July 31st, 2007

Doom & Gloom Nightly — Your Sour Wall Street Source

Posted in Money by ed

This DOOM & GLOOM SCENARIO is brought to you by www.newcombat.net, where the glass is always empty — Waiter!?

In light of the recent turmoil in the markets,

A FRIEND WROTE: So is this a turning point, a sea change, the beginning of high interest rates, low to no growth, maybe stagflation?

NEWCOMBAT ANSWER MAN: Yes. These things have been on the worry-horizon. Now they will be realized.

FRIEND WROTE: Is this all Warren’s fault?

(That is: Warren J. Spector, an old mutual college friend currently on the hot seat at Bear Stearns (BSC), where he is President and co-Chief Operating Officer. Bear had two “hedge funds” specializing in mortgage bonds fail this past month, and today announced it has forbidden redemptions by investors in a third.)

ANSWER MAN: Well. Maybe it is somewhat Warren’s fault. But it also seems he was a victim — paid, according to Forbes Online, about $35 million in 2006 — of a nationwide network of venal mortgage brokers who bent rules to write mortgages for (i) “subprime” humans (FICO credit scores less than 625 more or less) and (ii) “Alt-A” humans, like me, who don’t have normal jobs and thus are sent to the “Alt-A” mortgage pool when looking to gamble on real estate.

But, well, they were only able to sell the stuff because peeps like Warren atop the food chain were packaging and selling them worldwide. Why would a German Landesbank want to own American mortgages? Salesmanship, I guess. Was Warren a salesman? I don’t know.

After the Tech Crash, peeps lost some confidence in the stock markets. Wanted to put money elsewhere. And when Greenspan knocked rates down to near nothing, all the more so, peeps needed a place to put money where some return could be expected. For all these reasons American real estate seemed perhaps the best bet.

And that sudden tap into worldwide cash yearning for yield is what suddnely drove real estate here thru the roof across the decade. Ie a much larger pool of credit was suddenly able and willing to fund mortgages here, and this juiced the buying, kicking in the ahistoric upward jag that perhaps now has seen its top.

One of the spectacular failures is happening today. American Home Mortgage. (AHM). A specialist in Alt-A mortgage lending. Stock was trading at $20 two weeks ago; today closed at $1.04. You can get a chart to see what it looks like at:

http://bigcharts.marketwatch.com/advchart

Also check out Countrywide (CFC), which specializes in subprime mortgages. And check out the titans of Wall Street. Merril Lynch (MER). Goldman Sachs (GS). Lehman Brothers (LEH). Bear Stearns (BSC). Barclays (BCS).

And Citibank (C). Bank of America (BAC). JPMorgan Chase (JPM). Wachovia (WB). Capital One (COF).

These boys are too big to fail (aren’t they…?). But they’re not used to being pushed around like this.

The Dow Industrials were down 300 last Thursday, 200 on Friday. Up 80 yesterday. Down 100 or so today. And it seems will be down several hundred tomorrow, at least in the morning, on the AHM failure.

SO WHAT’s ALL THE NOISE ABOUT?

ANSWER MAN: It’s more than a typical “liquidity” crisis (ala when the huge “hedge fund” Long Term Capital Management failed in late 90s).

The difference this time is that the mortgage-bond failures have demonstrated that the Rating Agency (Moody’s, S&P, Fitch) “models” (ie spreadsheets) for evaluating and thus rating “asset-backed securities”, “collateralized debt obligations” and other complex “structured finance” bonds sare seriously flawed.

The implosion nationwide of the housing market, following upon a great expansion of credit under Greenspan (which expansion was possible in good part BECUASE of the structured finance revolution that began in the 80s with the advent of personal computers and spreadsheets) — this implosion, I say, was the first extreme test of the Rating Agency models, and they flunked.

I.e,. mortgage bonds rated AAA (the best) have been failing as wildly as the BBB- bonds (bottom rung of so-called “investment grade”).

Upshot: The global finance system is loaded with more than a trillion dollars worth of these complex bonds and at the moment no one is sure what they’re worth.

You won’t hear this Rating Agency methodology problem talked about on CNN or in the Wall Street Journal yet. For now it’s the mortgage bond failures and the failures these are causing among “hedge funds” and the big lenders in the affected spheres.

But the rating methodology problem is the underlying failure, and it seems likely to cause riotous panic. (Unless everybody decides to ignore it. Say, via a Price Control program instituted by the Fed …)

The mortgage and credit-card businesses rely ENTIRELY on their ability to sell the risk through asset-backed securities. If the market for those securities dries up (as it may well have already — it’s hard to tell because the markets are not public) — the businesses will contract in ungodly fashion. Very hard to get a mortgage or credit card, unless you reside in Richistan and need neither.

Before it’s over we may have to go back to the 1930s for a similar scenario re crisis credit contraction and its dire sequelae.

Ie I should sell my apartment yesterday.

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