Saturday, February 23, 2008

The New Deutsch Mark

It looks like the German banking system is starting to unravel. Here is a link from Der Spiegel to the article. A hat tip to

The German government has had to bail out state-owned banks with taxpayers' money after their managements recklessly gambled away billions on sub-prime investments. But if a state-owned bank were to go under, the consequences could be disastrous for the whole economy.

In England, Northern Rock just got nationalized by the government.

The two situations are drastically different. The English can print more money and solve the problem. The German banking crisis is in a catch 22. They are in the European Common Market using Euro dollars and have no fiscal control over their currency.

What is becoming evident here is that Germany may break out of the European Union. Many of these member countries want and need to solve their economic problems in a way different from all of the rest. Nationalism is on the rise (doesn't that have a familiar pre WW II ring to it?).

If the German banking system collapses, the logical option would be a new national currency. Airbus can’t compete against Boeing. The appreciation of the Euro against the dollar is killing German industry. Unemployment problems similar to the 1930’s seem to be reappearing. Many have suggested that Germany’s joining the EU, was the second signing of the Treaty of Versailles.

The new Deutsch Mark could have an unsettling effect on world markets. The Euro in time could fade away. Let's face it; the Euro dollar is financial socialism without government representation. It's a little like the milkman delivery jokes. The fun was his, the kids are yours.

Copyright 2008 All rights reserved

Wednesday, February 20, 2008

Wal-mart (Made in China)

Content edited from a comment previously posted by an anonymous contributer

Multinational Corporations have no loyalty to any one Nation. They only desire the fruits of their capital. Thus, they invest where the capital bears the most return. Today that is not America, but China and India and the Far East. They need to expand into the new markets.

American business doesn't need the US consumer anymore. There are geographical boundaries which require them to locate their production or operations here. They can go anywhere. It doesn't even make sense to be incorporated in the USA; too many regulations and taxes.

Much of the U.S. economy is based on consumer spending. But consumers are out of money. Better to save and do without. Maybe you can put enough away to pay for one semester of insanely expensive college tuition...or maybe just some books.

There are fundamental macro economic changes taking place. Remember England at the end of the last century. The sun never set on British soil. They had it all and watched it slip from their fingers into nothing. Is that what lies ahead here; the only jobs available to the masses will be working at Wal-Mart selling each other Chinese made goods?

It's a new of diminished importance of the American consumer.

Sunday, February 17, 2008

Buyers Paid Too Much for Too Little

The newspapers claim that homeowners are in trouble because they bought too much house. Let’s put that in perspective, they paid too much, for too little! In our area people paid three times what the house was actually worth. There was no concern as to making the astronomical payments. So now they get to give it back to the bank.

If you think carefully about this mess, when it is all over, someone will own each and every house now in foreclosure. It just won't be at today's prices. Who eventually ends up really owning the house, whether it be owner or investor, is not really relative to the issues at hand. Newspapers keep suggesting that this is the loss of the American dream and it really isn't. Many families are not financially prepared for home ownership.

The problem not yet realized by the lenders holding this foreclosed debt is that this problem doesn’t disappear with the exit of the Alt-A loans. The Alt-A got the inventory up to a high level. Now you want to buy a house. Do you have a 20% down payment? Chances are about nil in California right now. Not at these prices!

Financing for a home loan is harder to find. The money pool is contracting. A bank, doesn’t tell a perspective borrower that they have no money to loan. More than likely, they would inform the potential borrower that their credit report wasn't up to the bank’s standards.

The problem is getting worse. As housing prices drop, more people become upside down in their homes; including people who put down a sizable down payment. This is where the lenders have been blindsided. The explosive growth in REO’s has taken them by surprise. The financial infrastructure needed to process all of the defaults isn’t even in place. Deep discounts of REO’s, exacerbates the problem even more, resulting in more home owners becoming upside down.

Last week, Henry Paulson mentioned that the lenders have gotten together to help out the troubled homeowner (no homeowner left behind). It’s kind of like buying a horse and buggy with a two year guarantee. The wheels give out and your horse is exhausted from dragging the buggy with you in it. What’s the solution? They’re going to give you a fresh horse!

The solutions of late, border on incompetence. Why hand out tax rebates when it is very obvious that next year is going to be very bad year for tax revenues? Advising people to keep on paying on a mortgage that they can’t even afford is ill advised. On top of that, there is confusion on who owns some of these housing notes if they're part of a CDO.

We got into this mess because of very lax government supervision. Everyone was making money (don’t rock the boat). Now that we need real leadership, no one will step forward to do what's necessary. Frankly I don’t blame them, they would be crucified one at a time. We are going down the hard way. It’s a little like looking for a gas leak with a Bic lighter. It works, but just not quite the way you imagined.

Copyright 2008 All rights reserved

Tuesday, February 12, 2008

The Collapse of Hypthocated Assets (reprinted)

Reprinted from May 17, 2006

There is a problem that is beginning to be realized: "Are my assets safe for retirement?" Sadly the answer is no. Your mutual fund or IRA, buys stocks, bonds options and whatever.

These Mutual funds etc have been rising in price since 1982. That's pretty much when this bull market started, I don't even count a bear market unless its at least 4 years in length. The last real one was about 12 years long. The one after the great depression was about 20 years long in the tooth.

The real irritating thing about a lot of these stock assets is that they don't even pay a dividend. As long as it goes up--who cares? Most of the people who own them have never seen a bear market.

When I mention bear market from 1966 to 1982 we are talking Dow 500 to Dow 1000 back and forth never higher. How many Mutual Fund advisors are old enough to remember back then? The herd mentality is working very well for them up to now. With stocks that do pay a dividend, their price tends to increase as the dividend increases and vice versa. This is what you want to invest in, if you want retirement income.

A market goes up when more people want to buy, than those that want to sell. Well, all of these first time home buyers have no spare cash for the Stock Market. The Baby Boomer's, sometime in the future are going to want to sell. The question arises, "Sell to Whom?"

A lot of these stocks could be marked to market if no one wants them. Remember Lucent at $160--it split 2 for one and is now at $2.50 a share. Talk about evaporation of equity. Remember you have to do absolutely nothing for this to happen, your neighbor can sell his stock for whatever and that determines the present new value of your holding. Neat isn't it?

Copyright 2008 All rights reserved

Saturday, February 09, 2008

The Money Supply Game

Imagine a rich relative dies and leaves you 100K and you deposit it in your bank. Along comes Mr. I-want-to-be-rich who borrows the 100K from your bank and buys Mr. I-want-to-retire’s home. Mr. I-want-to-retire puts the money in his bank. Figure that housing prices plunge and Mr. I-want-to-be-rich walks away from the house.

You put 100K in the bank and Mr. I-want-to-retire put 100k in the bank. The reality is, there is only 100k of cash in the system. The other 100K is what the house was valued at when bought. Note I could be shot again for over simplification with this example.

With 3 transactions, the money supply doubled. We didn’t have to stop at three transactions. Another loan and deposit would have created another 100k. Suppose you and Mr. I-want-to-retire decide to “Stuff the Mattress” and cash out both accounts today. The money isn’t there, so one or both banks will borrow from the Federal Reserve. The system works very well if the asset can be converted to cash with no loss of value. Right now, that just doesn't happen to be the case.

In very simple terms, it is easy to see how the money supply can expand in good times and contract in bad times. Two people have claims of 100K against the banking system. The money in a bank is insured and most probably is not at risk because of that fact.

The banks learned their lesson from the 1990’s savings and loan debacle. That doesn’t mean that they are off the hook. Everyone who ever wanted a credit card, now has one. That problem is another story for later.

Whose money was spent on this whole mess? It wasn’t the foreclosed homeowner’s money, now was it! The only money left is OUR money (retirement funds come to mind). The baby boomers are just starting to retire, so there is no real problem ---Yet!

One to three trillion dollars of real estate value will vaporize in the coming years. It’s so comforting to know that this was all someone else’s money. It’s kind of like selling 5 million tickets to the next Super Bowl, there is no problem until the day of the game. Surprisingly there would probably be empty seats. Most ticket holders (4.7 million) would be stuck in a massive traffic jam trying to get to the game. Sometimes things do work out alright, for all of the wrong reasons (our government functions a lot like that).

Copyright 2008 All rights reserved

Saturday, February 02, 2008

Fannie Mae, A Ticking Time Bomb

Congress created Fannie Mae in 1938 as a government sponsored entity (GSE) with private ownership. Their goal was to provide financing to make home ownership available for the common man. With the present housing collapse, this giant is facing a fiscal catastrophe. Meltdown is probably a better choice of words. This implies a Congressional bailout (the price of gas will go up another dollar).

The housing market swings like a pendulum, right now it's going the wrong way. The financial institutions are not set up for a swing of this magnitude. Fannie Mae can weather a 20 % drop in home values and break even. Most of their note packages are at 80% of actual value. The typical Fannie Mae loan has a 20% down payment or a 20% second mortgage held by a third party. In banking circles, a 20% drop in housing values is almost unheard of. Just about every house sold in the last ten years could come under the axe. That’s how far values have swung.

Fannie Mae has about 2.7 trillion dollars worth of loans guaranteed. They have 34 billion cash on hand. Just for the sake of simplicity, let’s figure the average guaranteed home loan at $340,000. Divide $340,000 into the 34 billion cash on hand and the result is 100,000. That figure is the actual number of houses Fanny Mae can redeem at any one point in time. So if the pundits are predicting 2 million foreclosures this year and Fanny Mae underwrites 40% of the market, that’s about 800,000 houses.

Figure a best case scenario. Calculate houses guaranteed at $170,000 apiece, half of the price above. That would give them room to cover 200,000 returned contracts. Also figure of the 2 million homes that only 20% of them are covered by Fannie Mae (another 50% reduction). The total houses would still be 400,000. Fannie Mae's goal is to convert each home to cash and apply the proceeds to the next problem loan. It could prove difficult.

There are side issues here that are not real apparent. Another 1.2 million houses are in the same foreclosure mill in competition with them. Is the house boarded up? Have the pipes frozen and broke? Has the house been stripped or trashed? Who pays the property taxes? Converting the asset to cash will take time.

What can be deduced from this experiment in unscientific speculation is that Fannie Mae will run out of operating capital (cash in the till) somewhere between 100,000 and 200,000 housing contracts. If the market drops 30%, they would have a guarantee commitment of 10% of the insured amount. This assumes the note was for 80% of the home's purchase price and they can sell the unit for 70% of the original purchase price. In the San Diego area the question comes up "Sell it to whom?"

There is the ongoing discussion; can the government let a GSE like Fanny Mae, go belly up? In theory they should be able to, but would it wise to do that? It could destroy faith in the system.

Time is the real killer here. It's kind of like waiting in line to use the rest room. The wait only makes it worse!

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