Chris White

Big Ben Panics and Gold Responds

Drilling down through the derivatives, structured products, cdo's and whatever each is hedged against or swapped for down at the bottom of the heap will be found someone who took out a mortgage to buy a house. The security for his mortgage is the house. As they used to say "if you pay you stay, if you don't you won't".

Suppose, pre-Greenspan's interest rate reductions, the 'house' would have sold for around 250K. There will be an 80% first and some mix of down payment and second for the balance. After the rate decreases and the mania the price may have gone north of $700k. The owner has no equity in the property. His income is the same as the guy who bought it at 250K.

The housing market turned in the summer of 2005. By last summer it was clear that sales had collapsed nationally. By this summer as inventories move beyond 11 months worth of sales at current levels we now know we're in a buyer's strike. Buyer's are waiting for the excesses to be wrung out of the system.

That may get resolved by what might come next in housing when the "sellers' panic"."Let's do what we have to do to sell, never mind holding on for price."

Already the equity in the $750k house should have been marked down. When the sellers' panic begins the mark downs will head back to where these houses were priced before Greenspan started his thing.

With the buyer's strike and houses not selling it is not possible to know what the mortgages at the bottom of the heap are worth because there is no value for the asset securing the mortgage. They aren't worth anything because no one wants to be holding the asset when prices collapse. Anyone lending today is not only going to need a really qualified buyer, with real income and documentation to back it up, they will also want to build in protections against the sellers' panic which will set prices much, much lower.

This problem cannot be dealt with in the credit markets either by interest rate reductions or repos and fractional lending. That will produce digital Weimar inflation even while the properties securing the asset class and everything leveraged against it continues at zero. That's when the Fed goes into the business of property management and becomes the country's landlord. Somehow that doesn't seem like anymore of a solution than having the banks take over the properties.

Last time anything like this happened they had to wait for the 'holiday' that cleaned out the financial part of the mess, which included converting what they then called "balloon" notes into 30-yr self-amortizing paper. This gave banks an income stream and kept people in their properties. Nowadays you'd have to forget about all the fancy structured stuff, and just replace the computers its all on with new ones with clean hard drives. But people get attached to all the bits and bites they say are making money for their employers.