paul1307

Bank Liabilities: Why the Discussion Isn't Explicit

By the way, using a five or 10 year price average takes you back to a time - at least here in N. VA - where houses went from $50,000 in 1995 to $500,000 in 2005. There is no simple solution, and that's the rub. Even if you split the difference to $250,000 or so, the mortgages are still closer to $500K than $250K. That's what happened in FL. Folks bought houses for delivery in one year. If you needed immediate occupancy you paid flippers prices for available houses which were appreciating at 3% per month. That's not only how we got here but also why selling them has become the problem. What's next? I'm waiting for the radio air heads to start telling "their people" that if they don't like the way their neighbors are being bailed out while they still have to pay their mortgages, just stop making your mortgage payments. I can already hear them saying it now: "What's your mortgage company going to do, kick you out? Foreclose? They aren't foreclosing now! So just stop making payments and tell them you want your principal reduced." I think that may be coming sooner than later, and that's when the real anarchy of this situation begins, when the rule of law no longer works, contracts are not enforceable and average citizens think they have a right to "get even." Like I said, it hasn't really gotten ugly yet.

Bank Liabilities: Why the Discussion Isn't Explicit

Actuarial versus accrual; interesting point. The problem is in encouraging the banks to value depreciating assets as though they were appreciating, which they're not. The assumption is that housing will go up; the question is, when? My point about a 50% decline requiring a 100% appreciation to get back to even is that we may be two years yet from a bottom. How long then - after a further 50% or more depreciation - will it be until housing goes up 400% (if it quarters, it needs to quadruple). In an orderly market, those toxic assets would have been sold when they caved, but kiddie bankers with no concept of depreciating housing prices held them rather than dump them, and that's why FAS 157 was enacted in 2007, nearly two years ago, to provide a method for valuing depreciated assets they never should have held in the first place.

It's not "banks," but "bankers" and they're trying to save their jobs - at any cost (except to themselves, of course). When TARP started under Paulson, the plan was to buy the toxic assets; the banks wouldn't sell them at a discount (ala RTC and the S&L crisis). Rent them out? By all means, but first you'd have to find renters with proven credit histories, and folks who've been served liens and eviction notices aren't good risks. Trouble is that the glut of houses are in areas suffering the worst economic problems, meaning the potential pool of renters is poor. The bankers played as fast and loose as anyone on Wall St.

I wish there was a simple solution, like "ditch mark-to-market" but the trouble lies not in the accounting procedures but the depreciation of the underlying assets, no matter how you "account" for them. They'll mildew into the ground before the banks can dump them, unfortunately. What's really needed is a surgical separation of the assets from the banks, a forced auction or some such where when the banks go FDIC, FDIC auctions them off to the highest bidder. Then you'll know what they're really and truly worth.

It's at the point now where the banks aren't listing vast numbers of the houses they've set liens on, and they refuse to foreclose which would put a value on the houses, or sell, which would put a market value on the defaulted mortgages. I've seen FL houses where the "owners" didn't like eviction; many thousands in damages. "As bad is this is, we haven't even seen ugly yet; but we will." To those waiting for the laws of chemistry to be rescinded, you're not looking very closely at the situation, and by the time YOU notice anything, it will be way beyond "too late." That's why there's always that 10% who "didn't get the memo" if you know what I mean. When they're finally impacted directly, they're "shocked!" to think it could have crept up on them without their noticing it. Hello, this is your wake-up call, ugly is about to happen.

Bank Liabilities: Why the Discussion Isn't Explicit

Oh, and those "loans to deadbeats?" When housing was going up like a hot air balloon, banks LOVED bad loans. Let's see, there's the loan origination fees, points, bankers fees, this fee, that fee, and let's not forget the "hidden fees." Then when the "mark" defaults on his loan, the bankers take the house back and sell it at a profit. Whoopee! Everybody wins! Well, except the home buyer who didn't know he shouldn't have bought in the first place, but was told, "don't worry; I can get you a good loan, then you'll be living the American dream." NO ONE, and I repeat, NO ONE forced any bank to make "bad loans." They did it because it was profitable to foreclose, probably more so on an annualized basis than having the loan paid to term. Again, the radio heads have got this all wrong trying to blame the buyers. What rubbish, like bankers purposefully set out to lose money on home loans because they "had no choice - the government made them make them." Follow the money, and use your head for thinking instead of parroting. Think about this: being called a "ditto-head" by the head ditto is not that flattering when you think about the connotations, is it? You've been had...

Bank Liabilities: Why the Discussion Isn't Explicit

Mark-to-market is an accounting method; it doesn't change the underlying situation. And, the underlying situation is that banks saddle themselves with houses they won't - not can't, but won't sell - at a price less than they're owed. Example: tried to buy a short-sale in FL two years ago. The mortgage was for $480K and the house was listed at $305K, and the bank owed two years back real estate taxes (which they would have had to pay off in the event of a sale). The house is now worth about $200K.

1 - accrual accounting in the case of depreciating assets would have discounted the value of the house anyway, as would have mark-to-market.

2 - but, the banks have this mythical thinking that if they just hold on long enough, these bad loans will someday be worth more than they're owed on them. Some simple trading lessons are needed here. When your portfolio goes down 50%, it then has to go up 100% for you to break even. Get it? Housing down 50% requires herculean growth for the banks to break even.

3 - the banks are basically insolvent. All of them. They don't have to own mortgages, CDOs do the same thing and since your average mom-and-pop local banker owns CDOs from across the country now rather than "just" local mortgages, the risk was/is spread, but so too are the losses. It's not enough to say "We're in an area where housing hasn't changed much over the last 10 years. Doesn't matter; they "own" housing across the country.

4 - the idea that some "magic" of going from mark-to-market to accrual is the pipe dream of radio heads who make a ton of money telling the "unwashed masses" that the problem "is them" and the solution "is simple" if we'd "just use some common sense." Absurd, but the rabble is easily roused into thinking that the "new messiahs" have all the answers when brilliant people of all stripes are grappling with them and having difficulty.

5 - "These assets are impossible to value." Another absurdity fed to the easily mis-lead. Did they ever hear of computers? Let's see, mortgage gets written, then assigned to CDO; CDO sold to bank; bank "just can't get their poor pumpkin heads around the 'real value' of these garbage assets." Duh! Put it on the market and see what you can get for it at auction; that's how we value stocks, bonds, treasuries, rare books and expensive artworks. But that's not the point. Bankers are used to foreclosing and then selling the foreclosed property at a profit. When confronted with the necessity of selling at a loss, they stubbornly refuse and (repeat after me) "the market is not fairly valuing this property."

6- the markets "get it;" the "bankers don't." All the noise about mark-to-market is baloney. Assets usually DO go down "once they leave the lot" like cars, boats, planes, appliances, you name it. Except for houses, of course, which "always go up." Just goes to show that if real estate agents say something long enough the public begins to think it's like religion: they take it on faith and when it doesn't work that way, they think the blame lies with the appraiser, not the property.

Mark-to-market FAS 157 came about because bankers couldn't evaluate the value of depreciated assets, so FDIC gave them a "tool" (read FAS 157; it's remarkably short and simple). I fear the bankers (who fear for their jobs) are guilty of over-active imaginations in thinking "someone else" should take the losses for bad mortgages (and bad CDOs are bad mortgages; forget the derivatives, they were supposed to be insurance and AIG is getting beaned on them along with Citi). You loans the money; you takes your chances. So fine, change accounting to accrual and just put off the inevitable, but you won't and don't change the underlying (lack of) value in collateralized debt obligations. But go ahead, change the rules, and if bank stocks go up, you go right ahead and buy a bunch. Me, I'll be buying SKF and riding that pony back down into the ground when it inevitably gets pounded down again as housing prices continue to drop like a stone, 2% per MONTH in FL and other areas of the country. Accounting rules won't change that, or did you think that accounting rules are what caused housing prices to crater???

Bernanke Seems Clueless About the Real State of the Economy

Someone asked, "How did this happen?" I'll tell you; it's really a fairly simple chain of events that improbably occurred.

9/11 happened; the government lowered short-term interest rates to stimulate the economy. They continued lowering them as time went on. The administration decided that falling interest rates "were good for the economy" because the dollar began to decline, citing "increasing exports due to the more favorable exchange rate." On January 1, 2002, you should have taken your money (let's use $100,000 just for example) and taken it to a European bank, exchanged it for Euros and put the Euros in a safe deposit box.

The stock market was heading South, bounced briefly in the fall of 2002 when it became clear that the US was going to invade Iraq regardless of what weapons inspectors found or the UN decided. At the time of the invasion, March, 2003, the stock market turned upwards. Here you should have bought stock in Ceradyne (maker of ceramic body armour) or some shoe company whose name I've forgotten because they made combat boots. As ridiculous as it was, you would have made a fortune on these sorts of stocks; it was a bubble.

The dollar, as measured against a basket of European currencies traded from a high of 120 plus on 1/1/2002, plummeting downwards in 2003 and beyond, while the administration, obsessed with the stock market as a supposed proxy for the economy, smiled greasy grins and stated "We're for a strong US dollar" while, rather than intervene to prop the dollar up, let it continue its slide. As the dollar slid, pundits stated that multinational corporations were seeing increased profits "due to increases in productivity." Nonsense. As the dollar slid, productivity in dollars soared because of the escalation of the exchange rate.

Because the dollar became weaker, Mid-East oil producers insisted on more dollars for oil; their yachts are usually built in Europe where the eroding dollar was buying much less with each passing year.

In the meantime, "the carry trade" was using cheap Yen and cheap dollars to loan to American homebuyers, who, if they could fog a mirror could get a mortgage. And why not? If they could make payments, then banks and mortgage lenders made out well on 6+% mortgages while short-term money was lending for 2% and less. If the buyer couldn't make payments, that was okay too. In places like FL where housing was appreciating 3% PER MONTH, foreclosing was a great way for banks to flip houses and profit on both sides of the situation, loans and initiation fees on the one side, and profits on foreclosures as housing went up 30% per year.

Not to forget oil. During wars in the Mid-East, historically since WW II, the price of oil rockets upwards: 1954, 1973, 1979, 1992, etc. As oil went up, so too did the expense of war. The US military uses 1/2 of the oil imported into this country, and consumes more oil than the other top 10 users in the world. With oil shooting upwards towards the eventual high of about $147/bbl from the lows of about $28//bbl circa 2001 or so, and 50% of our imported oil going into the war effort, something had to give, and it did.

Eventually, the low income buyers at the bottom of the housing food chain got pinched when their budgeted $50 per month for gas became $250 for gas and it was either eat or lose their houses. What would you choose? So did they and began to begin slipping on house payments in about late 2003 and early 2004. By the end of 2004, housing in outlying areas of DC and other long-commute parts of the country were seeing 25% drops in prices for houses in the long-commute communities where traditionally first-time buyers go for a lot of house for a lot less money. Their long commutes also slammed their gas budgets. The slide began.

Banks used to foreclosing and making money found that the houses they were foreclosing on were becoming difficult to sell precisely for the same reasons that their buyers were defaulting: long commutes and high gas prices. Banks held tight to their non-performing assets because young bankers didn't believe that housing prices ever went down, or went down for so long that they would lose money on their foreclosed houses. They were however somewhat prudent in that rather than continue to foreclose on every bad loan, they filed liens, but didn't foreclose, leaving the houses in their owners name while the owners were barred from living in them. Bankers also don't pay homeowners dues (liens were placed by home owners' associations) and bankers stopped paying real estate taxes (no money coming in; none going out). Meanwhile, they were sitting on powder kegs of declining value assets and no money coming in.

Crude oil soared reaching $147/bbl on price hikes by oil-rich countries and speculation by "investors" pushing prices to the limit. Houses in the long-commute areas spiraled downwards while banks held them expecting "future profits," "once housing recovers." Bad bet bankers.

We're now in 2007. Take those Euros you put in the safe deposit box and exchange them for dollars. The DXY, having slid from a high of about 120 was now down to about 70 something. Your Euros were now worth $154,000 in exchange, a cool 54% profit on the sliding dollar. The stock market was peaking or close to it based on that 54% windfall associated with the decline of the dollar against European currencies that made a constant profit when measured against the Euro look like sheer genius when converted to dollars. Again, 54% profit for nothing more than the declining dollar. Sweet, no?!!

Bankers in 2007 are now really scared. Nobody holds mortgages; they all hold bonds linked to pools of mortgages. The meltdown in subprime was the canary in the coal mine I like to say. Those buyers were on the margins to begin with, sold mortgages by mortgage brokers and builders who simply sold the mortgages off while the ink was still wet. What did anyone care when they weren't going to make a lifetime commitment to holding the paper? No one actually. But the banks were holding assets depreciating almost daily on diminishing house prices, down as much as 35% or more in parts of the country where the boom was biggest. Where it's biggest, of course, when the bubble bursts, it also hurts the worst. Problem was that banks in Podunk that had for many years held only local mortgages they sold had few to no local mortgages anymore, instead, holding "collateralized debt obligations" in the form of pooled mortgages from all over the country, including those outlying long-commute areas near DC and other large cities that Podunk was not simply hundreds of miles from, but philosophically continents away from.

So that's it. Simple story, law of unintended consequences and all that. Who knew that in promoting American exports by letting the dollar slide at the same time we had a war on two fronts sucking more oil out of the Mid-East than at any other time in history that rising oil prices - five-fold or so - would strain housing bottom-feeders (the Krill of the housing boom and bust) with unexpectedly high gasoline prices that caused them to choose between eating and making house payments would cause the single-largest housing bust in 75 years, saddling every bank in the country with CDOs on houses hundreds or thousands of miles away from them, with prices falling like a stone and making their balance sheets run red? Well, not many people, as it turns out, or we wouldn't have the banking crisis - they're all insolvent, don't you know because of the CDOs they hold in lieu of local mortgages they've traditionally held - and death-spiral in housing prices that are killing us right now.

Don't blame me; I only analyze this stuff. But I will say this: when you want to fight a war and lower taxes at the same time; then fail to prop up a falling dollar because letting the dollar fall increases the earnings of multi-nationals and causing a bubble in the stock market because only fools believe that the economy and the stock market are synonymous, you're taking a mighty big chance. At the very least you're hoping the bubble will burst on the other guy's watch. Didn't Cheney say "Reagan proved deficits don't matter?" Didn't the administration say that "gas prices won't really affect the economy until they hit $4 per gallon?" Ooops! I guess they forgot that the military uses oil too, and the law of unintended consequences let the rest of it fall into place.

Where or when will it end? I can't tell the future, only piece together the pieces of the past that flow logically together. They sort of do, don't they? But, we could see DOW 4,000 this year, pretty easily, the way things are going (not that that is tied to the economy, but it isn't pretty, and it is tied to personal wealth). Gold goes up when there's inflation, not simply because stock markets are tanking, lest why isn't it already $2000 per ounce the way some folks think it should be already? Gold may be a "safe haven" but you can't eat it and you can't build houses of it. The stock market has already lost $10 Trillion, housing $3 Trillion, so far, and we're still counting. DOW 4,000 would cost another $3 Trillion.

Another sobering thought or two from Mr. Sunshine here: the DOW peaked in Aug, 1929, bottomed in 1932, down 90%. It took three years to bottom. Of course, if you're "in it for the long-term," not to worry. The DOW hit the Aug, 1929 highs again - in 1954. Let's see. That means we'll probably hit DOW 14,000 again in, well, 2020 at the very earliest, which seems doubtful. More likely 2026, maybe not until 2030.

The lesson is this: the next time a politician says "(anybody) proved that deficits don't matter" and they try to rescue the economy by letting the dollar go into free-fall, take your money and start to put it under your mattress. Is helicopter Ben right, could we see the bottom this year? In the stock market maybe, DOW low 4,000 (or lower), and if it continues to drop, 1400 in 2010. But the economy is another story altogether; housing won't bottom until 2011, and not forgetting that one out of every new job created in the last eight years was in construction, the economy won't bottom and begin to grow again until the "Krill" of the real estate economy, those first-time buyers and buyers of houses on the fringes of both commuter distances and low prices start to buy houses again. We'll need stable oil for three or four years before that starts up again, and as long as our military uses 50% of every drop of oil we import instead of the more usual 40% during non-wartime, oil will remain high, and due to emerging economies, international use will continue to grow even if our use stabilizes. Hybrid cars? You've got to get serious. We need a serious way to get off oil or we'll have no recovery. Ever.

By the way, the reason the stock market won't recover quickly is that like following the '29 crash, the buyers of a whole generation, having been plucked and stuffed, screwed, blued and tattooed, tagged and bagged and permanently separated from their money, will not be investing in the markets again, if my guess is correct, for a whole generation, 20 years or so. Besides, $10-15 Trillion of wealth will have evaporated. When you lose 50%, you don't get back even by getting a return of 50%; you need returns of 100%. If you've seen your markets decline 90%, you don't need returns of 90% to get even, you need returns of 1000%. Think about that, and ask yourself just where is that money going to come from??? I'm sorry; I just don't have that much under my mattress, and neither do George Soros, Warren Buffet and Bill Gates combined. It only gets uglier from here on; we haven't even seen ugly yet, imho...

On Martin Armstrong's 'It's Just Time'

"The trouble with economists is that none of them have lived long enough to have personally experienced every variety of economic condition, so they write from the perspective of what they've lived rather than about the broader picture." This man seems to take a broader view, for which I say "Bravo!"

Am I allowed to take from his writings those things I find useful while ignoring those things that are not factual or to my liking? Am I allowed to ignore his criminal activities (alleged, but I've no doubt true) but still learn from what he writes? Must I throw out the baby with the bathwater, embrace him in total or reject him totally?

Here's my prediction: we're going to go through the 1970's once again (I was there the first time; it hurt), and we're going there for many of the same reasons: 1) an unpopular war (two actually) unfunded or at least not included in the regular budget, the interest on which will eventually cost twice the principal (think buying a house with a mortgage; you'll eventually pay triple the asking price). 2) Oil crises that rapidly drove the cost of energy to all-time highs, not unlike the Yom Kippur War of '73 and the OPEC embargo of 1979; we've visited $140/bbl once and with the next disruption in the Mid-East (whatever it is, and there will be one) we'll visit $140/bbl again, probably higher. 3) The cost of wars, both Viet Nam and Iraq/Afghanistan are always borrowed, the costs spreading far beyond the length of military engagement, sapping funding that could have been used for domestic programs or tax cuts. Here we've had tax cuts while at war, pushing the cost out to future presidents and generations. The cost of recovering an economy following a war is always a direct consequence of that war, not merely an untidy and unexpected "surprise." It always happens that way. Did anyone really believe "Iraqi's will pay us back (after WE invaded THEIR country) through reparations paid for by (their) increased oil production?" or that that was a way to fund the war? We are going to see 1970's style inflation; count on it and gold will hit the mythical $2000 per ounce sooner than later.

Because I agree with Armstrong in one area doesn't mean that I agree with him totally. I don't believe that the world is ready for, or going to go to a single currency model as he suggests, but I do find myself wondering, as he does, just how we're going to coerce the rest of the world into funding our debt - buying treasuries - without a rise in interest rates occurring. I further agree and have long been a proponent of the fact that the government doesn't set interest rates. Get real; treasuries are sold at auction, and the buyer determines the interest rate by what they're willing to pay. Every day in the bond pits of the CME, formerly the CBOT, bonds and treasuries are sold to the highest bidder with interest rates on face-value bonds inversely proportional to their price. Where this notion that the government sets rates got started is beyond me, probably by people who've never been to any auction I suppose. As the next $1 Trillion in treasuries hits the world markets, disinterest in buying them will push prices down and (therefore) interest rate up, which will impact all preexisting bonds, both private and government, raising rates across the board. Just like the 1970's. Even Volker, if you remember back that far, raised rates in response to prevailing rates set in the bond pits, trying to leapfrog ahead of the market in an effort to slow the economy; he didn't raise rates in anticipation of bond auctions or sales in the bond pits of the CBOT, he followed them.

Of course if you still want to believe that setting rates on overnight interbank lending affects anything but that and other short-term lending, you do so at the peril of failing to understand how and why inflation - and I definitely liked Armstrong's separating inflation from the usual "too much money chasing too few goods" argument - really happens and really works. In this day when almost all money is just electronic blips on some computer hard disk, and, as Armstrong points out, the effect of money leveraging makes trying to count the money "out there" totally different than trying to count the number of actual dollar bills in circulation, define "too much money" in that antiquated equation. Inflation will proceed as it did in the 1970s from excessive borrowing, and it will be severe; pray-tell, how could it not be?

Good article. Keep what you like, ignore the rest, but it's not necessary to "take sides" on whether Armstrong (or his adherents or detractors for that matter) is a hero or a goat to enjoy what Armstrong has written and to learn from it what one can.

I just hope that the investment scheme that seems to have gotten him into so much legal trouble wasn't based on his view of economics as presented in this writing... LOL