Saint Joe and the impending global financial crisis
By Mike Whitney
Online Journal Contributing Writer
Dec 10, 2007, 00:46
The wreckage in the housing market just keeps piling up.
Sales of existing homes in October dipped 23.5 percent from last year. Prices
on new homes dropped 13 percent year over year. Third quarter foreclosures
skyrocketed to 635,000, a 94 percent increase over last October and an all-time
high on the misery-meter. The real estate market is in free-fall and the real
trouble hasn't even begun yet.
California, Nevada, Arizona and Florida are mired in a
full-blown housing depression. Inventory is off the chart. Presently, there's a
10.8-month backlog and the numbers are steadily rising. If foreclosures
continue at the current pace, by the end of 2008, there'll be a 14-month
inventory. That means that every builder in the country could drop his tool
belt right now and stop working FOR MORE THAN A YEAR before the market would
clear. Contractors would be filling out job applications at Red Lobster or, holding
a tin cup, looking for an empty street corner.
We're now entering the crisis phase of the biggest housing
bust in US history; Greenspan's remake of Three Mile Island; only this time the
whole country will be vaporized by a subprime-radioactive cloud.
As bad as the housing market is now; it's going to get a
whole lot worse. Judith Levy sums it up in her article �ARM Resets to Hit Fan
in 2008�: �In 2008 interest rates will be reset upward on $362 billion worth of
adjustable-rate subprime mortgages [ARMs]. . . . The 'real crest of the reset
wave' has yet to take place, which promises more pain for borrowers, lenders
and Wall Street. . . . In addition to the $362 billion of subprime ARMs, $152
billion of other adjustable-rate loans are scheduled to reset in 2008,
including jumbo mortgages and Alt-A loans. The Mortgage Bankers Association
estimates that 1.35 million homes will enter foreclosure in 2007 and another
1.44 million in 2008, up from 705,000 in 2005.�
$514 billion in resets; 3.5 million foreclosures.
Did I say Three Mile Island? I meant Nagasaki.
California is bound to be the state that's hardest hit by
the housing slump. Homeowners can expect to see price depreciation that could
rival the Great Depression. As Broderick Perkins says, �The California
Association of Realtors reported the median price of an existing,
single-family, detached home in California dropped 9.9 percent in October,
compared to the same month a year ago. The decline was the largest year-to-year
decline in CAR's history books. . . .
"We believe that a downturn is imminent, with sales
volumes down 52 percent from the peak (in January 2005) and inventory (11.8
months) up 100 percent since last year. House price depreciation and credit
deterioration go hand-in-hand. We anticipate residential mortgage credit
deterioration to follow house price declines in California. Presently, credit
quality (in absolute terms) is better in California versus the national
average, but the rate of deterioration is much worse. For instance, in the
second quarter of 2007 delinquency rates for prime ARMs and subprime ARMs rose
92 percent and 73 percent year-on-year respectively in California, versus 53
percent and 38 percent nationally," Goldman Sachs reported.� (Broderick
Perkins, �Record Home Price Declines Portend Extended Downturn,� Seeking Alpha)
Wow. Home prices dropped 10 percent in a MONTH! Inventory is
up 100 percent. Sales volumes are down 52 percent. It's the trifecta!
It's getting so hard to sell a house in California, that
people are resorting to divine intervention. A number of websites have popped
up on the Internet promoting transcendental or occult techniques for attracting
potential buyers. Luckymojo.com recommends an old favorite; �burying a statue
of Saint Joseph upside down in the yard.� The site even features its own �Real
Estate Spell Kit� which includes:
1 Dressed and Blessed Saint Joseph Candle
1 Statuette of Saint Joseph
1 Bottle Saint Joseph Oil
1 Saint Joseph Chromo Print
1 Saint Joseph Holy Card
Luckymojo even provides an optional prayer that can be
recited during the ceremonial burying of St. Joseph:
�Saint Joseph, I am going to place you
in a difficult position
with your head in darkness
and you will suffer as our Lord suffered,
until this [house/property] is sold.
Then, Saint Joseph, I swear
before the cross and God Almighty,
that I will redeem you
and you will receive my gratitude
and a place of honor in my home.
Following the prayer, the supplicant takes the statue of
Saint Joseph and plugs him into the ground upside down and waits for the phone
to start ringing. Who needs a Realtor anyway? �If there's no yard, then dig a
hole in a large potted plant.� St. Joe won't mind. All of this can be done
without chanting, amulets, prostrations, or messy sacrificial animals.
It's worth a shot.
But sorcery won't work for everyone and the deteriorating
housing market is sending tremors through the broader economy. In fact, the
accelerating rate of foreclosures has put Washington in full panic mode.
Treasury Secretary Henry Paulson has been frantically trying to put together a
bail out package that will keep millions of homeowners from losing their homes.
Here's Paulson's statement from earlier in the week: �As we are all aware, the
housing and mortgage markets are working through a period of turmoil, as are
other credit markets, as risk is being reassessed and re-priced. We expect that
this turbulence will take some time to work through, and we expect some penalty
on our short-term economic growth.
"To speed up the modification process, Treasury is
working through the �HOPE NOW� alliance with the American Securitization Forum
to convene servicers and investors so they can develop categories of borrowers
eligible for appropriate modifications and refinancings, and an industry-wide
solution . . . I am confident they will finalize these standards soon. And I
expect all servicers will implement them quickly, and create benchmarks to
measure their progress along the way. As a result, what was a fragmented,
cumbersome process can be a coordinated effort which more quickly helps able
Who does Paulson think he's kidding? He knows the plan is a
nonstarter. Why would homeowners opt to make outrageous monthly payments on
homes that are quickly losing value, when they can just park the keys on the
kitchen counter and vamoose? There's no incentive for them to be shackled to a
home if prices are going down. They'd be better off loading up the U-Haul,
grabbing the dog, and letting the bank worry about it. That's who Paulson is
really worried about anyway. �Helping the homeowner� is a red herring.
There are a number of glitches to Paulson's scheme. For
example, if he freezes monthly mortgage payments, then bondholders won't get
what they bargained for and the market for mortgage-backed securities (MBS)
will dry up. As Tom Deutsch, deputy executive director of the American
Securitization Forum, said, ``If they no longer invest in mortgage-backed
securities, you've cut off the credit available for refinancing, you cut off
the lifeblood of being able to give better loans.� (Bloomberg)
That's right. If investors don't get the returns they were
promised -- or if the government arbitrarily changes the terms of the
deal�bondholders will just take their money and put it somewhere else. It's as
simple as that. That would trigger a run on the MBS market and put the kibosh
on Paulson's plan.
One thing is certain, investors will not sit by quietly
while their rights are trampled and their profits are slashed so that people
can stay in their homes. That won't happen. Any viable bailout plan will have
to be evenhanded, so that everyone shoulders part of the burden. Besides, these
bonds are covered under contract law and the investors have rights. Paulson
seems to thinks he can just make up the rules as he goes along. But he's wrong.
If he tries to void or rewrite the contracts he'll be hit with class-action
lawsuits that will stop him in his tracks.
The best summary of Paulson's plan appeared in the Wall
�This whole scheme is an act of eminent domain, except the
government isn't formally seizing property rights, but emboldening private
parties to do so. Why is no one calling a spade a spade?�
It's ironic that the biggest boosters of free enterprise --
like Paulson -- are the first to do an about-face at the first whiff of
grapeshot. Whatever happened to principles? Does Paulson really want to promote
a scheme that forces the revision of contracts as well as repeals basic
property rights? Needless to say, Paulson's metamorphosis into Leon Trotsky has
not been warmly received on Wall Street where he has been lambasted by friend
and foe alike.
The housing blowup is having dire effects on global
financial markets. The credit crunch has spread throughout Europe where lending
standards are tightening and industrial growth is threatened by the falling
dollar. Consumer confidence has plummeted in Europe just like in the US. Two
weeks ago, the Dow Jones slipped below its August low of 12,850 following the
path of the Transports. The stock market continues to lurch back and forth
furiously like an overloaded washing machine; soaring 100 points one day and
then, plunging 200 the next. The volatility is just another indication that we
are entering a primary bear market. Dow Theory suggests that the trajectory
will continue downward into recession.
The subprime debacle has cast doubt on whether the
�structured finance� model of securitizing debt will survive. Last Monday,
there were crucial new developments in this story that will have profound
effects on the future of many of the country's largest investment banks.
E*Trade Financial has been forced to liquidate $3 billion of its
mortgage-backed securities. Up to now, the banks, hedge funds an other holders
of these toxic MBS and CDOs have been reluctant to sell, fearing that trillions
of dollars in asset value would be immediately wiped out (for similar
investments) once a firm �market price� is established.
Well, the Day of Reckoning arrived last Monday and the only
thing missing was the funereal dirge and the wreath of fresh lilies.
According to Reuters, �Financial analysts on Friday said
E*Trade got anywhere from 11 cents to 27 cents on the dollar for its $3.1
billion portfolio of asset-backed securities. The portfolio sale was part of a
$2.5 billion capital infusion from a group led by hedge fund Citadel investment
"The portfolio sale, one of the few observable trades
of such assets, has very clear, generally negative, implications for the
valuation of like assets on brokers' balance sheets," Credit Suisse
analyst Susan Roth Katzke said.�
Twenty-seven cents on the dollar! Yikes. No doubt they'll
soon be pulling a few weepy bankers off the ledge.
What is particularly distressing about the E*Trade sale is
that over 60 percent of the $3 billion portfolio �WERE RATED DOUBLE-A OR
HIGHER.� That means that even the best of these mortgage-backed bonds are pure,
unalloyed garbage. This is really the worst possible news for Wall Street. It
means that trillions of dollars of bonds which are currently held by banks,
insurance companies, retirement funds, foreign banks and hedge funds will be
slashed to 27-cents on the dollar OR LOWER. Banks will have to hoard reserves
to meet the new capital requirements on the falling value of their assets, which
means that they'll have less money to lend to businesses and consumers. In
fact, this is already taking place, which is the real reason the Fed keeps
injecting money into the banking system. The E*Trade �firesale� confirms that
the country -- and perhaps the world -- is now headed into a downward
deflationary spiral. The Fed will HAVE to cut interest rates 50 basis points on
December 11, just to keep the financial system from freezing up entirely. That
will, of course, further emasculate the dollar and send food and energy prices
through the roof.
There's really no way to overstate the importance of the
E*Trade sell-off. It is the equivalent of a neutron bomb detonating in the
heart of the financial district. Yes, everyone is still milling around with
their caramel Macchiatos, clutching their Blackberries just like before. But
the game is over. Trillions of dollars of market capitalization will be lost
and some of the biggest names in banking will be carted off to the boneyard. It
will be a miracle if the Fed's interest rate cuts are enough to keep the
economy sputtering along while the losses are written down and the country
recovers its footing.
Twenty-seven cents on the dollar should be inscribed on the
headstone of every Wall Street fraudster and every chiseling �financial
innovator� who transformed the world's most powerful and resilient markets into
a carnival sideshow. It should include every subprime �no doc -- no down�
homeowner who lied on his loan application to goose the system and get another
50 grand for a jet-ski and 42-inch plasma TV; every cheesy realtor who fudged
the paperwork to put unemployed busboys with bad credit in $550,000 McMansions
in Loma Verde; every ratings agency stooge who got carpal-tunnel from stamping
each shaky subprime loan with an AAA seal of approval; every lacquer-hair
banker in a two-toned shirt who bundled up garbage loans and dumped them on
Wall Street; every shabby hedge fund manager who used the subprime loans to
beef-up his own personal administrative fees by leveraging the MBSs and CDOs at
rates of 10 to 1; every regulator who serenely looked the other way while the
market was dousing itself with jet fuel and reaching for the matches; and, of
course -- above all -- the Federal Reserve, who initiated this whole boondoggle
by producing trillions of dollars of low interest credit which flooded the
system, creating the greatest speculative frenzy in history. P.T. Greenspan �
the Ponzi Ringleader -- deserves the place of honor at the head of the
charlatans' conga-line as they are frog-marched to some remote black site where
they can pay for their transgressions.
The rest of us will have to stay put and endure the fallout
from a �completely avoidable� Great Depression. We're dead ducks.
Managing Director of Pimco Managed Funds, Bill Gross,
summarized our present conundrum in a recent article: �What we are witnessing
is essentially the BREAKDOWN OF OUR MODERN DAY BANKING SYSTEM, a complex of
levered lending so hard to understand that Fed Chairman Ben Bernanke required a
face-to-face refresher course from hedge fund managers in mid-August. My PIMCO
colleague, Paul McCulley, has labeled it the "SHADOW BANKING SYSTEM"
because it has lain hidden for years -- untouched by regulation -- yet free to
magically and mystically create and then package subprime mortgages into a host
of three-letter conduits that only Wall Street wizards could explain.� (Bill
Gross, �The Shadow Knows,� Pimco Funds)
A few months ago, Gross's observations would have been
dismissed as the ravings of a doomsday nutcase. Not anymore. Now they are part
of the mainstream analysis. Gross is a realist. The financial markets are
broken. It's time to strap the patient to the gurney and wheel it in to I.C.U.
No more Band Aids, thank you. Time for major surgery.
The president of the St. Louis Fed, William Poole, discussed
many of these issues in a recent speech. Poole insisted that it is not the
Fed's intention to �pump up the stock market� or to protect investors from
losses by easing rates. Rather, the rate cuts are supposed �to restore normal
market processes. He said, � An active financial market is central to the
process of economic growth and it is that growth, not prices in financial
markets per se, that the Fed cares about.�
He added, �One of the most reliable and predictable features
of the Fed�s monetary policy is action to prevent systemic financial collapse.
If this regularity of policy is what is meant by the 'Fed put,' then so be it,
but the term seems to me to be extremely misleading. The Fed does not have the
desire or tools to prevent widespread losses in a particular sector but should
not sit by while a financial upset becomes a financial calamity affecting the
The Federal Reserve is now actively trying to forestall �a
systemic financial crisis� (Poole's words). The trillions of dollars that were
loaned to mortgage applicants -- which ignored traditional criteria for lending
-- have created the likelihood of a decades-long downturn in the housing industry,
as well as a meltdown in the broader financial markets. The bundling of dodgy
subprime liabilities and selling them as valuable assets to unsuspecting
investors; is a scam that any competent regulator should have spotted
immediately. It doesn't take genius to see that offloading sketchy MBSs and
�marked to model� CDOs to gullible institutions is wrong and a danger to the
Financial innovation has created a dilemma for which there
is no easy solution. The Genie cannot be put back in the lamp. Paulson's
remedies have no chance of succeeding. Mortgage-backed securities have been so
chopped up and spread throughout the system; it would be easier to unravel a
bowl of spaghetti, separate each strand, one by one, and lay them next to each
other without touching. It can't be done. The bad debts will have to be written
down, banks will have to fail, and government will have to investigate
affordable housing alternatives for millions of defaulting homeowners.
Deregulation has created a monster. The prevailing
Reagan-era �supply side,� free market doctrine has removed tariffs, subsidies
and other state-created price-distortions, but it has also eliminated all
oversight and accountability. Government agencies no longer play an active role
in policing the markets and, as a result, US financial institutions have fallen
This is, first of all, a credibility problem and it will
require leaders with a strong moral foundation, not evasive bureaucrats who're
looking for a painless way to �cut their losses� and keep the wheels of
industry clanking along. Asset-backed commercial paper -- a $2 trillion
business -- �is hardly trading at all.� The securitization of credit card debt,
mortgages and car loans has slowed to a crawl and is in danger of stopping
altogether. Many of the main engines for generating revenue for the banks --
the repackaging of debt and amplifying it through levered derivatives -- have
vanished overnight. The financial markets have never been under such stress.
There's so much mortgage-backed gunk in the plumbing, institutional lending has
been reduced to a dribble. This is no the time for �business as usual� �garbage
in, garbage out.� We need people who really understand what is going on to step
up to the plate and propose coherent �fiscal� policy options that will steer
the global economy away from the reef.
Forget about Paulson's �quick fix� snake oil. It's utter
bunkum. The credibility of the system is at stake. It's time to get serious.
Whitney lives in Washington state. He can be reached at email@example.com.
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