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EJ
04-11-07, 04:44 PM
http://www.itulip.com/images/uscreditDOWN.jpgUpside Down to Right Side Up

Implications of a righting of the US consumer lending system

by Eric Janszen - April 11, 2007

James Scurlock's book and movie "Maxed Out" appears to be about over-indebted Americans. That is in fact what the Wharton Business School graduate set out to discover, he told us in an interview this week (http://www.itulip.com/forums/showthread.php?t=1192). What he found instead during six months traveling the nation was an out-of-control lending system, causing more than half of Americans to take on debts they cannot repay, leaving a wake of financial and personal destruction. The system is driven by the rational behavior of economic actors: lenders in desperate competition with each other for loans, customers, and profits; consumers taking as much cash as they are allowed to borrow; and regulators asleep at the switch. The system is running to its grim, logical conclusion.

This happened not as a conspiracy but by various parties in the system acting in their perceived economic interest. To understand how this came about, for the uninitiated, a brief and ultra-simplified primer on lenders.

A loan is a debt on your balance sheet, but it's an asset on a lender's balance sheet, representing an income stream from the difference between the monthly payments the borrower makes to the lender and the cost of the money that the lender borrowed from the Fed or the credit markets. Think of a loan as a product, like a TV. The lender buys the TV (loan from the Fed, which becomes the lender's capital), repackages it and rents it to the buyer (borrower), who signs a rental contract (such as a mortgage) that says he'll pay rent to the lender once per month (the monthly mortgage loan payment) for 30 years, after which he owns the TV (house).

Just like any other business, lenders need to constantly increase the sales of products (loans), so that the company grows, so that the stock price goes up.

Banks make money by borrowing at a low rate of interest, say, 4%, and lending out at a higher rate, say, a fixed rate mortgage of 6.5%. The higher the spread, the greater the profit. The rate of interest banks pay is set by the Fed and the credit markets. The rate consumers pay depends on their credit rating–the worse the credit rating, the more the borrower pays in interest to cover the bank's risk that the borrower might default.

The economic logic of lending to people with bad credit, then, is simple: the more people with bad credit the better, to a point, because banks can charge a higher rate of interest. Some of the loans will default, of course. But enough borrowers will make the minimum payments on their debts at high interest rates that the sum profits of all of the loans in the bank's portfolio is high.

However, if a lender has too many loans that do not get repaid, then the lender can become insolvent, that is, the capital the bank has to lend is insufficient to meet legal requirements. A sub-prime lender is a lender that specializes in making loans to people with less than prime (good) or "sub-prime" credit. This business is highly profitable because banks can lend money at higher interest rates to sub-prime borrowers. But the business is also more risky, because default rates are higher. If the economy turns down, incomes fall and defaults rise. As the US economy slows, as of this writing, 54 sub-prime lenders have gone under (http://www.bloomberg.com/apps/news?pid=20601103&sid=a4VFaOuDnuWw&refer=news) since the sub-prime mortgage lending crisis started.

How about the prime lenders? Evidence is mounting that these lenders are getting into trouble, too. (http://money.cnn.com/2007/03/19/news/economy/next_subprime/index.htm) Why? Because, according to James Scurlock, people with good credit were sold the riskiest loans of all, such as interest-only, no money down, stated income or "liar loans," for which the borrower, usually with the knowledge of the originator, exaggerates their income to qualify for the loan. James' research shows that approximately 50% of loans made in California in 2006 were liar loans. Further, as CEO of Dynamic Credit Jim Finkel explained to us in March (http://www.itulip.com/forums/showthread.php?t=757), credit scores are regularly gamed, so many the buyers of these loans may not really have such good credit after all.

According to the FBI (http://news.rgj.com/apps/pbcs.dll/article?AID=/20070211/HOMESCAPE/702110395), "People need to understand that any false statement made to a lender or false document presented or prepared is mortgage fraud and that's a federal crime." Maybe liar loans should be renamed "felony loans."

http://www.itulip.com/images/fedratevsconsumercredit.gifRight Side Up to Upside Down

As James explains in his book, falling interest rates in the 1980s started to turn the credit system upside down. Low interest rates meant that lenders could borrow at low rates, but expectations of high interest rates among consumers meant lenders didn't have to lower the rates on their loans to borrowers. The spread produced a huge profit opportunity. The profit opportunity attracted many new lenders to the market. As competition increased, loan creativity increased as well. The loan products became highly complex, and lenders went after more naive customers, such as high school students and elderly people on fixed incomes. James recounts in his book how Harvard law professor Elizabeth Warren asked her law students to explain a mortgage contract they were given and they could not. Any wonder why the average homeowner didn't know what they were getting into when they bought a interest-only liar loans?

The period before and after interest rates fell in the early 1980s divides consumer banking into two distinct periods, the "Right Side Up" period and the "Upside Down" period.

Right Side Up Signs
Borrowers pursue lenders for loans
Lenders mail a few million credit card solicitations per year to only the most credit-worthy borrowers
Lenders prefer credit-worthy borrowers
Borrowers who do not repay are "deadbeats"
A mortgage is a debt
A house is a place to live
Revolving credit is used to finance major purchases, such as autos
Banks don't need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"Upside Down Signs
Lenders pursue borrowers
Lenders mail more than 4 billion credit card solicitations per year, often to the least credit-worthy borrowers
Lenders prefer borrowers with poor credit
Borrowers who repay are "deadbeats"
A mortgage is "wealth"
A house is an "investment"
Revolving credit is used to finance all purchases, such as food and clothing
Banks need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"I'm often asked, "When will it be time for me to buy a house?" and "How will I know that the credit bubble is over."

You will know the coast is clear when Upside Down becomes Right Side Up again: borrowers pursue lenders, not the other way around; borrowers who do not repay are "deadbeats" not those who do repay; lenders prefer credit-worthy borrowers versus deadbeats; and so on.

What will cause the flip to Right Side Up?

In a word: unemployment. Housing prices are strongly correlated to unemployment, as this FDIC report shows.

http://www.itulip.com/BLShousingpricesvsemployment.jpgIf you start to see unemployment ticking up, the reversion back to Right Side Up has started. And I do mean "see," as in, with your own eyes. Don't pay much attention to the government numbers. As Paul Kasriel noted after the Bureau of Labored Statistics' employment numbers came out last week, the employment numbers are becoming increasingly self-contradictory and non-sensical (http://news.google.com/news/url?sa=t&ct=:ePkh8BM9E2IF2mHAArEFyE4yYCNoj5HAlFv2LMlJhs4zvW daxOZcqwQAWPoOCw/0-0&fp=461dc535f02171b1&ei=tUQdRtuUOYygsQGtpojXCA&url=http%3A//www.fxstreet.com/fundamental/analysis-reports/daily-global-commentary/2007-04-08.html&cid=0).

James believes the transition back to Right Side Up will be rapid and catastrophic, taking only a couple of years. After studying this problem for over seven years, I stand by my prediction that the transition will be a slow and catastrophic process, taking a decade or more, much as the Japanese post-bubble period lasted, because the government will get involved to manage the transition. The difference is, whereas Japan's post-bubble period was deflationary, the US period will be inflationary.

Although we disagree on the duration of the time it takes to get from Upside Down to Right Side Up, James and I agree that a major financial crash is inevitable, which puts him in the same camp as Dr. Hudson (http://www.itulip.com/forums/showthread.php?t=891) and Rick Ackerman (http://www.itulip.com/forums/showthread.php?t=1171).





http://www.itulip.com/images/uscreditUP.jpgThere will be a major financial crash. Anyone who does not believe that is as a dreamy owner of Nortel stock in 2000, when it was selling for a reverse splits-adjusted price of $1,200, now $28.

What will trigger it? I asked James in Part II if he thinks the FDIC and Fed were unaware of the problems he found or were aware and knowingly allowed this credit bubble to occur. After pausing a moment he said, "They're not stupid. I believe they are corrupt."

Market inefficiencies caused by corruption will be the root cause of the financial panic I expect. The crash will be triggered by the usual source, a revelation of fraud that exposes the corruption. The most likely ground zero? The GSEs. At some point, perhaps soon, a major fraud will be revealed there. This will cause an epiphany among mortgage securities investors that most of the value they perceived is non-existent. A panic ensues as investors try to unload their securities before the entire market becomes aware of the true value of what they are holding. The fear will spread to other markets, such as the over-valued stock market.

Much of what we discuss here at iTulip is about what happens after the smoke clears. My money is still on a reversal of the virtuous circle to become a vicious circle.


http://www.itulip.com/forums/../images/virtuouscircle.gif

Virtuous Circle


http://www.itulip.com/forums/../images/viciouscircle.gif


Vicious Circle

(Source : Wikipedia (http://en.wikipedia.org/wiki/Virtuous_circle_and_vicious_circle))



In the current recent period, over with the past few weeks, the markets have been flat market, where stocks, bonds, and gold are all more or less treading water after a recent correction. This feel like March 2000, when I made my NASDAQ call (http://www.itulip.com/GlobeArchiveJanszen.htm).

In my interview with James this week (again, Part I is available here (http://www.itulip.com/forums/showthread.php?t=1192)), James is as methodical and deliberate in his speech as he was at collecting and reporting what he discovered from his six months spent traveling the country. That made it all the more chilling.

iTulip Select (http://www.itulip.com/forums/showthread.php?t=1032) interviews are typically divided into two parts. Part I is designed to reveal "What it is," that is, states the problem. In the case of Part I of the James Scurlock interview (http://www.itulip.com/forums/showthread.php?t=1173), James reveals how Upside Down credit came about.

iTulip Select Part II explains "What it means." In Part I of the James Scurlock gives us his take on how we get to Right Side Up.

I strongly recommend James' well researched and written book <a href="http://www.amazon.com/gp/product/141653251X?ie=UTF8&tag=wwwitulipcom-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=141653251X">Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders</a><img src="http://www.assoc-amazon.com/e/ir?t=wwwitulipcom-20&l=as2&o=1&a=141653251X" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" />. He strongly recommends <a href="http://www.amazon.com/gp/product/0141011459?ie=UTF8&tag=wwwitulipcom-20&linkCode=as2&camp=1789&creative=9325&creativeASIN=0141011459">The Smartest Guys in the Room</a><img src="http://www.assoc-amazon.com/e/ir?t=wwwitulipcom-20&l=as2&o=1&a=0141011459" width="1" height="1" border="0" alt="" style="border:none !important; margin:0px !important;" /> if you want to understand the nature of the credit bubble and how it is likely to turn out (hint: the way Enron did).
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Rajiv
04-11-07, 06:23 PM
Some minor corrections


Right Side Up Signs

* Borrowers pursue lenders for loans
* Lenders prefer credit-worthy borrowers
* Borrowers who do repay are "deadbeats"
* A mortgage is a debt
* A house is a place to live
* Revolving credit is used to finance major purchases, such as autos
* Banks don't need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"

should read

Right Side Up Signs

* Borrowers pursue lenders for loans
* Lenders prefer credit-worthy borrowers
* Borrowers who do NOT repay are "deadbeats"
* A mortgage is a debt
* A house is a place to live
* Revolving credit is used to finance major purchases, such as autos
* Banks don't need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"


Upside Down Signs

* Lenders pursue lenders
* Lenders prefer borrowers with poor credit
* Borrowers repay are "deadbeats"
* A mortgage is wealth
* A house is an investment
* Revolving credit is used to finance all purchases, such as food and clothing
* Banks need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"

Should read

Upside Down Signs

* Lenders pursue BORROWERS
* Lenders prefer borrowers with poor credit
* Borrowers WHO repay are "deadbeats"
* A mortgage is wealth
* A house is an investment
* Revolving credit is used to finance all purchases, such as food and clothing
* Banks need to be given specific guidance by the FDIC "To make reasonable efforts to determine a borrower's income"

I hope that this helps avoid any confusion.

bill
04-11-07, 06:52 PM
The crash will be triggered by the usual source, a revelation of fraud that exposes the corruption. The most likely ground zero? The GSEs.




The GSE stocks act as if there are implicit government guarantees. There are no such guarantees.http://en.wikipedia.org/wiki/Mortgage_GSE_controversy

Read the conclusions in William Poole Jan 17, 2007 speech on GSE concerns.
http://www.stlouisfed.org/news/speeches/2007/01_17_07.html

"Three essential reforms are needed to eliminate the GSEs’ threat to financial stability. First is a limit on their portfolio growth; second is an increase in their minimal required capital; third is satisfactory bankruptcy legislation so that, should the worst happen, federal authorities can deal with the problem in an orderly way. "

Has there been any bankruptcy legislation proposals? Even if there was I don’t see any orderly fashion of unwinding the real estate bubble. I call it a crash and burn the debt holders.

DemonD
04-11-07, 09:44 PM
re: the chart with the federal funds rate. I am reminded of Aaron Krowne's assertion about the NY Fed, prior to greenspan, setting interest rates that were organic with the demand in the markets, as opposed to pushing supply or witholding supply to hit a certain target rate. Which is why the fed funds rate looks more "organic" before a certain date and more computerized/controlled after a certain date (I think it was that 1995 thing?)

After reading all that I have, I would agree with James: The bankers are much more corrupt than stupid. I would say there is an element of stupidity, as there have been many economists that are very well-regarded that have now been using the power of the pen (and the internet) to try to educate people about what is really going on. At what point do the quant funds get destroyed by the completely out of balance fundamentals?

FRED
04-11-07, 11:33 PM
Some minor corrections

I hope that this helps avoid any confusion.

Thanks. Published an early draft. Doh!

don
04-12-07, 04:31 AM
"Big business takes no chances, as the recent stockpiling investigation showed. I should like to call your attention to one of of de Tocqueville's prophecies. He believed modern democracies would produce less crime, more private vice. Perhaps he should have said less private crime, more collective crime. Much of this collective or organizational crime has the object precisely of reducing risk."

and

"In every community there is a class of people profoundly dangerous to the rest. I don't mean the criminals. For them we have punitive sanctions. I mean the leaders. Invariably the most dangerous people seek the power."

Saul Bellow, Herzog, 1961.

BK
04-12-07, 10:39 AM
For all the negative Statistics and stories about Real Estate there are lots of folks who believe the Bottom is in for Real Estate (not me).

Two friends of mine - one has a Masters from a prestigious University in Medford-MA and the other is a Retired Army lieutenant colonel (they bright and the even save money on a regular basis). One just purchased a home (there was a bidding war for the home) and the other will be buying in the next two months.

No way to persuade these folks that there are more "shoes to drop" in the Real Estate down cycle. My attempts to convinced them are met with contempt. Both friends are hearing from many family members who are sitting on vast piles of 'HomeEquity' that they'll miss the boat if they don't buy.

So, if my friends are any indication we haven't hit bottom - and its a long way off.

grapejelly
04-12-07, 11:49 AM
For all the negative Statistics and stories about Real Estate there are lots of folks who believe the Bottom is in for Real Estate (not me).

Two friends of mine - one has a Masters from a prestigious University in Medford-MA and the other is a Retired Army lieutenant colonel (they bright and the even save money on a regular basis). One just purchased a home (there was a bidding war for the home) and the other will be buying in the next two months.

No way to persuade these folks that there are more "shoes to drop" in the Real Estate down cycle. My attempts to convinced them are met with contempt. Both friends are hearing from many family members who are sitting on vast piles of 'HomeEquity' that they'll miss the boat if they don't buy.

So, if my friends are any indication we haven't hit bottom - and its a long way off.

I've had the same experience.

Here's why I think this is happening.

A mark of our times in the US has been a slow diminution of the net worth and buying power of the middle class. But many of us here on iTulip and elsewhere are above the mean in terms of affluence.

The more affluent folks are much less affected negatively by what's happening in real estate.

The higher end houses haven't fallen off a cliff and people who are more affluent haven't been as affected by real estate. So they may read about it in the papers but have yet to experience it except in a few areas.

So they remain bullish on real estate.

I agree with you, we are a long way from bottom. Several years at least.

bill
04-12-07, 12:35 PM
Anyone have a link to the new Fannie Mae, Freddie Mac legislation bill introduced today by a group of Senators?
<O:p</O:p
By the way EJ when that jet flipped how close was it to the ground?

Sapiens
04-12-07, 12:48 PM
Anyone have a link to the new Fannie Mae, Freddie Mac legislation bill introduced today by a group of Senators?
<O:p</O:p


http://www.house.gov/apps/list/press/financialsvcs_dem/hr1427030907.pdf


By the way, what kind of bombs are in there? See this:


‘‘(d) PROVISIONS RELATING TO CONTRACTS EN18
TERED INTO BEFORE APPOINTMENT OF CONSERVATOR
19 OR RECEIVER.—
20 ‘‘(1) AUTHORITY TO REPUDIATE CONTRACTS.—
21 In addition to any other rights a conservator or re22
ceiver may have, the conservator or receiver for any
23 regulated entity may disaffirm or repudiate any con24
tract or lease—
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F:\M10\FRANK\FRANK_023.XML
f:\V10\030907\030907.123.xml (366079|1)
198
H.L.C.
1 ‘‘(A) to which such regulated entity is a
2 party;
3 ‘‘(B) the performance of which the conser4
vator or receiver, in its sole discretion, deter5
mines to be burdensome; and
6 ‘‘(C) the disaffirmance or repudiation of
7 which the conservator or receiver determines, in
8 its sole discretion, will promote the orderly ad9
ministration of the affairs of the regulated enti10
ty.
11 ‘‘(2) TIMING OF REPUDIATION.—The conser12
vator or receiver shall determine whether or not to
13 exercise the rights of repudiation under this sub14
section within a reasonable period following such ap15
pointment.
16 ‘‘(3) CLAIMS FOR DAMAGES FOR REPUDI17
ATION.—
18 ‘‘(A) IN GENERAL.—Except as otherwise
19 provided under subparagraph (C) and para20
graphs (4), (5), and (6), the liability of the con21
servator or receiver for the disaffirmance or re22
pudiation of any contract pursuant to para23
graph (1) shall be—
24 ‘‘(i) limited to actual direct compen25
satory damages; and
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f:\V10\030907\030907.123.xml (366079|1)
199
H.L.C.
1 ‘‘(ii) determined as of—
2 ‘‘(I) the date of the appointment
3 of the conservator or receiver; or
4 ‘‘(II) in the case of any contract
5 or agreement referred to in paragraph
6 (8), the date of the disaffirmance or
7 repudiation of such contract or agree8
ment.
9 ‘‘(B) NO LIABILITY FOR OTHER DAM10
AGES.—For purposes of subparagraph (A), the
11 term ‘actual direct compensatory damages’ shall
12 not include—
13 ‘‘(i) punitive or exemplary damages;
14 ‘‘(ii) damages for lost profits or op15
portunity; or
16 ‘‘(iii) damages for pain and suffering.
17 ‘‘(C) MEASURE OF DAMAGES FOR REPUDI18
ATION OF FINANCIAL CONTRACTS.—In the case
19 of any qualified financial contract or agreement
20 to which paragraph (8) applies, compensatory
21 damages shall be—
22 ‘‘(i) deemed to include normal and
23 reasonable costs of cover or other reason24
able measures of damages utilized in the
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March 9, 2007 (12:42 p.m.)
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f:\V10\030907\030907.123.xml (366079|1)
200
H.L.C.
1 industries for such contract and agreement
2 claims; and
3 ‘‘(ii) paid in accordance with this sub4
section and subsection (e), except as other5
wise specifically provided in this section.

FRED
04-12-07, 02:05 PM
For all the negative Statistics and stories about Real Estate there are lots of folks who believe the Bottom is in for Real Estate (not me).

Two friends of mine - one has a Masters from a prestigious University in Medford-MA and the other is a Retired Army lieutenant colonel (they bright and the even save money on a regular basis). One just purchased a home (there was a bidding war for the home) and the other will be buying in the next two months.

No way to persuade these folks that there are more "shoes to drop" in the Real Estate down cycle. My attempts to convinced them are met with contempt. Both friends are hearing from many family members who are sitting on vast piles of 'HomeEquity' that they'll miss the boat if they don't buy.

So, if my friends are any indication we haven't hit bottom - and its a long way off.
The iTulip position is re-stated in this post on the Housing Derivatives web site:

How Housing Prices Fall - A Script (http://housingderivatives.typepad.com/housing_derivatives/2006/10/index.html#entry-13674314)

iTulip.com (http://www.itulip.com/forums/showthread.php?t=547) has a posting about the latest New Home Sales figures and the mechanics that can make housing prices fall:


"The way housing busts happen is not exactly a mystery. They occur as a series of self-reinforcing deflationary waves. The process is non-linear. Inventories rise, then price pressures rise, then transaction volumes fall, then sales volumes rise again–although not to previous levels–as prices decline, then inventories rise again, price pressures increase further, and so on. If unemployment rises, price pressures increase proportionately.

"If I can figure out how they're going to start (seize up then slow decline (http://www.itulip.com/forums/../housingnotlikeequities.htm)), how they're going to evolve (revert to the mean (http://www.itulip.com/forums/../housingbubblecorrection.htm)) and when they're going to happen (starting in mid 2005 (http://www.alwayson-network.com/comments.php?id=10485_0_24_0_C)), you'd think nine out of ten economists could, too."
So, is it time to add New and Existing Home Sales and Housing Starts instruments to the suite of products? With or without a "price bust," trading these instruments would allow for risk and financial transfers in these fundamental, non-price changes.
What iTulip predicted was a non-linear decline in the housing market, with periods when sales and prices are rising. This is the "tide going out" phenomenon of a declining market which iTulip also talked about during the stock market decline starting in April 2000; if you watch each and every wave, such as by watching stock prices daily or housing prices quarterly, just as when you are watching ocean waves lapping onto shore as the tide goes out, you will note that some waves reach higher onto the beach than the previous wave. But, place a stick in the sand and come back once every 30 minutes, and the trend becomes obvious. Same with housing.

Your friends don't understand the "tide going out" principle so they interpret instances of higher waves as evidence of a growth trend. But they are mistaken.

grapejelly
04-12-07, 04:36 PM
Your friends don't understand the "tide going out" principle so they interpret instances of higher waves as evidence of a growth trend. But they are mistaken.

Thanks Fred. I realized that this is no different than how all of nature works. All stocks, all bonds, all commodities. Heck, I was sick and then started to feel better, but then I felt a little sick again and then even better, etc. We all know that everything works this way.

Housing seems different because the waves are so lengthy and us humans, due to our cognitive recency bias, don't weigh things that happened last year or the year before nearly the same as what happened last Sunday.

And, most of us in housing are not financial traders and are completely unsophisticated.

akrowne
04-12-07, 09:42 PM
re: the chart with the federal funds rate. I am reminded of Aaron Krowne's assertion about the NY Fed, prior to greenspan, setting interest rates that were organic with the demand in the markets, as opposed to pushing supply or witholding supply to hit a certain target rate. Which is why the fed funds rate looks more "organic" before a certain date and more computerized/controlled after a certain date (I think it was that 1995 thing?)


Yes it's the same as one of the charts from my last article. This transition wasn't 1995 -- it was 1987, with the start of Greenspan's tenure.



After reading all that I have, I would agree with James: The bankers are much more corrupt than stupid. I would say there is an element of stupidity, as there have been many economists that are very well-regarded that have now been using the power of the pen (and the internet) to try to educate people about what is really going on. At what point do the quant funds get destroyed by the completely out of balance fundamentals?

I'd say equal parts corrupt and stupid ;) In boom times, lots of "young turks" show up with all kinds of whacky ideas that are always leverage dressed up in sheep's clothing. I know lots of the old-timers sigh every time this happens; but who can stop the race to the bottom as it brings with it windfall profits, for a time?

The whipper-snappers have never seen a real credit crunch.

Of course for this to happen the bank Chieftans have to basically give consent to it. They know what is going on in the ranks; they are just gambling that they'll get away with a slap on the wrist at worst.

akrowne
04-12-07, 10:00 PM
Thanks for this post Eric and I'm looking forward to taking a look at James' work, and appreciate all he is doing to publicize our economic problems.

Personally I come down on his side by a little bit -- I think the crash will be more on the fast side.

I have two reasons for believing this:

(1) Japan's slow-motion crash depended on unique circumstances that will be difficult to reproduce/unlikely to happen again.

(2) Things are already happening fast. We're already past the "subprime implosion" -- now it's the "Alt-A implosion" too (the latest Implode-O-Meter (http://ml-implode.com) companies are tilted towards Alt-A), which is being acknowledged by most of the major media outlets. By May it will be the "ARM implosion"; and I predict within a few months it will also be the "pay option-ARM implosion" (pay option ARMs almost by definition cannot themselves "implode", but I see financial companies that deal heavily in them imploding first). By mid/late summer journalists will widely be calling it the "mortgage meltdown", and lawsuits, far from imploding, will be exploding (http://www.bloomberg.com/apps/news?pid=20601109&sid=avI34G5JBAjQ&refer=home). It will also be obvious by that point that the US financial modus operandi is in big trouble -- there will be no going back and no soft landing.

You can argue that the government will do a lot to try to manage the crisis, but I simply don't see them as having much control over it. It is potentially too all-encompassing and systemic. I don't think they'll be able to slow it down: everything they do on a large scale will just make things worse. The Fed has pretty much nothing left in its bag of tricks, and they basically cornered.

EJ
04-13-07, 12:04 AM
Yes it's the same as one of the charts from my last article. This transition wasn't 1995 -- it was 1987, with the start of Greenspan's tenure.
And the same as charts iTulip has been showing since 1998-1999. The trend has not changed in nearly ten years.


I'd say equal parts corrupt and stupid ;) In boom times, lots of "young turks" show up with all kinds of whacky ideas that are always leverage dressed up in sheep's clothing. I know lots of the old-timers sigh every time this happens; but who can stop the race to the bottom as it brings with it windfall profits, for a time?

The whipper-snappers have never seen a real credit crunch.

Of course for this to happen the bank Chieftans have to basically give consent to it. They know what is going on in the ranks; they are just gambling that they'll get away with a slap on the wrist at worst.
Not quite. See: Jocks and Geeks Theory of Financial System Dysfunction (http://www.itulip.com/forums/showthread.php?t=383)

Spend a few years on company boards and you'll see what I mean.

Charles Mackay
04-13-07, 07:42 AM
The crash will be triggered by the usual source, a revelation of fraud that exposes the corruption. The most likely ground zero? The GSEs.

The GSE stocks act as if there are implicit government guarantees. There are no such guarantees.http://en.wikipedia.org/wiki/Mortgage_GSE_controversy

Read the conclusions in William Poole Jan 17, 2007 speech on GSE concerns.
http://www.stlouisfed.org/news/speeches/2007/01_17_07.html

"Three essential reforms are needed to eliminate the GSEs’ threat to financial stability. First is a limit on their portfolio growth; second is an increase in their minimal required capital; third is satisfactory bankruptcy legislation so that, should the worst happen, federal authorities can deal with the problem in an orderly way. "

Has there been any bankruptcy legislation proposals? Even if there was I don’t see any orderly fashion of unwinding the real estate bubble. I call it a crash and burn the debt holders.

Whether the government bails out sub prime and GSEs is really the pivotal factor in deciding the inflation/deflation debate isn't it?

jk
04-13-07, 08:38 AM
does anyone here believe that the gov't would NOT bail out the gse's?

bill
04-13-07, 12:29 PM
The Goldman’s of the world have used the yen carry to borrow on the cheap and pool investors backed by real estate with attractive yields and using high approval rating’s (insurance) from Moody’s for example. The Goldman’s make a fortune brokering paper, pump the real estate to a all time bubble and have escaped liability. We call this activity corrupt as James put it, Goldman’s calls it business as usual and a good return. By the time, as EJ put it “crash will be triggered by the usual source, a revelation of fraud that exposes the corruption” I’m sure Goldman’s will already have their best finger pointing blame experts (legal counsel) assembled and ready to go. Goldman’s of the world will already be gearing up for the next potential bubble in another industry and put the last one behind them. <O:p</O:p
If the government does bail out the gse’s it will be a very slow process, dragging it out over time letting us tax payers foot the bill gradually.

Charles Mackay
04-13-07, 12:55 PM
does anyone here believe that the gov't would NOT bail out the gse's?


Well, letting the paper collapse in a debt default and then riding in on a white horse and buying it up at .30 cents on the dollar in a few years can also be a very profitable move by GS and MS. This cleans up the balance sheet of USA Inc. and then they can move on and create the next bubble while everyone else is worrying about a depression.

As investors we need to be nimble enough to anticipate that as a possibility.

jk
04-14-07, 07:43 AM
to clarify: i do not think the gov't would bail out the stock holders in fannie and freddie. but i am sure the gov't would bail out the holders of gse paper.

EJ
04-14-07, 10:36 AM
to clarify: i do not think the gov't would bail out the stock holders in fannie and freddie. but i am sure the gov't would bail out the holders of gse paper.

Or ala LTCM, get the boyz to buy them out and clean them up?

Blackstone, Rival Group Compete
In Bid to Get Control of Sallie Mae (http://online.wsj.com/article/SB117649368915369422.html?mod=us_business_whats_ne ws)

By HENNY SENDER and JOHN HECHINGER
April 14, 2007; Page A3


Blackstone Group and a group consisting of JC Flowers & Co. and J.P. Morgan Chase (http://online.wsj.com/quotes/main.html?type=djn&symbol=jpm) & Co. are each in talks to acquire control of SLM Corp., or Sallie Mae, the nation's largest provider of student loans, in a deal that could be valued at as much as $20 billion.

stumann
04-14-07, 08:26 PM
Agreed, but Japan's 90s experience was hardly deflationary. Recall all those loaded Japanese tourists jumping off the buses and buying up everything in the overpriced gift shops!!! The Japanese consumer/wage earner was basically a hostage within a certain set of circumstances. Japan was in fact a figure of health during those years - "growth" tanked because they were so much more efficient compared to the ever wasteful-and-growing-ever-more-wasteful-awash-in-debt Americans.

I disagree with original article's position that the debt bubble was not the result of a conpiracy. Read Batra's "Greenspans Fraud" - back in the 80s, old Mr. Green-pants knew full well he was shifting the tax burdon from corporations onto the average working American in order to create the appearance that voodoo economics actually worked. This was the beginning of the "market logic" trend which culminated in the out of control debt bubble - a small lie covered up by a series of ever larger ones. I mean, come on...when Mr. Green-pants came out and told us to switch over to adjustable rate mortages - what better proof does there need to be he was out to inflict pain on the little people?

Until a few months ago, I figured there'd be "a big one" - a big market decline. Now I'm not so sure. I'm thinking both markets & information are now so manipulated, America will instead follow a 1980-90s Soviet style decline rather than a repeat of the Great Depression. The Soviet people continued to get poorer and poorer, all in the face of good news, until the system collapsed and the criminals running things from behind the curtain came out into the open. That's what seems to be occuring in America today. The Bush & Cheney crew no longer bother to hide their corruption - the PPT keeps markets within a trading range - gold & oil are kept artificially high - foriegn currencies are kept way over inflated in the lead up to another engineered "Asian Crises".

It's an in-plane-sight conspiracy (to borrow words from the 911 conspiracy theorists). America's financial community is setting things up to destroy foriegn markets. Watch for 50+% declines overseas and crashing currencies while the US markets hardly budge. Of course, not wanting to destroy these countries, the price of oil will have to come way down (oil & gold have remained practically constant in foriegn currency terms - more proof of conspiracy).

The US is positioning itself as the world's safehaven - the US$ will explode upward, and the subprime mess just won't matter - exactly what occured in New Orleans. The poor were destroyed & forgotten - eclipsed by Halburton's billions of contracts.

it's 100% conspiracy - and becoming more transparent because those pulling it off no longer bother to hide it. so DON'T short the US market - you might make 10-20%, but that will quickly reverse as the rest of the world take what capital they have left and head for American markets.