The Economy's Worst Is Still Ahead of Us

by: Ian Cooper

A year ago, Wall Street hotshots were living high on the hog, lying to and deceiving investors out of billions of dollars.

And now, they're getting what they deserve.

Lehman Brothers is out of business. Merrill was lynched. Bear Stearns is hibernating. Banks have folded. Jobs have been lost. Consumers have stopped spending. And the global community has suffered.

And now government officials and Wall Street are scrambling to fix what they began, throwing hundreds of billions of dollars at the very CEOs who contributed to the mess.

But who didn't see this coming?

Nouriel Roubini, a New York University professor who has emerged as a leading commentator during this financial crisis, predicted this would happen for years.

But no one listened.

Roubini tried to tell fellow economists at a September 2006 International Monetary Fund meeting that a crisis was coming... that a once in a lifetime tsunami would crush the U.S. economy, that consumers would stop spending, and that the country would face recession.

Still, no one listened.

Instead, the Street dismissed warnings that subprime mortgages would trigger a financial meltdown, as well as views that Fannie Mae and Freddie Mac would collapse, that investment banks would suffer, and that the global community was headed toward a long recession.

Even Hank Paulson, who in 2007 said "we're at or near bottom" for housing again... and again, ignored it.

And he's now eating those words, wasting billions trying to fix it.

Even "depression expert" Ben Bernanke dismissed subprime views:

We have spent a bit of time evaluating the financial implications of the subprime issues, tried to assess the magnitude of losses, and tried to determine how concentrated they are," said Bernanke in 2007. "There is a sense that, although there is always a possibility for some kind of disruption ... the financial system will absorb the losses from the subprime mortgage problems without serious problems." He also said he didn't expect the subprime problems to have significant spillover to the rest of the economy.

Still, I wasn't buying it, and wrote the following against Bernanke's and Paulson falsities in February 2007.

Truth be told, when it comes to an "improving" housing market, do yourself a big favor. Ignore the mainstream press, and Wall Street hot shots that would have you believing in a housing bottom, or the illusion of priced in lending weakness.

Among the worst hit lenders are the sub prime lenders, or those companies that make loans to borrowers with less than perfect or poor credit histories. While subprime lenders charged higher interest (two or three points higher than prime lenders) as insurance for the higher risk the borrower represented, rising foreclosures have left the sub-prime industry facing substantial fallout risks.

Subprime lenders could offer adjustable or teaser rates to those with bad credit. Loans like this made up 23% of the U.S. mortgage market in 2006 as compared to the 8% in 2001, according to Yahoo News. And it's now a big problem as one in five sub-prime mortgages are now ending in foreclosure, according to the Center for Responsible Lending as mentioned by Yahoo News.

The Lending Market has not bottomed... nor has it priced in all negativity.

I'd love to sit here and jump on the bullish housing bandwagon that dominates Wall Street. Really, I would. But I'm not a fan of flushing my money down the toilet.

In reality, the housing market has not bottomed. Subprime lenders are doomed. You can continue to listen to the delusional madness pouring from the mouths of Street analysts, and the mainstream press, or you can listen to the homebuilder CEOs and the subprime lenders that have gone belly-up because of a weak housing market.

It's your choice. But I'd go with the latter, though.

That's just an inkling of the tumultuous future for subprime lending.

But one thing's for certain - the worst is not over for subprime lenders, Alt-A, homebuilders, banks, retailers, consumers, and the global community.

Rest assured, no one's ignoring Roubini any more.

While the market looks to rally near-term, creating value opportunities for beaten down, undervalued stocks, here's what many people haven't been talking about... Option ARM resets.

Why Roubini Thinks Things Will Get Worse

Roubini is now predicting that hundreds of hedge funds will go belly up and stock markets may have to shut down for up to a week to stem global panic selling.

But for all of his predictive successes, critics still urge calm.

Instead, those that criticized Roubini's last prediction now believe he's nothing more than a "doom-monger" who crowed about recessionary fears even as the economy boomed.

But, says Roubini, "These crises don't come out of nowhere. Usually they arrive because of a systematic increase in a variety of asset and credit bubbles, macro-economic policies and other vulnerabilities."

So what do current indicators tell him? An end is not in sight.

"Every time there has been a severe crisis in the last six months, people have said this is the catastrophic event that signals the bottom. They said it after Bear Stearns, after Fannie and Freddie, after AIG..." and after $700 billion bailout plan.

"Each time they have called the bottom, and the bottom has not been reached."

Here's What No One's Talking about... Yet

If you thought the first leg of the credit crisis has been bad...

Wait until the mountainous Option ARM loans begin resetting... and the second leg of the credit crisis begins.

Alt-A loans were given to borrowers with credit scores of between 620 and 700, and included the option of interest-only loans, option ARMs, and no documentation loans that required little if any documentation for loan approval. Ninety percent of those that got an Option ARM in 2006 provided little or no documentation.

Ninety percent!

And it's estimated that only 60% of Option ARM borrowers make only minimum monthly payments. Others estimate that up to 80%.

Say a borrower makes minimum payments on a $600,000 loan. That loan could easily be a $750,000 loan within two years.

Stock position: None.