Mortgage Meltdown on the Horizon

Includes: ICF, IYR, SHY
by: Andy Abraham

We are at the threshold of a further frightening scenario in the mortgage and housing arena. This next wave of the mortgage crisis stands the possibility of not just forcing people out of their homes, but enhancing serious ripples throughout the economy that are starting to be seen and felt.

In the upcoming months approximately 2 million adjustable-rate mortgages [ARMS] will reset with a valuation of approximately $600 billion. Some economists have stated that this is not going to affect the general welfare of the 14 trillion dollar U.S. economy. I find this hard to fathom. This reset will cause higher interest rates for homeowners which will cause many of them to be unable to make their payments. Bill Gross, chief investment officer of PIMCO, the world’s largest Bond fund manager stated "We haven't faced a downturn like this since the Depression”. The mortgage defaults have shaken the basic financial foundation of many institutions, but the greater fear is the contagion to the general economy.

The contagion and the domino effect is what bother me the most. There is diminished liquidity from the financial sectors. Lending standards have risen and in many cases negated the possibility of obtaining mortgages. There is a diminished level of consumption by U.S. consumers, and consumer spending makes up a vast majority of the U.S. economy. There are countless jobs lost in the construction sector. Jobs in the financial sector - ranging from Wall Street to local mortgage brokers - as well as, on the horizon, jobs at retailers and even car dealers, due to their dependence on consumer spending, are all at stake. It seems an ever increasing dollar amount of potentially worthless paper is appearing on the balance sheets and the SIVs of the world’s largest banks. (Last guess estimate was approx 500 billion dollars).

The situation is unfolding into a much harder situation to contain. Potentially we are witnessing the start of one of the country’s worst banking crisis. The question is as with the S&L crisis in the 1980’s, or even in 1907, can the government come to the rescue? The worst-case scenario is anyone's guess and can cause economic tremors we have not seen in our lifetimes. With these dire warnings tremendous opportunities will present themselves. One needs to have a plan, maintain liquidity and be available for the upcoming opportunities. My suggestion is raise cash and place it in short term U.S. Government Treasuries, prepare your list of wide moat stocks so when they are screaming buys - as Warren Buffet would say Fat Pitch - you are ready to take action, and look at other asset classes such as managed futures. Managed Futures is not contingent on the stock market and historically has outperformed in volatile and inflationary times.