John Hussman: Do Worse Credit Problems Lie Ahead?

Excerpt from the Hussman Funds' Weekly Market Comment (6/2/08):

Look carefully at the slopes of the lines on the chart below. Given that mortgage resets remain heavy and will continue well into 2010, is it really reasonable to assume that the increase in non-current loans will suddenly subside? From our perspective, it is far more likely that the rate of loan-loss reserves will be forced up sharply, simply to prevent further erosion in the coverage ratio. In order to actually raise the coverage ratio to normal levels, far more massive write-downs will be required than we've observed to date.

The implications of this go far beyond whether or not the prices of financial stocks have “discounted” the lower potential earnings. See, this isn't just a problem of whether the stock prices of financial companies are right. The larger issue is what happens on the real side of the economy, in terms of spending and lending and economic activity. I can't overly stress the points made by Martin Feldstein (the head of the National Bureau of Economic Research, which officially dates U.S. recessions) just a few weeks ago:

“I'll tell you what worries me. We saw house prices overshoot by 60% relative to costs of building and relative to rents. And I worry about the possibility that they will keep falling; they will spiral downwards. In the same way that they went much too high, they could go much too low. And if that happens, then we are going to see individuals feeling a lot poorer, cutting back on their spending, defaulting on mortgages, and we're going to see the holders of those mortgages see their assets, their capital being cut and therefore their ability to make loans being cut.”

In short, investors appear to be viewing the recent period of weak but not terrible economic news as a signal that the worst is behind us and that clear conditions are ahead. That could very well provoke some self-feeding speculation, which we would observe first through an improvement in breadth and price/volume behavior. But even if we do see some fresh short-term speculation, the evidence suggests that the worst of the credit problems are still well ahead.

 

Comments

[drmalaka:]

I saw Dick Bove today talking about the banks and the first thing I thought about was this article. He said that if you back out loan loss reserves the banks had great numbers. I am not sure how you could back that out, why not just back out salaries too while you are at it.

The one thing I do not get is how can a supposed expert like Dick not realize that the loan loss reserves are there for a reason, DUH! But in relation to this article, his hypothesis totally neglects the fact that the higher real reserves are actually a lower percentage of problem loans.

2008 Jun 02 07:44 PM

[joof:]

because of changes to accounting regs related to limiting the scope of potential "cookie jar" reserving the banks have deferred reserving problems compared to with they would have done even 10 years ago. They can't reserve until the problems become apparent

More shoes will drop

2008 Jun 03 03:13 PM