Banks ask Congress to fill a $3 Trillion Hole

"Watch that first step, Doc. It's a lu-lu!" - Bugs Bunny

How much trouble are the banks and financial companies in relation to this housing bust?

In my previous post I demonstrated how they essentially milked out all of the equity Americans have in their homes through their fruadulent and corrupt lending practices.

In summary, back in the 90s Americans had $10 trillion in housing wealth against $5 trillion in mortgage debt. During the height of the bubble both numbers swelled to $20 trillion and $10 trillion respectively. We are now on the downslope and it will end with $10 trillion in housing wealth being backed with $10 trillion in mortgage debt.

However, it's even worse for the banks. Because 30% of the houses in this country are owned outright. This means that the endgame, is that there is $10 trillion in debt held against $7 trillion in housing wealth. The fact that the mortgaged housing stock is still "valued" at $14 trillion doesn't matter because it's shrinking every day (last month national housing prices fell almost 2%, that's $400 billion in housing wealth up in smoke).

This is what is making the banks and financial companies crap their pants. They know that $3 trillion of what they are holding is almost certain to default. Once people have lost all their equity, they'll have very little incentive to stay in the house (especially if rents are cheaper). When you also throw in the fact that we have millions of "homeowners" who never put a penny down on their homes and the debt slaves who HELOCed and Refied all of the equity out of their house these past 5 years, you have a very, very big problem.

But wait! The problem is even bigger. You see many of these banks and financial institutions went out and used this debt as collateral to leverage up their portfolio by 20 or 30 times! So one bank could have $100 million in mortgage debt receivables on their books, but they could have used that to borrow $20 - $30 BILLION more. What did they do with that money? Well they bought more debt instruments: like CDOs or US Treasuries, or Agency debt.

It was all supposed to be very safe. But when you have leveraged yourself to the hilt, a tiny move in the wrong direction (if you're leveraged up 20 to 1, it only takes a 5% move to WIPE YOU OUT!) can send you to bankruptcy very quickly.

If you want an example, look at the Carlyle group and Thornburg Mortgage. They both overleveraged their positions, the value of their collateral dropped by a small amount and generated huge margin calls. Both of these companies have been unable to sell their debt securities (because the debt markets have been frozen for months and they continue to deteriorate), so both of these companies are both going to evaporate.

Poof! Like magic, they will disappear forever.

So now these big and powerful financial firms, who made hundreds of billions of dollars on the way up are now begging the government to fix this.

The only problem is, the hole is too big!

Both the Government and the Federal Reserve are doing everything they can to try to fix and unfixable situation. In the entire history of our country (that's 232 years) we've only now been able to accumulate $9.4 trillion in debt. Now the bankers and financiers are looking for a $3 trillion handout to bail them out of their own greedy stupid mess that THEY CREATED! Shoot, the annual Federal Budget is $3 trillion!

Look at some of the crazy proposals out there right now:

• Ben Bernake wants lenders to REDUCE THE PRINCIPAL of mortgage balances for people that are underwater. I talked about this in a previous post on Debt Negotiation - THEY WOULD NEVER EVEN CONSIDER THIS UNLESS THE SITUATION WAS BEYOND GRAVE AND THE ALTERNATIVE (MEANING LET THE HOMES GET FORECLOSED ON AND TRY TO RESELL THEM IN THE OPEN MARKET) WOULD END UP COSTING MUCH, MUCH MORE!


• Congress is proposing tax credits of $5,000 to $15,000 for people to buy a home. Personally, I'm waiting for a bigger tax credit before I would buy.


• The Federal Funds rate has been reduced from 5.25% to 3% in less than 6 months and it will probably be dropped another 0.75% next week, even with inflation and commodity prices soaring and the dollar depreciating more than 10% since they started cutting interest rates!


• Fannie Mae, Freddie Mac and the FHLB have all had the limits raised on conforming mortgages. So now a conforming mortgage can be up to $729,000 in some parts of the country (so much for helping the poor afford homes).

Sorry, banks. You created a problem that's too big to fix. Everyone sees that all of these proposals don't help homeowners, they help the banks and financial institutions that created this mess.

Just look at how Agency debt from Freddie Mac and Fannie Mae have been tanking since they raised the loan limits. Everyone knows that this is just a ploy to allow companies like Merrill Lynch and Citibank to pawn off their toxic debt onto the government (meaning, us taxpayers). No one wants to come within 100 yards of this toxic debt! In the meantime we have to suffer with higher gas and food prices (along with everything else) just so they can keep their game going until at least after the election in November.

It won't work, and I don't think they can hold this thing together for another 9 months, but that's just my opinion.

Pump and Dump

Here's the Headline on Yahoo today:

Homeowner Equity Is Lowest Since 1945
Thursday March 6, 2:15 pm ET By J.W. Elphinstone, AP Business Writer
Federal Reserve Report Shows Homeowner Equity Dipping Below 50 Percent, the Lowest on Record

http://biz.yahoo.com/ap/080306/home_equity.html

How is this possible? Haven't we just experienced the greatest decade ever
for housing appreciation? Didn't the average price of a home in the United
States double during this time?


But wait, the news is actually worse than what's reported. Right now the value of housing in America is about $20 trillion. There is a total of about $10 trillion in mortgage debt held against this equity.
Everything looks pretty good so far, right?



However, about 30% of the housing stock is owned outright ($6
trillion). So that leaves only $14 trillion in housing equity against $10 trillion in debt - all of a sudden that cushion doesn't look as big as
it did.


In the past year, the Case-Shiller Home Price Index has said that
housing values across the country have plunged by almost 10%! Take away 10% from $14 trillion and you're down to $12.6 trillion in equity. Uh oh, all it's going to take is another 20% drop to WIPE OUT ALL OF THE HOME EQUITY IN 70% OF THE HOUSES IN THIS COUNTRY!


This, my friends, is a classic pump and dump of the housing
market. If you understand economics you will know that all pricing
power happens at the margins. Housing is a product that has very small margins. At any given time, only about 1%-2% of the existing housing stock is for sale (there is about 100 million housing units in this country).

Because of easy financing (no down payment, no documentation, liar loans, option ARMs, etc., etc.) you had a large number of people enter the housing market. Anyone knows that when you increase demand without a corresponding increase of supply (housing supply takes about 2-3 years to catch up) the price goes up. In this case, the price went up substantially.

Now we have about 4% of the homes in America for sale and you would think it was the end of the world! However, at the margin prices need to come down substantially in order to clear out this excess inventory. The fact that sales are also slowing substantially is another problem because it puts even more pressure on prices to come down.

So where are house prices going? To answer this question I want to take you back to the last bubble, the tech bubble. From 1996 to 2000 the Nasdaq went from 1052 to 5048. Then the bubble burst and the Nasdaq fell all the way to 1142 in October of 2002.


ALL OF THE GAINS OF THE BUBBLE WERE WASHED AWAY ONCE IT POPPED!


Even today, 8 years after the Nasdaq reached that lofty high, the
Nasdaq closed at 2220. That's almost 60% off it's all time high. If you add in inflation (3%/year), the Nasdaq is still down OVER 80%.


In my opinion, the same thing is going to happen to the housing
market. ALL OF THE GAINS IN THE PAST 10 YEARS WILL BE LOST! That means the average price of a home in America is going back to around $100,000. Also, because the housing market is not nearly as liquid as the stock market, it will take longer to deflate than the Nasdaq did. The peak of the housing market was in the fall of 2005, so we're 2.5 years in right now and prices are only down 10% (and all of that loss occured in 2007).


Equity is a phantom, but Debt is permanent!


In the end we'll have $10 trillion in housing stock backed by $10
trillion in debt. That means Americans will have, on average, NO EQUITY in their homes when this is all done!


That means the end result is that we, as a nation, have become poorer due
to the housing bubble. Not to mention we now have to live through the massive housing led recession that we are entering right now.


We've been played, America! We were the Mark and we fell for it, and now we have to suffer the consequences. The scam artists are laughing all the way to the bank!

Oh My God!

Thank you "Mess Greenspan Made" blog for finding this. Feel free to check out this excellent website.

There is a closed gas station that I pass by on the way to work that still has prices listed on its sign. There it is, frozen in time: $1.37/gallon for unleaded.

Ahh, the good old days!

Be Careful of What You Wish For

I remember back in High School I had a conversation with this girl, Kelly (who was my date to the Prom). We were talking about what time period we would like to have lived in. We both agreed that the 1920s would have been awesome. This was really against the grain because most of the kids my age would have said the sixties.

Why did I say the twenties? Well, it was a really exciting time in America. It was a decade long party filled with jazz music and flappers (hubba, hubba). It was an incredible time for artists, architecture(Art Deco), design, and pop culture (movies like “Metropolis”). It was a time of exciting technological innovation like the automobile, radio and flight. There was an economic boom and a stock market boom. Everyone was getting rich, and it just looked so classy!

My younger self always thought how cool it would have been to have lived in such a time. Of course, I wasn’t that concerned about what happened in the decade after the roaring 20s – the Depression.

It’s interesting because the more I learn about the roaring twenties, I see eerie similarities to what has transpired in our country over the past dozen years. The beautiful and popular spent their time and money at clubs where you could pay $1,000 for a private table and spend $400 on a bottle of liquor (with a 2 bottle minimum). Women salivated at $1,000 Jimmy Choo shoes and $5,000 Christain Dior handbags. Not to be outdone, men bought things like $3,000 Plasma Televisions and $50,000 Hummers and Escalades. We also had the internet revolution during this time - think about how much that changed your life. Finally we were blessed with twin bubbles, first in technology and then in housing to power all this excess.

The dark side of the 20s was that it was all fueled by debt. Consumers and Businesses took on massive amounts of debt in order to live “the good life”. Unfortunately, it was all a house of cards. Once the debt reached a certain level, people couldn’t service it anymore. People started to default on their obligations and the economy collapsed in a deflationary spiral. The banking system seized up and there was no more credit or liquidity that people could use to fuel the economy. In order to service the high debt loads, people had to sell their assets (including stocks, bonds and houses) at greater and greater losses. As an example, by 1933 home prices across the country fell 90%! That's a fact that the NAR will never tell you about.

So, I guess I got my wish. Near as I can figure, the past decade has been as close to the 20s as I could have experienced. Did I enjoy it? Yes I did, but I could never embrace the debtor lifestyle. It would have been so easy for me to have pulled hundreds of thousands of dollars out of my house and gone on exotic trips, bought overpriced foreign cars and lots of techno gizmos to impress my friends and relatives. I could have gotten myself a dozen credit cards and maxed them all out on shopping trips, expensive restaurants and entertainment.

But that’s not me. I knew that would be a dead end that would only end in tears. I can only imagine what is happening across this country with people who owe more on their home than what it is worth, who are in danger of losing everything because they took on too much debt. The stress and fear must be overwhelming, and it is something that – hopefully – I will never have to experience myself.

The plus side is that if we do hit a deflationary spiral like what occurred in the 30s, I will be waiting with baited breath and cold, hard cash to buy those assets at pennies on the dollar!

FJ Quote of the Day

"Many Americans are now realizing that being tied to material items comes at a heavy costs. If you have beaucoup debt you are unable to do other things. When you ask Americans to imagine a wealthy individual, they will tell you that they drive in a foreign luxury car, wear a $5,000 watch, and live in an uber
McMansion. Yet the reality is very different. As highlighted in the Millionaire Next Door, many of the day to day millionaires drive nice but not super expensive cars, live in modest homes, and don’t spend ridiculous amounts
on artifacts of wealth. The book was written before the housing bubble but the fact remains, wealth is not possession of expensive items. Wealth is having the freedom to do what you want. Having massive amounts of debt hanging over your head is not wealth, it is a financial albatross that will take your freedom away."

Thank you Dr. Housing Bubble for such an eloquent quote! I also recommend you read "The Millionaire Next Door", it is a fascinating book about what it takes to become wealthy in this country!

I've also added a link to Dr. Housing Bubble's website on the right. Please check him out. His "Real Homes of Genius" are awesome!

FJ Prediction: $4/gallon gas by Memorial Day

Please note, I am not giving any investment advice. You need to do your own due diligence in regards to investing.

We’ve got a perfect storm brewing in the energy markets right now. Oil has recently hit, and for the first time closed at, over $100/barrel this past week. On top of that, the springtime has many refineries switching from winter blends to summer blends. Alongside both of these issues is the fact that Memorial Day kicks off the summer driving season when gasoline consumption tends to peak.

All three of these trends lead me to believe we are going to see a major uptick in the price of a gallon of gas starting now. Here in Santa Fe we’ve already seen gas jump up by about $0.50/gallon in the past month, to about $3.09/gallon (and I have seen some stations at $3.19 for regular unleaded).

I know that oil also was hovering around $100/barrel oil in November and December of last year. For some reason we didn’t see a big bump in the price of a gallon of gas. Here in Santa Fe, prices remained in the $2.60 - $2.80/gallon range during that time. I’m not sure why prices stayed so low (although my conspiracy theorist has lots of ideas about government manipulation to keep prices down over the critical Holiday shopping season).

Regardless, we didn’t face the other two issues back at the end of last year. Refineries are already stretched to their limit trying to keep up with our energy consumption. When they start to switch over in the next few months, expect major increases in the price of gas. Last year, even though oil was in the $60/barrel range, gas prices jumped over $3/gallon because of the refinery bottleneck.

I’d be interested in finding out if they’ve been shipping extra number fours (for the signs) to local gas stations in anticipation of the $4/gallon being breached. For the record, I also thought this was going to happen last year, but that never materialized. Nevertheless, everything seems much more likely this summer.

The only thing that could change this prediction is a sudden and dramatic slowing of the economy in the next 3 months. Even though this is a possibility, and the economy is slowing right now, I doubt this is going to have much of an impact on oil prices. There is a real bull market happening in energy right now and I expect that to continue in the short term.

However, longer term I’m positive that prices will be falling rapidly starting in Winter, 2008. I think by that time you are going to see real recessionary indicators on both the American and world economy. If worldwide oil consumption drops by only 10%, that could result in a 50% drop in the price of oil (back to $50/barrel and probably under $2/gallon gas). I hate calling this good news because it only happens if the recession is stronger and deeper than anyone thinks right now.

I will follow up with this on Memorial Day to see if my prediction comes through.

Sorry I've been so sporadic with my posts. This month has been crazy, but I've got lots of stuff to talk about going forward. I'm going to try to post some more real soon!

Old School Housing Truisms

Amid the housing frenzy of the past few years, there was a lot of conventional wisdom which got ignored. I want to remind all of you that it was not that long ago that all of these rules were rigidly followed (and had been followed successfully for 50 years).

When I bought my first house in 1998, all of these rules were still being followed.

1. YOU NEED A 20% DOWN PAYMENT. This shows the bank that you have discipline and are able to live below your means. It also means the buyer has some "skin in the game" and will be less likely to walk away from this debt. If you didn't have 20%, you have to pay Private Mortgage Insurance (PMI). PMI was a very expensive penalty, it would usually add another $100 - $200/month to your mortgage payment, which further reduces how much home you can afford.

2. GET A 30 YEAR FIXED MORTGAGE. If you couldn't afford a 30 year fixed, you couldn't afford the house. Adjustable rate mortgages, interest only mortgages, subprime mortgages made up a very small percentage of all mortgages and were reserved for very special cases.

3. IF YOU NEED TO SELL YOUR HOME WITHIN 3 YEARS OF BUYING IT, YOU WILL PROBABLY LOSE MONEY. This is why when you took a job in a new city you rented! If you weren't sure if you were going to be in a place for at least 3 years, you didn't buy a house! Remember, when you sell there's a 6% commission plus closing costs (about 1.5%). You needed about 3 years of appreciation in order to cover those costs, and even that wasn't a guarantee.

4. HOMES ONLY APPRECIATE AT THE RATE OF INFLATION. This goes back to point #3, you could only count on about 3%/year appreciation on your house. That means a $100,000 house should only increase in value by about $3,000/year. After 3 years, a $100,000 house would be worth about $109,272. If you needed to sell and paid 7.5% (commission and closing costs) you would net out about $101,000.

5. YOUR LIFE WILL BE THOROUGHLY DOCUMENTED, TOP TO BOTTOM, BEFORE A BANK WILL GIVE YOU A MORTGAGE. They want to see two years of steady employment (pay stubs, W-2s and tax returns). They also want to see your investment and savings accounts, and no more than 25% of your down payment can be a gift from your family. They check your credit report to see if there are any judgements against you, and if there are - you need to pay them off. This is a grueling process and they basically find out everything about you before they end up loaning you money.

6. HOUSING PRICES CAN AND DO GO DOWN. Despite what Realtors tell you, every housing market - at some time - has gone down. Even some of the biggest and most expensive housing markets, including San Francisco, Honolulu and New York, went through periods of sustained housing declines. These declines take years before the losses are recovered. The bank wants to be sure you will stick it out and keep making your payments and that's why they wanted a large down payment and a full documentation of your financial situation in the first place.

All of these rules are slowly being reinstated in the wake of this massive housing bust currently in effect.

For 50 years the homeownership rate in this country held steady at 65%. In the past 10 years they've been able to push that up to 70% but only by repealing every one of these rules. The entry of approximately 15 million homeowners over that time caused the average price of a home to double. Now those 15 million fake homeowners who never put any money down, who used no documentation loans and Option ARM or subprime mortgages will lose their homes and prices will go back to their inflation adjusted norms.

And there's nothing that the Republicans or the Democrats can do about it.