Vigilant Investor

“The Federal Reserve as other central banks is obviously taking onto its balance sheet a lot of mortgages these days.” “Well, the creators of the Federal Reserve system would be rolling over in their graves if they knew the Federal Reserve is buying mortgages.”
– Former Federal Reserve Chariman Paul Volcker

Whether or not the creators of the Fed would be rolling over in their graves is debatable in our opinion. Like Andrew Jackson — we believe central bankers have always been dangerous, incompetent meddlers. We feel the Fed should never have been created — and and that it continues to prove itself as bungling as any other central planning committee. But we digress…. That said, the former chairman’s grave concern over the central bank taking on billions of not so hot private debt is quite valid.

Volcker went on to warn that recent intervention by the Fed in securities markets might compromise it’s independence. He went on to say that the Fed’s inability to contain inflation will create a 1970’s like scenario. Again, he’s right there. We’ll also add, it’s too late Paul — the nationalization of the US private debt has begun. When politicians, who’s outlook is only as far as the next election — get involved, the trend will only accelerate. So to will corresponding inflation and Dollar degradation.

Beyond the blatant example of the Fed’s $30 Billion bailout of Bear Stearns — we now see Senator Christopher Dodd proposing the creation of an FHA program to insure refinanced mortgages following partial forgiveness of the loans by lenders. OK, let’s think about this. In an environment where U.S. foreclosures have risen 65% over the past year — and private banks/lenders are preferring to seize homes rather than renegotiate with already defaulting borrowers — the Federal Government is going to step in with money it does not have (but will be all to happy to print) — to back already bad debt.

Also, earlier this month, the Fed agreed to accept securities backed by student loans pledged as collateral for Treasuries the central bank would in turn lend to Wall Street Investment Banks. Let’s analyze that deal. Investors had become far less willing to finance student loan debt at pre-existing prices — due to liquidity issues, the economy, and the fact that consumers (including students) are hurting — and are therefore higher credit risks. The cost to finance such loans would have to naturally go up. Wall Street investment banks (you know, the ones who paid themselves billions in record bonuses over the past year) were less willing to hold onto securities they owned backed by this type of debt. However, if they tried to sell it — they would sell it for a loss. No worry, the Fed would lend/swap them Treasuries for the riskier (and worth far less) student loan backed securities.

Effectively, you have the government, or quasi government institutions backing substandard debt with money it will have to print. That spells one thing — accelerating inflation — and the always accompanying confiscation of private savings. And we’re not talking the low single digit inflation figure the government “calculates” (and bases Social Security payment increases on). We’re talking about the inflation you see in the supermarket ($4 for a handful of blueberries anybody?) — and at the gas pump.

When we hear the Treasury Secretary, or the Chairman of the Fed talk tough on inflation and defending the Dollar — we just smile. When we hear political candidates blaming oil companies and “speculators” for rising prices — we smile again.

We think the next 3-5 years will be quite interesting.

Regulators “are playing with fire,” said Allan Meltzer, a Fed historian and economics professor at Carnegie Mellon University in Pittsburgh. “With good luck, none of these liabilities will come due. We can’t expect that good luck, and we haven’t had it.”
– Bloomberg (March 26, 2008)

The reason you want solid collateral to secure a loan is obvious. You want to protect adequately against the borrower’s potential inability to pay you the loan back. How interesting that the Fed is taking 30 $ Billion of illiquid mortgage securities as collateral from otherwise insolvent Bear Stearns to bail the Wall Street firm out. As intriguing (alarming) — is the Treasury’s encouragement of Fannie Mae and Freddie Mac to buy more mortgage-backed bonds.

We ask — who in their right mind would lend out their own money backed by such risky collateral? Who today would buy mortgage backed bonds with their own money?

Ah, there lies the rub! It’s not their money which backs these shenanigans – it yours!

We’ve continually warned about the bailout addicted U.S. Another voice of clarity and reason all along has been Bill Fleckenstein. As usual, he nails it in his latest commentary, “Catering to the Bailout Nation.” BTW, Bill’s recently released book Greenspan’s Bubbles: The Age of Ignorance at the Federal Reserve – is definitely worth a read! We wonder — has anyone ever been un-knighted? Can they do that?

Any reasonable person knows that bailouts beget more (and larger) bailouts. Like a drunk having another drink, it’s just going to make the hangover (and resulting inflation) even worse.

Also, ask yourself this one – why are big Wall Street banks getting bailed out (with taxpayer money) – when the 5 largest recently paid themselves 39 $Billion in bonuses?

Think long and hard about the answer to that one – because you are paying for it – in overt taxes, and the great hidden tax – accelerating real inflation.

With today’s 75 basis point rate cut – we see continued evidence as to whom the Fed really serves. As we have long said, it’s not you and I – it’s the Big Wall Street Banks. The “Big Rip-Off” of your savings continues. Jon Markman gets right down to it…

In today’s New York Times, Ben Stein writes an article pointing out that Goldman Sachs has sold $ billions in Collateralized Mortgage Obligations (C.M.O.’s) — including during a period where current Treasury Secretary Hank Paulson led the firm. In his piece, Mr. Stein also mentions that while Goldman was selling C.M.O.’s – it was also shorting them through index sales.

We don’t agree with Mr. Stein’s belief that the Fed will be able to save the lending day with injections of liquidity – because (among other reasons) we believe the resulting inflation will be painful and destructive. Also, after raising the “Spock Eyebrow” over the nexus between Treasury and one major investment bank – perhaps he should cast the same discerning gaze towards the Fed and it’s true loyalties.

That said, his article certainly poses quite interesting and intelligent questions — which should make any rational person think long and hard. An interesting read, indeed!

Today we learn that the Fed has again made another temporary liquidity injection to qualify as the largest since the times around 9/11 in order to provide grease for the still shrinking U.S. commercial paper market. The amount, $47.25 billion, was to defend the federal funds target of 4.50% that had traded as high as 4.81% earlier in the day — and was largely attributed to $40.5 billion of rollovers in “maturing operations.”

Now, if you’re like most folks, much of what that means — well, it may as well be in Greek. Moreover, what lies beneath the surface is opaque and functionally down the rabbit hole that even pros have a hard time making sense of what actually has been going on. After all, is that not largely what we can deduce from the lock-up of the credit markets?

Some might suggest FAS 157 — the new accounting rule that makes it harder for banks to hide market values of hard to value securities through mark to model valuations — might be a little painful, but will also finally restore some clarity to the system. We encourage readers to catch up on the changes: No doubt it will provide clarity, although we believe the recent large write-offs from major players are only the tip of the iceberg on institutions coming clean.

Now, while the difference between what FAS 157s Level 1, 2, and 3 assets actually mean in real terms is still quite Greek (and yet to be valued), we can’t help but remind readers that the fundamental problem of this highly public fiasco that started in the mortgage back securities markets really are a distraction from the actual problem that will eventually be exposed. Continue Reading »

Our long–term readers know we have continually cautioned about serious economic consequences to come. Not because we’re “doom and gloomers” – but because we feel the best way to take advantage of the truth – is to first acknowledge it. Our opinion has been that when these truths gain increasing acceptance – the full brunt of their effect will soon to be felt. While those in the mainstream conventional camp have long been in denial over unpleasant, troublesome, displeasing economic facts (i.e. the truth) – things are beginning to change.

In today’s New York Times, Bob Herbert writes an “on the money” op-ed titled, “Recession? What Recession?” In it he describes increasingly looming economic eventualities we have long warned about – and he does not sound optimistic – at all.

We feel the consequences of unhealthy, dysfunctional economic policies will, for the uninformed – and those in stubborn denial – have sadly devastating effects. One being their savings & purchasing power inflated into oblivion. However, for those who acknowledge the truth – and act appropriately — this is a time of incredible opportunity.

The window is closing. The boat is pulling away. There is still time. Are you prepared?

Well, we’ve warned about what’s now going down for a long time. The other shoe is dropping right through the floor — and it’s a Clodhopper!

Just this week we’ve learned from the National Association of Realtors that the number of Americans signing up to buy previously owned homes in August dropped 6.5 percent from July. Over the past year, pending home sales are down over 20%. We also learn from Moody’s that the most recently created (2007) sub-prime mortgage backed bonds contain loans growing delinquent at literally a record pace. But wait — the reckless, loose money caused fiasco is hardly contained to the U.S! Moody’s also reports that loan delinquencies in Spain could grow 15 times by the close of 2008!

We’ve said it before, and we’ll say it again. You can’t borrow your way to prosperity. There is a yin to every yang. What goes up must come down. Every action has an equivalent reaction.

As things become critical in an era where the “pundits” seem to make everything so illogically complicated — we encourage you to find consultants who believe they understand the basic laws of financial physics.

As we write, Asian indexes are rising on the Fed’s half percent cut in the discount rate, and pundits are touting the move as saving global markets. We say – “Please!” We also ask the simple question, “What’s fundamentally really changed?” (Hint – “Nothing)!

The sub-prime fiasco is far from resolved. In September, an estimated $60 Billion of adjustable mortgages begin to re-set through next year. Because the riskiest lending practices took place during the final years of the real estate bubble – and thus the shakiest mortgage loans are soon going to cost borrowers more to pay off — there has to be a lot of breath holding taking place on Wall Street and in the credit markets. In other words — we would not be surprised to see a dramatic increase in defaults which, could make current problems with mortgage-backed bonds look minor. The subsequent required bailout could make that performed by central banks over the past few weeks – seem miniscule in comparison. All of this has nothing other than inflationary implications.

If you really boil it down to it’s simplest – central banks – Fed included – are giving institutions a place to get rid of their garbage. Only a central bank (certainly not a private one) would offer loans AT A DISCOUNT for collateral of highly questionable quality (of course with money created out of thin air)! Well, not exactly folks. That money is being taken from your hard earned savings. Yep — as the monetary system is flooded with newly created money designed to bail out reckless lending, banking, and Wall Street business practices – your hard earned savings (and purchasing power) is diluted commensurately. In other words – you are paying for this. And you are going to keep paying.

All along we’ve been cautioning that continual injections of liquidity – whether through cheap credit, increased government borrowing, or central bank bailouts will have inflationary ramifications. We’ve also said that the Fed is between a rock and a hard place. If they try to fight inflation by keeping rates higher (or raising them) – the credit dependant, consumer based U.S. economy could go over the cliff. If rates are lowered to re-stimulate (or bail out credit markets) – the Dollar will be sacrificed. Based on the last few weeks, the latter has begun.

More than a few traders these days know of a routine where very loud trades enter the market in the final half hour to drive the closing price above comfortable technical thresholds, whatever they may be. From a technical trading perspective, when those support levels are broached, a recalculation of lower expectations takes place, and corresponding sell trades are made to either mitigate potential losses or capture the downside momentum. Noisy trades seem quite contrary to the whole idea of buying as low as possible by slowly easing into the market and buying at lows before everyone else catches on, thus leading to suspicions about who is behind the clumsy buying power at crucial times?

Above we have the Dow and note the 200 day moving average in green — which some say is a crucial support point for a Friday’s close. Yesterday’s surprise late day move and today’s jump out of the gate certainly left many wondering about the sudden change in attitude. Enter suspicions that the President’s Working Group on Financial Markets (a.k.a. The Plunge Protection Team) is hard at work supporting such levels in order to keep the market from “irrationally” selling itself into the abyss. At least that’s the theory behind the creation in 1988 of this low profile U.S. Treasury related department — in the wake of the 1987, 40% plunge, to provide vital support during irrational events.

A battle raging for the Dow’s 200 day simple average?  Some say a close below that mark for any week will be a bad omen for equities.

You make the call. In the meantime, feel free to peruse our past articles on the secretive Plunge Protection Team.

“In a weak world, they (hedge funds) pay the price of all the risk they’ve taken. And that is, they melt down.”

– Jeremy Grantham

Last week was an interesting one to say the least.

G.M, Ford, Daimler-Chrysler, Toyota, and Honda all reported declines in sales from a year earlier. The above quoted and highly respected Jeremy Grantham pronounced that half of all hedge funds might be forced to shut down in the next 5 years due to credit market turmoil. Friday’s drop in the Dow of 281 points (-2.09%) and 39 points (-2.66%) in the S&P provided the final exclamation point. Although, if Grantham’s forecast is correct – last week’s stock market decline could be minor in comparison to future losses.

As our regular readers know, we have continually cautioned that a credit-based economy and highly leveraged financial markets can’t continue on forever. That, in the end, debts will have to be paid and savings restored — as sure as chickens come home to roost. Now, it seems that we may be entering the beginning of the great recalibration. At the same time, we don’t think this natural turn of events will take place without artificial intervention in an attempt to prevent it. While the Fed talks of inflation being it’s primary concern – it seems to be increasingly interested in the slowing economy, along with the struggling financial markets. If the bad news continues, we’d not be surprised to see the Fed lower rates – resulting in the Dollar plummeting further. We’d also not be surprised to see the bailout game played once again, as certain financial institutions are deemed to be too valuable and important to fail. These rescues, as they always are (wink, wink) – would of course be in the best interests of the common man. And as always, such bailouts are made with money not currently in existence – which of course is inflationary. And inflation causes prices to go up – and hard earned savings to disappear.

Some are calling for a complete market dislocation. We think that day may well come (timing uncertain) — but, we don’t expect the Fed to give up the ship without a fight. Interest rate cuts could well save the day (for the time being) – even driving the stock market to new highs (numerically) for a while. Such rate cuts — resulting in even more credit being injected into the economy — would, of course, be inflationary. They would also make the long-term problem even worse, and the ultimate recalibration even more painful.

As we seem to say with increasing regularity and foresight – this week will be interesting.

Stay tuned.

Earlier this year, we kept hearing mainstream pundits (typically those with a vested interest in the areas they commentated on doing well) tell us that the housing slump had “hit bottom” — and the sub-prime mortgage fiasco was under control. Well – each day proves them increasingly wrong. As we have continually cautioned, people are almost always bullish on what they are selling. For this reason we have been highly skeptical about realtor association & homebuilder commentary stating that we have seen the worst in the housing sector. Commentary by financial “experts”, analysts, and the Chairman of the Fed stating that the “sub-prime contagion” has been contained cause us to raise the “Spock Eyebrow” and say, “oh really?”

Every ball thrown in the air falls the same distance back to earth. Every return trip is the same distance as that initially traveled. Every bubble deflates to its beginning size. Highly leveraged, overly risky (invested in predominantly sub-prime mortgage backed bonds) hedge funds go bust.

Thus, we agree with the more astutely objective such as Jim Rodgers – who in an interview with Bloomberg today stated that the correction in homebuilders and U.S. investment banks has a long way to go.

The beat goes on.

While most of the nation was catching up on American Idol or attending a viewing of the summer movie season’s first blockbuster, Spider-Man 3, the investor faithful had their annual pilgrimage to hear the Oracle of Omaha once again. Asked about the sub-prime mortgage meltdown at the Berkshire Hathaway annual meeting this past weekend, Warren Buffett couldn’t have described the housing bubble mentality better: “I think that’s dumb lending and it’s dumb borrowing.” To that, we’d add “enabled by excessively dumb credit / money supply expansion.”

Buffett also struck a chord with us by suggesting that the sub-prime fiasco is a problem for the companies involved. We take that to mean “no bailout for the aforementioned partnership of Dumb & Dumb.”

However, we won’t hold our breath on that. In the past, any time Wall Street looks to be holding the bag on big losses on risky deals gone sour (usually after already earning really big profits on the same deals precisely because they were risky), usually the cry goes out that the economy will be irreversibly dragged down. In the case of sub-primes, many of the the victimolgists in Congress are already calling for bailouts of the sub-prime borrowers who were given sufficient rope to hang themselves in a noose of debt. Traditionally bailouts come from taxpayers and dollar holders in the form of government contributions to the problem, as well as in the form of a further deflated currency as the banking system simply papers over the problem with freshly minted dollars.

Buffett still thinks the sub-prime mess will remained contained, but we’re not so confident. Housing is still shifting gears downward slowly — as is the nature of any housing downturn. But as Buffett himself once observed, you don’t know who is swimming naked until the tide goes out — and the tide is just started heading outward on housing related effects on the economy. As it recedes, more and more credit bubble induced nakedness (bad business decisions, economic dislocations, inflationary pressures, etc.) is going to be seen if you know their relationships. Those relationships give an advanced look at the dangers and opportunities ahead.

Buffett also criticized hedge fund managers, who he called an “electronic herd” rapidly moving in an out of assets in a “fools game.” Of the current (over)confidence in continued comfortable economic conditions and unprecedented profit growth, Buffett issued a warning. “Corporate America is living in the best of all worlds, and history has shown that those conditions don’t persist indefinitely.”

Such should be expected from the inevitable fiction that is long-term money supply / credit expansion induced economic “growth.”

“Everything moves in cycles, so twice a century the ocean lets us know just how small we really are. A storm comes out of Antarctica, tearing up the Pacific, and it sends a huge swell north 2,000 miles. And when it hits Bells Beach it’ll turn into the biggest surf this planet has ever seen, and I will be there.”

–Bodhi (Patrick Swayze) in Point Break

Yeah, Bodhi dude — you were there, just a little too long.

Checking the latest economic headlines, we see news such as sales of previously owned homes in the U.S. retreating to the lowest levels since 2003; consumer confidence dropping; the U.S. economy expanding at the slowest pace in 4 years; the Dollar plummeting to an all-time low against the Euro; sub-prime bondholders potentially losing $75 billion; homebuilder confidence dropping as profits slide; first quarter foreclosures doubling from one year prior; a weaker economy as inflation picks up, etc., etc.

And therefore, quite logically – stocks continue to rise, with the Dow closing above 13,000 for the first time ever!

An objective observer would have to ask, “Are the financial markets going nuts?!” The rational answer would seem to be “yes” – and we’d be the first to tell you that markets cannot continue to go through the roof forever in the face of lousy economic news. However, there is a logical reason for all of this. You have to keep reminding yourself of one thing — that you are witnessing the powerful pricing effect of record levels of liquidity on everything, including the current financial markets. It’s nothing new. The stock bubble of the 1990’s, and the subsequent real estate bubble over the past several years were beneficiaries of the same massively expanding money supply. During the current market run-up, equities continue to surf the same liquidity wave. And right now, nobody is complaining

Continue Reading »

When you consider how much sub-prime and Alt-A borrowers contributed to the demand for housing over the last few years, and then consider how many borrowers (not just the aforementioned) used gimmicky mortgages to buy their homes with hopes that continued price rises would justify the precarious nature, well… you understand that housing is just seeing the tip of the iceberg when it comes to the decline.

Just a few weeks ago analysts were celebrating the news that March’s housing start numbers came out better than expected vs. February by being positive vs. negative. Of course, bubblevision (MSNBC, etc.) reported that this lofted the equity markets higher, never mind that the year over year numbers from March 2006 were simply abysmal.

All that aside, today’s news that Existing home sales plunged 8.4% vs. February — the biggest plunge since 1989– does not come as a surprise. Rather, get familiar with that sort of refrain since the contagion consensus analysts say will be confined to the sub-prime market is only now merging upstream into other markets. With sub-prime and Alt-A borrowers finding it harder to find funding, and with each representing about 20% of all mortgages in 2006…. well, that totals 40% of housing demand drying up in a matter of months. (Granted, not all mortgages were for new homes — some were refi’s, but the overwhelming majority were.)

Likewise, the steep decline had another horseman riding alongside: It was the eight straight monthly fall in median home prices, which is the LONGEST SUCH PERIOD OF FALLING PRICES ON RECORD.

Contained? If you believe that, how about I sell you a certain bridge in NY?