The Mortgage Finance Bubble / The Daily Reckoning

verfasst von - ELLI -, 30.01.2003, 22:17

-->The Mortgage Finance Bubble

The Daily Reckoning

Paris, France

Thursday, 30 January 2003

--------------------

*** What the world needs now - panic!

*** Great recovery...where are the jobs? $100 billion
dollar loss? Good work!

*** Where are the exits? War...war...war...
and more...more...more!


There is something missing from the world financial picture
- nerves. Nobody seems to panic when they should.

"No end in sight to defaults and downgrades," writes the
FT. But bondholders don't panic.

"2004 likely to show record budgets deficits," says the
Washington Post. The federal deficits"could top $300
billion," says the New York Times. But Treasury buyers are
as calm as serial killers.

The economy seems dangerously close to what Stephen Roach
calls"stall speed"; still, the Fed doesn't cut rates in a
panic.

Consumers are losing their jobs and going bankrupt as never
before. Still, there's little change in their desire to
spend what they don't have on what they don't need."Trade
deficit sets record," notes USA TODAY. Despite a 20% drop
in the dollar last year, the November '02 trade gap hit $40
billion.

Stock investors have lost money for three years in a row.
Stocks are still very expensive. Why don't the poor saps
panic?

And what's wrong with foreign investors? Don't they have
any sense of fear, either? While U.S. stockholders lost 24%
in the S&P last year, European investors in the S&P lost
38%, because they also suffered a loss on the dollar.

What all these people need to do is to look around for the
exit sign...and stampede towards it. A good, bone-crushing
panic would drive down prices to reasonable levels.

Humpty-Dumpty can teeter on the wall for a long, long time.
Let's give the guy a shove and get it over with!

Right...Eric?

--------------

Eric Fry, reporting from New York...

- The stock market reversed an early morning sell-off
yesterday to eke out a slim gain. The Dow ended the day at
8,110, as an early 136-point deficit turned into a 21-point
advance by the closing bell. The Nasdaq added about 1% to
1,358. The commodity markets were equally volatile, as
crude oil jumped nearly one dollar to $33.63. Gold headed
in the opposite direction, falling $3.70 to $366.30 an
ounce.

- The stock market's mid-day recovery and the gold market's
sell-off resulted, in part, from rumors that the U.S.
government might be getting into the dictator-relocation
business. The U.S. might avoid war, or so the rumor goes,
if Saddam Hussein were to pack up his things and move out
of Iraq to a country-to-be-named-later.

- Colin Powell gave some credence to the idea yesterday at
a State Department news conference, when he said,"If
[Saddam] were to leave the country and take some of his
family members with him and others in the leading elite
that have been responsible for so much trouble during the
course of his regime, we would, I am sure, try to help find
a place for them to go."

- Shortly after Powell's remarks, however, State Department
spokesman, Richard Boucher, pooh-poohed the Saddam-
relocation theory as simply,"an idea floating out there".

- Another idea floating out there these days is that the
economy is stabilizing and will mount a recovery later in
the year. But as President Bush admitted in his State of
the Union,"Our economy is recovering. Yet it is not
growing fast enough, or strongly enough". In short, the
Union is in a pretty sorry state these days.

- The CEO of one large S&P 500 company told your co-editor
Tuesday,"This economy is far worse than the official
numbers indicate." Given the rough conditions on Main
Street, the CEO was justifiably proud of having produced
modest earnings growth last year. Unfortunately, the path
to that modest growth was littered with the pink slips of
more than 1,000 of his employees...Therein lies a HUGE
problem for the U.S. economy.

- Since final demand for goods and services is tepid at
best, achieving"growth" necessitates cost-cutting, and
cost-cutting often means job-cutting. Despite a
theoretically recovering economy - based on the latest GDP
numbers - the labor market keeps grinding lower.

-"The labor market downturn is far from behind us," the
Economic Policy Institute (EPI) reports."Today's labor
market is much weaker than it was one or even two years
ago, and the 'jobless recovery' grinds on."

- The EPI, citing a few of the most troubling labor market
trends, observes:"Payrolls contracted not only over the
recessionary year of 2001, but also over the alleged
recovery year of 2002. Unemployment rose throughout 2002,
ending the year at 6.0% in December. Since the most recent
economic peak, the jobless rolls have expanded by 2.8
million."

- Jobs are continuing to disappear, no matter how much
economic growth Wall Street strategists think they see and
no matter how many positive GDP numbers Washington's bean-
counters produce...There simply is no recovering evident in
the labor market.

-"Employment losses in the most recent recession and
subsequent jobless recovery have been greater than in any
of the other three [prior] recessions and recoveries," says
the EPI."Other recessions may have led to greater losses
initially, but by this point in those recoveries, the
economy had bounced back and payrolls were again
expanding." That's not happening this time...A bona fide
"jobless recovery" is underway...

- The only feat harder to achieve than accumulating $100
billion is losing it. Not just anyone can lose $100
billion. First, you have to get that huge pile of money
from somewhere. Next, you've got to figure out enough
idiotic ways to throw money around that you lose $100
billion-worth of the stuff. Somehow, AOL Time Warner
managed to achieve this epic feat in 2002.

- Yesterday, the struggling media-company-cum-Internet-
icon-cum-basket-case announced that it would take a $45.5
billion charge to account for the declining value of its
America Online flagship property. Earlier in the year, AOL
took a much-publicized $54 billion charge. Add it all up,
and before you know it, $100 billion has ascended into
money heaven.

- Three years ago, when AOL and Time Warner consummated
their union, your co-editor predicted that the merged
entity would display the agility of"an elephant on
Quaaludes." But a drugged-up pachyderm never could have
burned through $100 billion. Only delusional CEOs - flanked
by armies of MBAs and investment bankers - could
successfully plot the complete destruction of so vast a sum
of money.

--------------

Back in Paris...

*** If all these investors panic...what will they panic
towards? Our guess is that the exit sign has GOLD written
all over it. In dollar terms, the price of gold has gone up
31% in the last 12 months. In the near term, it may well go
down (we hope it does...we're buying)...but there are not
many other places for panicky investors to go.

*** The Europeans can retreat to euros, of course. The
dollar lost 26% against the euro in the last 12 months.
Deutsche Bank says that if the dollar were to follow its
cyclical pattern of the last 20 years, we should expect it
to drop to $1.25 to the euro 12 months from now. It's
currently at about $1.08.

*** The surprise may be that the dollar drops far more than
that - against euros as well as gold. Never before has the
U.S. has such a large trade deficit. Never before have
there been so many people with so many dollars outsize the
U.S. When these people panic, the pile up at the exits
might be much worse than anything in the last 20 years.

*** War, war...war. The word is on every pair of lips...and
every editorial page. We don't know whether the war against
Iraq will turn out well or badly, but colleague Dan Denning
thinks he's found a way to make a buck off of it.

"One way or another, Iraq is going to pump more oil," he
says."Oil may not go up in price, but a few companies -
the oil service businesses - are going to go up in price."

"These companies went between 15% and 40% during the last
war against Iraq," Dan tells us."They'll do the same this
time."

[Editor's note: we'll here more from Dan tomorrow about the
real 'smoking gun' behind the war with Iraq...stay tuned.]


The Daily Reckoning PRESENTS: As the U.S. housing market
continues its ascent, your editors can only stand by in
wonder...what can the lumpen be thinking? Below, the
Prudent Bear's Doug Noland takes a look at the reasons
behind...


THE MORTGAGE FINANCE BUBBLE
By Doug Noland

On my way to the office each day, I drive through an older,
more modest neighborhood. I have watched as a few 'For
Sale' and 'For Rent' signs last summer have turned into an
alarmingly large number as we begin a new year. It is my
impression that, despite low rates and ultra-easy credit
availability, the local existing home market has hit the
wall. Interestingly, however, only a dozen or so miles
north into suburbia, the market for new homes remains quite
strong. This is an unusual two-tiered marketplace worth
contemplating.

In the past, a weakening housing market and rising
inventory would rattle the nerves of local bankers;
financing for new construction would quickly run dry. But
this New Age housing cycle has evolved into something quite
different. For one, it is dominated by large national
builders with close ties to Wall Street and the mortgage-
backed securities marketplace. Importantly, these builders
today have unlimited access to cheap finance to pursue
their aggressive growth strategies.

Not dissimilar to the telecom sector during 1999, The
Street, bankers, and Washington are today content to cheer
along the construction boom and disregard the consequences.

As we have witnessed, the weaker the economy - and the more
intense the financial stress - the greater the impetus for
stoking the Great Mortgage Finance Bubble.

Limitless credit availability also affords the aggressive
builders the decisive advantage of providing zero or
minimal down-payment mortgages, together with other
inducements. Along with ultra-easy financing, new homes are
also effortless to insure...an attribute that has taken on
new significance with increasingly difficult-to-obtain
homeowners insurance.

"Zero-down, no payments until 2004" market distortions are
currently sustaining strong new car sales in the face of a
ballooning inventory of used cars (who wouldn't want to buy
new instead of used?). In the same way, we see distortions
emanating from mortgage finance excess increasingly coming
at the expense of the"used" home market.

A recent Dallas Morning News headline reads,"Home
Foreclosures are Casualties of Economy". Writer Steve Brown
comments:"A bleak economy hit home in North Texas last
year, putting thousands in danger of losing their homes.
The number of homeowners threatened with foreclosure in
Dallas County jumped 32%. And in Collin County - which has
been ravaged by layoffs in the high-tech and telecom
sectors - home foreclosure postings soared by 73% in
2002...January foreclosure postings for Dallas County were
up 43% from January 2002. And in Collin County, foreclosure
postings for the month were up a staggering 94%." And, yet,
the building boom hardly misses a beat.

One could build a case that, basically up to this point,
the Mortgage Finance Bubble has worked to the interest of
buyers, typical sellers and builders, alike. Perhaps this
year, gains for the builders will come out of the hides of
many distressed sellers (and their lenders and mortgage
insurers!). Again, reflecting back to the telecom boom:
many prosper for some time even after the boom has passed
its peak - although the"marginal" player can be devastated
as new finance is no longer forthcoming from increasingly
cautious lenders.

It may be helpful to recall the late-eighties office
building boom (and later bust). Even though vacancies began
rising markedly and serious problems were appearing on the
horizon - making it clear that putting a moratorium on new
construction was in virtually everyone's best-interest -
finance just rolled into the sector and additional high-
rises were added to the developing glut.

Many"investors" found the sector's above-market yields too
enticing; and, besides, the returns had been quite strong
for a few years! As we are witnessing today, in historical
proportions throughout Mortgage Finance, once the financial
apparatus (and speculative infatuation) has reached a
critical mass, it is nearly impossible to temper. The flow
of finance invariably turns to flood, and a painful bust
becomes unavoidable.

Indeed, it is the awe-inspiring nature of speculative
markets to inundate a sector with destabilizing finance at
the very late stages of the boom. The home-building boom is
poised to run through 2003, but the cost will be high.

Clearly, the entire financial sector is continuing to push
consumer and mortgage finance to their absolute limits -
pedal to the metal. But rampant lending excess appears to
have hit the point of diminishing returns. One should find
the fourth quarter of 2002's economic performance all the
more alarming after confirmation that it was another truly
extraordinary quarter of lending.

The Mortgage Finance Bubble is still managing to find
consumers to feed it...today. But sooner or later - and if
we had to bet, our money would be on 'sooner' - the
almighty consumer is going to run out of steam.


Regards,

Doug Noland

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• The Mortgage Finance Bubble / The Daily Reckoning - - ELLI -, 30.01.2003, 22:17