Vigilant Investor

Hardly a day goes by without someone’s proposing how to make the bad situation in subprime mortgage lending even worse. Legislators at all levels of government are contending for ownership of the most destructive idea. (One example of a thousand)Finalists in this legislative race to the bottom include punitively stiff lending standards, foreclosure holidays and taxpayer-financed bailouts. I would like to propose a far simpler, fairer and effective course of action: let free people sort it out for themselves.

Sound a bit harsh? Actually, when considered in the context of the Great Global Credit Bubble, the choice really is between letting it sort it self out or compounding the problem so that the clean up is much worse down the road. You can get the full scoop from Stever Berger whose piece is quoted above.

Consider also:

• WSJ: “Subprime’ Aftermath:Losing the Family Home“.
• Bloomberg: Fed Sees Housing Damping Growth Longer Than Expected
• CBS Marketwatch: Mortgage volume decreases as rates rise
• Bloomberg: U.S. Home Construction Bust May Last Until 2011
• CBS Marketwatch: U.S. home prices fall for first time since 1991
• Bloomberg: U.S. Existing Home Sales Drop to Lowest in Four Years

Cover them over with beautiful flowers,
Deck them with garlands, those brothers of ours,
Lying so silent by night and by day
Sleeping the years of their manhood away.
Give them the meed they have won in the past;
Give them the honors their future forecast;
Give them the chaplets they won in the strife;
Give them the laurels they lost with their life.

~Will Carleton

More quotes to ponder for a weekend to remember those who’ve given their lives in war.

The belief in the possibility of a short decisive war appears to be one of the most ancient and dangerous of human illusions.
~Robert Lynd

Never believe any war will be smooth and easy, or that anyone who embarks on the strange voyage can measure the tides and hurricanes he will encounter.
~Sir Winston Churchill

I’m fed up to the ears with old men dreaming up wars for young men to die in.
~George McGovern

The statesman who yields to war fever…is no longer the master of policy but the slave of unforeseeable and uncontrollable events.
~Sir Winston Churchill

The urge to save humanity is almost always a false front for the urge to rule.
~H.L. Mencken

..Violence as a way of gaining power…is being camouflaged under the guise of tradition, national honor [and] national security…
~Alfred Adler

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More quotes to ponder for a weekend to remember those who’ve given their lives in war.

A lasting order cannot be established by bayonets.
~Ludwig von Mises

Setting a good example is a far better way to spread ideals than through force of arms.
~Congressman Ron Paul

War is the gambling table of governments, and citizens the dupes of the game.
~Thomas Paine

History teaches that war begins when governments believe the price of aggression is cheap.
~Ronald Reagan

Most wars are started by well-fed people with time on their hands to dream up half-baked ideologies or grandiose ambitions, and to nurse real or imagined grievances.
~Thomas Sowell

We must not confuse dissent with disloyalty. When the loyal opposition dies, I think the soul of America dies with it.
~Edward R. Murrow

The cry has been that when war is declared, all opposition should be hushed. A sentiment more unworthy of a free country could hardly be propagated.
~William Ellery Channing

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Is academia biased towards proving man made global warming AND government ordained solutions? This is something worth considering. We’ve certainly heard a lot about the scientist that received some funding from Exxon as spouting lies for Exxon because they pay him to do so, but should grants being handed out — OR NOT — based on if the research sets out with the purpose of justifying one side or the other without clearly looking at counter-evidence be under similar scrutiny? Just because it comes through academia does not mean that it does not have a funding bias.

• Global Warming: The Origin and Nature of the Alleged Scientific Consensus
• Lobbying & Law - Cold Cash and Global-Warming Research
• Climate of Fear: Global-warming alarmists intimidate dissenting scientists into silence.

Now, while what’s good for the goose is good for the gander, we’re not fans of discrediting an argument simply based on funding sources along. Either the evidence holds up or it does not. However, we should be aware that one side or the other will clearly appear to be the correct side if 95% of funding goes to supporting the specific outcome — simply because the massive lopsided volume alone will give it an appearance of overwhelming academic support.

When we are told 95% of scientists think global warming is man made and the government needs to act now, perhaps we ought to weigh that 95% figure more carefully? Moreover, it should be noted that a counter poll suggested the numbers are closer to 1) 40% agree man’s the problem and the state is the solution, 40% 2) think man’s a contributor among a host of others, but not enough evidence suggests a prudent government forced solution given the lack of evidence, and 3) 20% who don’t buy it’s man’s fault.

In our lead off post about global warming, we presented our concerns about those who stand to gain financially and politically by hopping on the global warming bandwagon — especially anything that involves giving more power to government to regulate and doll out mandates and spending to “solve the problem.” The problem is that many with ulterior motives are a strong part of the lobby for “the government’s gotta do something to stop it before we all die” side. Big business interests with solutions to manufactured problems are nothing new, as are big business interests with theoretical solutions to problems that could be solved by the free market without government. Then there are the one-worlders and socialists who like every ounce of liberty, freedom and wealth to be dolled out by central planners who know better than us all. Many of both groups actually believe in the idea of the “noble lie” (ala Plato & Strauss) to justify their higher order objectives since they believe most commoners are too dumb to understand the world, hence it is up to the self-anointed types to tell us lies for our own good.

At any rate, with a multitude of special interests — the Exxon’s of the world included — don’t buy either side without knowing whose interests are what and getting a better understanding of the big picture.

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NOTE: In the past we’ve been accused of presenting only one side of this debate — that we show only those who don’t buy global warming. This is true, but that’s because 99% of the rest of the media is showing the other side. See our opening on the subject for more behind why we’re continuing with this series. We don’t recommend taking one side or the other without personally looking into both sides. Accepting the pro or anti side at their word is dangerous.

Some Quotes when thinking about the dead of war and U.S. policy.

America does not go abroad in search of monsters to destroy. She is the well-wisher to the freedom and independence of all.
~John Quincy Adams

Always there has been some terrible evil at home or some monstrous foreign power that was going to gobble us up if we did not blindly rally behind it.
~General Douglas MacArthur

The most successful war seldom pays for its losses.
~Thomas Jefferson

It is our true policy to steer clear of entangling alliances with any portion of the foreign world.
~George Washington

Commerce with all nations, alliance with none, should be our motto.
~Thomas Jefferson

There never was a good war or a bad peace.
~Benjamin Franklin

I believe in only one thing: liberty; but I do not believe in liberty enough to want to force it upon anyone.
~H. L. Mencken

Guard against the impostures of pretended patriotism.
~George Washington

If Tyranny and Oppression come to this land, it will be in the guise of fighting a foreign enemy.
~James Madison

U.S. Existing Home Sales Drop to Lowest in Four Years [Bloomberg]

Sales of previously owned homes in the U.S. unexpectedly fell in April to the lowest level in almost four years, dimming prospects for a quick recovery in the housing industry.

Purchases fell 2.6 percent to an annual rate of 5.99 million last month from 6.15 million in March, the National Association of Realtors said today in Washington. A measure of the supply of homes for sale rose to the highest since August 1992.

The decline comes a day after a government report showed sales of new homes surged as buyers took advantage of a slide in prices. Today’s figures suggest that owners of existing homes may have to cut prices further during the prime spring selling season. The drop also reflects the impact of banks making it tougher to get subprime loans, a response to rising defaults.

Big drop in home prices predicted: Some economists see steeper drop in store for home prices. [CNN Money]

Most industry watchers agree that home prices will continue to slide before they recover, but now some economists say they’ve got a long way to fall before bouncing back.

David Wyss, chief economist at Standard & Poors, has forecast a price drop of about 8 percent for the 24-month period through the fourth quarter of 2008. Housing prices will suffer from a “significant increase in defaults and foreclosures,” he said, with affordability still a major issue. Wyss worried how hard the slump will hit already highly inflated housing markets.

Sales of Existing Homes Fall to Slowest Pace in Nearly 4 Years

The National Association of Realtors reported Friday that sales of existing homes dropped by 2.6 percent last month to a seasonally adjusted annual rate of 5.99 million units, the slowest sales pace in nearly four years.

Mortgage industry reloads as subprime misery lingers

Angelo Mozilo, the butcher’s son who built Countrywide Financial Corp. into the largest mortgage lender in the United States, was in no mood for soul-searching over the subprime home crisis.

The total outstanding value of all derivatives contracts — the eye-glazing instruments Warren Buffett labeled as time bombs and “weapons of mass financial destruction” that are arranged in private deals around the world has now surged above $400,000bn for the first time, that according to new estimates from the Bank for International Settlements.

Its often said that nobody really can quantify how much risk is being covered by derivatives, and more importantly, if that risk is being properly valued. The second issue carries with it many implications in a leveraged up world that we live in.

Are we overstating the situation? Consider this account:

A few years ago, I got a phone call from an official at the Office of the Comptroller of the Currency (the OCC).

“We’re doing a major study on derivatives,” he said. “And I’m having a hard time finding any meaningful data on them. But we’ve seen your work on the subject and we’d like to know what your source is.”

For a moment, I was perplexed. Then I laughed. “Our source? That’s funny. Our source is the OCC - your office. In fact, just the other day, I called your office to try to find out more about YOUR sources.”

That was from a few years ago, and the OCC is spruced up on derivatives since then. But still, because derivatives are primarily private agreements that trade OTC (over the counter) vs. on an exchange, the real derivatives situation is somewhat a mystery. Most are marked to market without actually being bought or sold. With nearly 90% of all contracts tied to interest rates and over 90% held by the top 25 banks, well — a mispricing of said risk could lead to problems that Warren Buffet cautions us about.

Insight: A stretched credit cycle, a more savage downturn. (Financial Times)

High finance has never been more sophisticated. Bankers have never been more clever. Yet in the US subprime lending boom, banks fell over themselves to advance 100 per cent loan-to-value mortgages to out-of-pocket deadbeats. According to industry folklore, even an insolvent arsonist was given accommodation.

Lending standards to private equity are collapsing just as risks rise and returns are being competed away. “Cov-lite” loans are the order of the day, meaning that restrictions on a borrower’s interest cover and balance sheet leverage cease to apply.

The alchemists of finance (Economist)

AT LEAST since 1823, when Byron’s Don Juan described “Jew Rothschild, and his fellow Christian Baring” as the “true Lords of Europe”, investment bankers have inspired awe, envy and, rightly or wrongly, a measure of disdain. Exactly 100 years ago the undisputed patriarch of the modern industry, J. Pierpont Morgan, stemmed the Panic of 1907, a financial crisis caused by unregulated trusts (the hedge funds of their day). Acting, in effect, as lender of last resort from his Wall Street office, he was briefly feted before Americans realised the danger of having such power vested in one man. Cartoonists then mercilessly mocked him. After his death in 1913 the Federal Reserve was set up.

How S&P put the triple A into CPDO (Financial Times)

Last summer a team of financial whizzkids at ABN Amro, the investment bank, developed a new debt product that has since taken the markets by storm. Using complex mathematics, the designers had wanted to create an instrument that would pay the same high interest rate as a “junk” bond but be as free from risk as a bank deposit.

The effect of collateralised debt should not be underplayed (Financial Times)

Once upon a time, it was presumed that the actions of central bankers controlled behaviour in the risky lending world. For if central banks jacked up rates, the argument went, the cost of borrowing would rise - making it harder for highly leveraged groups, such as buy-out funds, to snap up deals.

Now, however, this argument is looking a touch quaint. In the last couple of years, Western central banks have indeed been raising rates. Meanwhile, investors have had to contend with minor matters such as surging oil prices, Middle East turmoil, and now subprime woes. Yet, the credit party has continued, seemingly oblivious - triggering a buy-out frenzy.

So could anything else take the punchbowl away?

Stocks Can’t Fall? Check Out REITs’ Retreat (The Street.com)

In late 2006, Sam Zell made history by selling his prized Equity Office Properties to The Blackstone Group. Investors saw this transaction as confirmation of value. By contrast, I viewed the sale by the “smartest man in the room” as a cautionary sign.

LBOs Attack Finance Company Bondholders; SLM Unravels (Bloomberg)

Bondholders were ambushed by last month’s $25 billion takeover of SLM Corp., the student loan company known as Sallie Mae. They had assumed that companies whose profits depend on investment-grade credit ratings couldn’t afford to pile on debt.

In order to prevent its currency from sliding with the dollar, Kuwait has made the move away from the dollar and to a “basket of currencies” as its peg for targeting its currency’s purchasing parity.

This is a game played my many minor currencies in the Breton Woods I and II eras, where central banks deliberately inflate or contract (mostly inflate these days) their currency to maintain a specific trading ratio between their own currency and the dollar. With the dollar having lost substantial ground since 2000, more countries are weighing the pros and cons of pegging the dollar vs. a broader basket of major currencies, and, as part of the process, often retaining many dollars as a reserve currency.

It should also raise questions about the dollar’s future if this trend gains momentum, especially in context of the U.S. dependency on foreign central banks for both dollar strength and its current environment of pleasantly low interest rates. The later is crucial given the servicing costs associated with the massive amount of debt that both private and governmental sectors in the U.S. have accumulated over the last two decades.

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As a gloom sets over the housing market, with the Spring season turning into the dud we expected it would, the only question outstanding is how far into the decline are we? From informed folks (vs. perma-bears) in our camp, we’ve heard anywhere from one-third to one-half way through. We lean somewhere in between.

New-home sales are expected to fall 0.1% to 857 million units in April. New-home sales fell 2.6% in the previous month and are down 23.5% compared with March 2006.

Existing-home sales are expected to only inch higher by 0.5% to 6.15 million units in April, after a sharp 8.4% decline in March — the biggest decline in 18 years.

As for prices, even the NAR is now saying they expect the first negative median price for existing homes since the Great Depression.

If you’re interested in getting a better understanding of why this is not your typical housing slowdown, read up a bit here.

Numbers on new-home sales will be released Thursday at 10 a.m. Eastern, while existing-home sales data will come out at 10 a.m. Friday.

China will invest $3 billion of its $ 1.2 trillion in reserves into the U.S. buyout-fund firm, Blackstone.

Stephen Schwarzman, Blackstone’s chief executive, called this all a “historic event that changes the paradigm in global capital flows”. You bet it does. This historic announcement is important on several fronts:

• Is this the start of the long awaited change where Bejing backs-off its torrid pace of “vendor finance” dollar accumulations, which have provided key support to the dollar and have enabled the depressed U.S. interest rate environment?
• Will this start a trend of central banks publicly entering the capital markets in order to diversify reserves? While it will certainly please the private equity dealmakers to play with more central bank liquidity, will it lead to the further politicization of asset pricing?

So far the IMF seems to think the first issue is a non-starter. Says Forbes:

Speaking at a press conference on the sidelines of a meeting of finance ministers from the Group of Eight leading industrialized nations, Rodrigo De Rato said he was not concerned about the impact China’s move could have on the U.S. dollar and U.S. Treasury bonds.

“It’s rational that emerging economies who have very high levels of reserves diversify their investments,” Rato said. “It has happened in other cases, and I don’t think we should consider that as extraordinary.”

“May you live in interesting times,” indeed.

As the equity markets continue to launch through the stratosphere — we have to step back and marvel. Friday’s Dow closed at 13,556 – posting gains for the seventh week in a row. (Heck, another 400 points or so and the Dow will again reach its inflation adjusted high from 2000)! Fueled by buyout fever, stock markets climb ever upward — and it appears no news is capable of changing their trajectory. Not record levels of debt, record budget deficits, massive trade deficits, negative personal savings rates, a bursting housing bubble, sub-prime mortgage woes, rising real inflation, slowing consumer spending, rising consumer credit, rising energy prices, a slowing economy, weakening dollar, and to quote Yul Brynner from “The King and I” “Etc., Etc., Etc.!”

Is this all madness? It depends on your definition of the word. In our opinion the answer is no. There is a logical and easily understandable explanation. It’s simply massive amounts of liquidity (much of it leverage/debt) being injected into the financial (and other markets). The reason the Dow sits at 13,556 and housing prices skyrocketed until recently — is also why gas, oil, and basically everything else is becoming so expensive. Simply put, if we were all playing Monopoly and decided to inject massive liquidity into the game – the price of Park Place and everything else on the board would soon skyrocket. It would not surprise us to see the markets continue their upward march. 20,000 Dow? Who knows! If the Dow does hit such a level, don’t be surprised to also see a $40 Pizza, $5 Cup of Coffee and $12 Beer.

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“It is time to attack the myth of global warming,” says meteorologist Augie Auer. “We’re all going to survive this. It’s all going to be a joke in five years…”

From New Zealand’s Times Herald:

Water vapour was responsible for 95 per cent of the greenhouse effect, an effect which was vital to keep the world warm, he explained.

“If we didn’t have the greenhouse effect the planet would be at minus 18 deg C but because we do have the greenhouse effect it is plus 15 deg C, all the time.” Continue Reading »

In his book “The Bull Hunter: Tracking Today’s Hottest Investments Daniel Denning points out that no matter what goes no in the U.S. economy, a great money migration is happening shifting the global economy from The West to the Eastern emerging nations such as China, India, Malasia, etc. The chart below from Bill Gross’ most recent Investment Outlook over at PIMCO tells the story:

We’ll be discussing on today’s show the effects of money supply increases and how the U.S. exportation of dollars via the massive trade deficit has carried with it the seeds of massive competition creation in the emerging markets. Freshly minted money gets its purchasing power only one way, and that is by absconding with it from existing dollar holders. Is it only U.S. citizens being pilfered to assist emerging markets? Absolutely not. Yet the fundamentals of money supply and credit expansions should be understood for not just their seen benefits espoused by modern economists, but also their unseen costs and the economic problems they create that are often misdiagnosed.