The $5 Trillion Bet

Includes: KBE, KME, KRE, XHB
by: The Housing Time Bomb

Did any of you know that you just made a $5 trillion bet? You didn't place the bet yourself of course because it was made for you without your consent. You can call your politicians and thank them for betting your financial future if you wish (click on chart to enlarge):

The FASB's new accounting rules 166 and 167 on the use of off-balance sheet accounting for securitized debt issues took effect at the beginning of 2010 for financial institutions with a calendar year fiscal year. From a data user's perspective, earlier this year, they were reflected in changes to commercial bank balance sheet data, and last week, with the release of the Q1 Flow-of-Funds data, we saw their impact more broadly on banks, GSEs and the special purpose vehicles (SPVs) these rulings were intended to reform.

It has been routine practice for issuers of securitized debt to "spin" the specific loans and the securities issues off the institutions' balance sheets to a subsidiary set up for the express purpose, an SPV. As FASB's notice explains, this SPV procedure is helpful for financing a narrowly defined project without putting an entire firm at risk.

However, the original intention of the SPVs was not to distort the institution's underlying risk profile over a protracted period, which had in fact been happening, as investors found to their dismay during the recent financial crisis. These new rules basically cause the securitized debt issuers to move assets and associated securities liabilities back to their balance sheets.

The chart (Editor's Note: see above ) shows the dramatic impact of the rule changes on the biggest item.

First, in the mortgage sector, 1-4 family mortgages that are held at "agency- and GSE-backed mortgage pools" plunged from $5.27 trillion at the end of 2009 to just $983 billion on March 31. By contrast, the direct mortgage holdings of the agencies themselves surged from $438 billion at year-end to $4.75 trillion on March 31."

My take:

Don't you just love this move? FASB changes the accounting rules for 2010 which is a good thing. The problem is they are about 2 years too late. As you can see above, the banks have already successfully passed the risk...errr should I say the losses onto the American taxpayer. The numbers above are stunning.

The banks are basically telling the Fed: "Sure we'll continue to do bad loans as long as they are put on your balance sheet!".

FHA is so screwed. You might as well call them Fannie (FNM) or Freddie (FRE) Part Deux! Keep in mind that FHA loans are now currently being done with 3% down and a 620 credit score.

This is basically a formula for disaster. The Fed's response to the housing bubble is essentially to try and build an even bigger bubble EXCEPT this time the risk is on the taxpayer instead of the banks!

If this doesn't make your blood boil than I don't know what will. This Ponzi scheme must be stopped because we are the ones that will be left with the losses. The GSE's now hold close to $5 trillion in debt on it's balance sheet.

WE lose if this $5 trillion dollar financial bet goes bad, and by the looks of jobless claims it appears that that's likely to be the case. The jobless claims were flat out awful ():

Claims are now starting to climb once again. This chart really puts things into perspective. The job losses at the PEAK of the 2001 recession were at the levels we are currently seeing now.

Let's not forget that we are now almost three years into this recession. Imagine what this number would look like if we included the people who have lost their UE benefits after 99 weeks.

The reality here is we are losing jobs at severe recessionary numbers and the data is beginning to show that the economic trends are beginning to worsen.

Ummm...I thought we were in the middle of a recovery? If you believe in "jobless recoveries" then I guess we are. I wouldn't be surprised at all to see a negative jobs print in June.

The "jobless recovery" combined with the tax credit expiration is now starting to really weigh on housing. Housing starts sinking faster than a barbell in a swimming pool ():

This tells you that the builders are forecasting grim sales moving forward. It's about time they turned off the bulldozers. I mean why build houses when you have millions of homes that are either empty or filled with squatters who have stopped paying their mortgages?

The Bottom Line

Things are going from bad to worse. The recent economic trends are pointing towards another slowdown. I wouldn't be surprised to see us fall back into a recession within the next year. Things will not improve until we stop throwing money out of helicopters. We are trying to fix our economy by essentially making the same bad bets that forced us to almost collapse in 2008.

This approach is like trying to cure an alcoholic by giving him even more alcohol. When will this insanity end!? In bankruptcy I suppose.

As the jobs situation worsens you can expect the housing market to roll over.

I hope you are feeling lucky because that $5 trillion wager that was made for you doesn't look too good. If this was a horse race you would be coming around the final turn in last place 20 lengths behind the leader.

When it's all said and done it will be our future generations that will be stuck with the trillions of losses.

Where are the founding fathers when you need them?

Disclosure: No new positions taken at the time of publication.