worldwide are up about 30%. And now...people say "the worst is behind us." We meteorologists here at The Daily Reckoning watch the skies like everyone else. But we also read reports from big storms of the past. And what we notice is that this doesn't look like the passing storms of the '80s or '90s. It looks to us like a major change in weather patterns. To be more precise, it looks to us like the Great Storm of the '30s. Do you remember that one, dear reader? No? Well, we don't either, but we've read the histories. It was a doozy. And it began...well...just like this one. In 1930, six months after the initial storm front passed, world output was down about 15%. Today, it is down about 15%, too. Stock markets were only down about 20% in mid-1930. Today, they're down about 35%. And world trade slipped about 15% in the six months following the onset of the Great Crash of '29. Today, it is down 25%. One thing you notice is that like the Great Depression, this downturn is global. A collapse in world trade followed the Crash of '29. It is usually blamed on two protectionist bumblers in Congress - Smoot and Hawley. But in a real depression, trade falls anyway. World commerce needs to readjust to new realities...whatever they are. That's happening again now. The other thing you notice is that this adjustment takes time...and takes the losses much further...much deeper...than anyone expects. The actual bottom in the '30s didn't come until 2 to 3 years after the crash. And it took stocks all over the planet down to about 65% below their peaks. World output eventually fell to only about 2/3rds of what it had been in the late '20s. It took two decades and a major world war before the world was back on its feet. Now here's Ian with some news on the fate of the Hummer: "As you've likely heard," writes Ian in today's 5 Minute Forecast, "a Chinese company will soon own the Hummer brand. Heh, let's count the ways this transaction epitomizes the new economic landscape: "1. A Chinese company now owns an automaker that will build and sell cars in the U.S. - a first. "2. That company - Sichuan Tengzhong Heavy Industrial Machinery - doesn't even make cars. For its first foray into passenger automaking, it's chosen Hummer, perhaps the world's most challenging and polarizing brand. "3. Business is so booming at Tengzhong HIM (its core is road construction and energy equipment) that the company will completely self-finance the deal...not one yuan borrowed from the Chinese government. "4. While neither party will disclose the price, Hummer was likely sold for a song...less than $500 million. "5. The White House is billing it as a victory: It's 'good news for the 3,000 Americans who will be able to keep their jobs, the two American plants that will remain open and the more than 100 Hummer dealers that should be able to stay in business all around the country,' said Bill Burton, a presidential spokesman. "6. Tengzhong claims its long-term goal is to make Hummer a legit brand in China, where there's already demand for the vehicle that embodies American excess and overcompensation. "We'd be delighted if the Hummer takes off over there...nothing wrong with making something that China wants to buy. And if Americans stop buying them, even better... "...would you really miss these things?" Each weekday, Ian brings readers The 5 Min Forecast - an executive series e-letter that provides a quick and dirty analysis of daily economic and financial developments - in five minutes or less. The 5 is free to subscribers of our paid publications, such as the Hulbert #1 Performing Investment Letter, Outstanding Investments. And now back to Bill, in London: "Treasuries Tumble," announced a cover of Barron's recently. Oh my. Long bonds are down 20% since January. Pity the poor Chinese. They've got $768 billion worth of them. And pity poor Tim Geithner. He's over there right now on a fool's errand, lying to the Chinese: "Geithner Tells Chinese its Holdings Are Safe," says the Washington Post. Reuters went on to report: "His answer drew loud laughter from his student audience, reflecting skepticism in China about the wisdom of a developing country accumulating a vast stockpile of foreign reserves instead of spending the money to raise living standards at home." More on Geithner's visit to China later in the week... "Those people did not become French in the last five months," says Mitch Daniels, Republican governor of Indiana. He was referring to the people who re-elected him. His point was that Americans are not necessarily in favor of socialism. They may be fed up with what they see as the failures of capitalism. But they're not ready to vote for Nicholas Sarkozy. But the country has clearly moved towards more government intervention in the economy. In 1986, 40% of Americans thought government regulated the economy too much. Now, 40% think it doesn't regulate enough. And get this... The Economist reports the results of a worldwide poll. When asked if "people [were] better off under free markets," 75% of Indians say 'yes' and so did about 72% of Chinese. But put the question to Americans and only about 69% think so. Even Italians are more in favor of free enterprise than Americans. Go figure. The Economist passes along the thoughts of an American lawyer to explain it: "The disaster in the housing and mortgage markets shows that free markets don't always get incentives right or generate the information people need to make wise decisions. There may be times, he adds, when government is better suited to giving people the information they need." Ha. Ha. Information? What information was it that people didn't have? All the information was not only available - it was free. We reported it here at The Daily Reckoning - for free. Day after day...we read the headlines and passed along the statistics. What was hidden from view? What was unknown? This information was available to the government too. Its thousands of regulators, representatives, researchers, and consumer advocates had computer terminals and newspaper subscriptions. They even had thousands of PhDs in economics whose JOB IS TO STUDY THE ECONOMY! If government were really able to give "people the information they [needed]," you'd think that one of these earnest meddlers would have whispered to Secretary of the Treasury...or maybe to the head of the Fed: "Hey...better tell the voters to watch out...this thing is getting out of control." But do you remember a word from the Secretary of the Treasury...from the Fed...from the SEC...from the other busybody parasites who live on the public payroll? We don't. All we remember is how they told us to "buy an SUV" and how derivatives "spread the risk to those who are able to bear it" and how "subprime mortgages help increase home ownership." The government, do a better job of running the economy? Ha. Ha. Until tomorrow, Bill Bonner The Daily Reckoning P.S. With the government giving banks and automakers bailout after bailout, it's becoming more and more likely that you'll be overlooked in this whole mess. You might want to find a way to bail yourself out. ----------------------- Special Offer ------------------------- How You Can Grab Quick Strike Forex Profits... Like a 2009 trade for a 99% gain in only 4 days! Get the next alert here... --------------------------------------------------------------- The Daily Reckoning PRESENTS: There's good news and bad news. The good news is the subprime meltdown has run its course. The bad news is there is another wave of loan defaults headed our way. BIG GOLD editor Doug Hornig explores... The Second Crash - On the Way and Unstoppable by Doug Hornig Afton, Virginia Tuesday, October 9, 2007 started as a nice day in New York City. A lovely early fall day, with the temperature still a balmy 80° at 2:00 in the morning. By evening, though, the temperature had dropped twenty degrees, the clouds had rolled in, there was thunder and rain. As with the weather, there were some hints of trouble here and there on Wall Street. But all in all, things could not have seemed better. Little did we know, the stormy end of 10/9/07 signaled a very large bubble that had just popped. That was the day when the Dow Jones Industrial Average hit its historic peak. From there, it was all downhill - slowly but steadily at first, and then violently after last August - until the Dow bottomed (for now) on March 9 of this year. Over that span, the index lost 54% of its value. It's been a crushing blow to just about everyone. But it's already being referred to as the crash. As if the unpleasantness were now all behind us. More likely, in the future it will be seen as, simply, the first crash. Don't believe it? In a moment you will, when you see the scariest graph of the year. "Is the stock market’s next 10/9/07 on the way? Yes. Which day will it be? That’s unknowable. It could be in a week, or not for another year." But let's quickly recall what's already happened. During the late, great housing boom, interest rates were at microscopic levels, while bankers were encouraged to grant home loans on little more than a wink and a nudge. In order to inflate their balance sheets, those bankers resorted to all sorts of gimmicky, adjustable rate mortgages (ARMs), whose common feature was an interest rate that would eventually reset. That is, it would balloon somewhere down the road. And those most likely to come quickly to grief were the riskiest borrowers, who held loans known as "subprime." "But not to worry," borrowers were told. "Betting on ever-rising home prices is the safest wager in the whole wide world. If you have problems with cash flow when the ARM resets, your house will be worth a lot more, so you can simply sell it and walk away with a nice chunk of change in your pocket." Uh-huh. The bankers themselves were a little more concerned about the deterioration of their portfolios. They took out insurance in the form of credit default swaps (CDSs). These were a brand-new invention in world financial history, allowing mortgages to be sold and resold until they were leveraged 20 times over. They became the shakiest part of a huge global derivatives market, with a nominal value in the tens of trillions of dollars. For a while, this Ponzi scheme even worked. But then, as they had to, the ARMs began resetting, and there were defaults. Then more of them. Because at the same time, the housing market was cooling off and the economy was stalling out. More and more people were trapped in a situation where they owed more on their home than they could sell it for. Many simply mailed their keys to the bank and moved on. All of this wreaked havoc in the derivatives market. Sellers of these exotic packages could no longer establish what they were worth. Buyers couldn't determine a fair price and so stopped buying. As the ripples spread through the world financial system, trust disappeared and liquidity dried up. Now consider that the base cause for all that dislocation was the subprime sector. And how big is that? Not very. Subprime mortgages account for only about 15% of all home loans. Their influence has been way out of proportion to their numbers, because of derivatives. Here's the good news: the subprime meltdown has about run its course. These loans were resetting en masse in 2007 and the first eight months of '08. Now they're pretty much done. And the bad news? No one in the mainstream media seems to be asking what should be a pretty obvious question: What about loans other than subprime? Truth is, the banks didn't just trick up their subprime loans. ARMs were the order of the day - across the board. Now, here's that frightening graph we referred to earlier. Take a good, long look. You can see that from the beginning of 2007 through September of 2008, subprime loans (the gray bars above) were resetting like crazy. Those are the ones people were walking away from, sending a shockwave from defaults and foreclosures smack into the middle of the economy. Now they're gone. The ARM market got very quiet between December 2008 and March 2009, hitting a low that won't be seen again until November of 2011. Small wonder a few "green shoots" have poked their heads above ground. But in April, resets began to increase and will reach an intermediate peak in June. After that, they tail off a little, going basically flat for the next ten months. It's not until May of 2010 that the next wave really hits. From there to October of 2011, the resets will be coming fast and furious. That's 18 months of further turmoil in the housing market, and the beginning is still nearly a year away! (Although the months in between are likely to be no picnic, either.) While it isn't subprime ARMs that are resetting this time, neither are they prime loans. Those eligible for prime loans wisely tended to stay away from ARMs in the first place, as indicated by the relatively small space they take up on each bar. No, the next to go are Alt-A's (the white bars), Option ARMs (green) and Unsecuritized ARMs (blue). Alt-A's are loans to the folks who are a small step up from subprime. Unsecuritized loans are a 50-50 proposition; either the borrowers were good enough that they weren't thrown into the CDS pool, or they were so risky no one would insure them. Those two are bad enough. But Option ARMs are the real black sheep, loans with choices on how large a payment the borrower will make. The options include interest-only or, worse, a minimum payment that is less than interest-only, leading to "negative amortization"-a loan balance that continually gets bigger, not smaller. Imagine what happens with those when the piper calls. Once the carnage begins, will it be as bad as the subprime crisis? That's the $64K question. Perhaps not. For one thing, subprime loans were a much larger chunk of the market when they started going south. For another, there's been a lot of refinancing as interest rates dropped; that should help ease the default rate. And the government has massively intervened, with measures designed to prop up those who would otherwise lose their homes. On the other hand, we're in a severe recession, which wasn't the case when the subprime crisis started. More people will be unable to meet payments. And the housing market has continued to decline, pressuring both marginal homeowners and banks that can't sell foreclosed properties. Is the stock market's next 10/9/07 on the way? Yes. Which day will it be? That's unknowable. It could be in a week, or not for another year. But make no mistake about it, the second crash is coming. It can't be prevented, no matter what desperate measures Obama and his hapless financial advisors come up with. All we can hope for is that, with a little luck, it won't be as severe as the first one. But it will last longer. We aren't even in the middle of the woods yet, much less on the way out. Regards, Doug Hornig for The Daily Reckoning