Which Comes First: The Cart or the Horse?

Before we get to the cart and the horse, let's answer a reader question that just came in: "What prevents the Fed from sending every household $100k?"

Just Five Things

1) Lack of authority
2) People would use it to pay off debt
3) Banks do not want to be paid back with money that is worthless
4) The Fed will act to bailout banks, not consumers
5) Hyperinflation ends the game. The Fed is simply not in the business of destroying itself.

Rest assured the Fed is going to do almost everything under the sun to encourage more borrowing. That includes slashing the discount rate, the Fed Fund's Rate, loosening rules on collateral, etc. Some of those we have already seen. This is likely the first inning.

But the one thing the Fed is not going to do is send everyone $100,000 or $10,000 or even $5,000. If for some reason I am mistaken and the Fed starts sending out checks or depositing money into people checking accounts to a significant degree, then I am willing to eat my deflation hat. Just so we are clear on this, another piddly $300 from Congress is not enough.

The Cart and the Horse

There was an interesting editorial article on Gold Eagle last week by Peter Schiff.

Prices Are The Cart, Money Supply Is The Horse

The sad truth is that despite the best efforts of monetary economists everywhere, fundamental misconceptions about inflation remain entrenched in government, business, and the media.

In an exchange earlier this week on CNBC, a guest explained that rising oil prices can not cause inflation because prices for other goods must fall as spending is diverted to pay for more expensive oil. That explanation prompted host Becky Quick to ask: "If rising oil prices do not cause inflation, then what does?" Since that question was left unanswered on the air, I thought I would take the time to answer it here.

Inflation has only one cause and that is the Federal Reserve itself. In the United States, the supply of money and credit is regulated by the Fed. Since inflation is by definition an increase in the supply of money and credit, only the Fed can create it.

If the money supply were held constant, increases in some prices would be offset by decreases in others. The result would be no overall inflation. In fact, without government created expansions of the money supply, the natural tendency of prices would be to decline as technology allowed for more efficient production of goods and services. So while most regard the Fed as the primary inflation fighter, in reality it is the sole inflation creator.

That is a near perfect explanation by Peter Schiff. Certainly, his definition of inflation is perfect: "Inflation is by definition an increase in the supply of money and credit."

My take, complete with an image of the cart and the horse, can be found in Inflation: What the heck is it?

Peter Schiff did make an error, however. That error is in the phrase "only the Fed can create it". When it comes to credit, the statement is simply wrong. Money (credit actually) and there is a difference, is borrowed into existence every day. This is a systemic problem and the Fed is clearly not in control of it.

Money As Debt

There is an educational 5 part You-Tube series on money and debt. It covers in nice cartoon animation what has happened to money over time, fractional reserve lending, how money is created today, why interest rates are so low, why we get unsolicited credit offers, and why debt is exploding.

The video concludes that it is taking exponential increases in debt (money) to stave off a collapse of the entire banking system, and that this cannot go on forever.



Click here (not on the image above) to see this 5 part series on debt.

I agree with the video that there are practical limits on how high debt can get. So does economist Paul Kasriel at the Northern Trust. (See An Interview with Paul Kasriel)

Interesting Quotes from the Video:

• "Debt... That's what our money system is. If there were no debts in our money system, there wouldn't be any money." Marriner S. Eccles. Chairman and Governor of the Federal Reserve Board.
• This is a staggering thought. Someone has to borrow every dollar we have in circulation, cash or credit. We are absolutely, without a permanent money system. When one gets a complete grasp of the picture, the tragic absurdity of our hopeless position is almost incredible, but there it is." Robert H. Hemphill, Credit Manager, Federal Reserve Bank, Atlanta Georgia.
• "One thing to realize about our fractional reserve banking system is that, like a child's game of musical chairs, as long as the music is playing there are no losers." Andrew Gause, Monetary Historian
• "Anyone who believes exponential growth can go on forever in a finite world is either a madman or an economist." Kenneth Boulding, economist
• I have never yet had anyone who could through the use of logic and reason, justify the Federal Government borrowing the use of its own money... I believe the time will come when people will demand that this be changed. I believe the time will come in this country when they actually blame you and me and everyone connected with Congress for sitting idly by and permitting such an idiotic system to continue." Wreight Patman, Congressman 1928-1976, Chairman, Committee on Banking and Currency 1963-1975
• The modern banking system manufactures money out of nothing. The process is perhaps the most astounding piece of sleight of hand that was ever invented. Sir Josiah Stamp, Director, Bank of England 1928-1941

Unfortunately, the video's conclusion is a bunch of socialist nonsense: Eliminate interest, let governments and only governments create money, and supposedly government will then use that money wisely to build roads and bridges that will add value to society.

Unfortunately, the government cannot decide what has value or not. Only the free market can do that. Otherwise you have bridges built to nowhere based on political clout, needless wars and other malinvestments of capital.

If government printing led to prosperity we would be talking about Zimbabwe, the Weimar Republic, and the Soviet style command economy of the 1940's through 1980's in glowing terms. The proposed solution is ridiculous.

The video also incorrectly blames the gold standard for problems created by fractional reserve lending. However, the video does a reasonable job of pointing out many of the problems with the current system of debt creation in a very entertaining and (for the most part) educational way. On that basis, I recommend watching all five parts.

Ability to Take on Debt is not Infinite

At the top of this article I outlined 5 reason why the Fed was not going to give money away. If one believes that rationale, then one must logically accept there is a practical limit to debt, at least at the consumer level.

Proof of concept is easy enough to find. Massively rising delinquencies, foreclosures, and bankruptcies should be proof enough. Additional proof can be found in a Drop in Revenue Growth at State and Federal Level.

At the state level, it's easy to see what is going to happen. Unlike the Federal Government, states are required to have balanced budgets. That means one of three things.

• Cutting Spending
• Raising Taxes
• Floating Bonds to Postpone the Problem

Raising taxes headed into a consumer led recession will not work. Cutting spending is absolutely needed but will throw people out of work at the worst time, and postponing the problem is not solving the problem. Postponement only makes things worse.

This is yet another version of Economic Zugzwang where there are no winning answers (at least as far as politicians are concerned).

The proper solution is to let free market forces work. If that means banks fail, then banks should fail. If that means the stock market collapses, the stock market should collapse.

Letting (encouraging) the dollar fall to zero is not a solution for the simple reason it does not create any jobs where they are needed, which is right here right now.

Given the amount of credit in the system vs. actual cash, and given global wage arbitrage and slower consumer spending, it would take a mammoth effort from Congress and the Fed to forestall the inevitable once again.

A Sure Thing?

Right now the surest bet in the world is that when the dollar drops the US stock markets rise. How long that remains is anyone's guess.

There is going to come a time when borrowing dollars to invest in equities is going to blow up. Of course the carry trade may blow up first (sinking everything in its wake). Perhaps a massive derivatives unwind sinks everything first. Then again, perhaps the trigger is something from way left field that no one is watching.

The fuse is now lit. The structural imbalances worldwide have never been greater and the fuel at the end of the fuse is enormous. In addition, amount at risk increases every day.

The interesting thing is that no one knows how long the fuse is. For some inexplicable reason everyone acts as if they can get out before the stick ignites. It's simply not possible.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

The Litigation Scorecard

Now that the World Series is over, many fans are suffering withdrawal symptoms over the need to keep a current scorecard of exciting day to day sports action. Weekend football just is not sufficient and Hockey belongs in Canada. Yes, there is basketball, but something is needed to replace baseball.

I have just the ticket: The Litigation Scorecard. Action has been fast and furious since October 18.

For example: Merrill Lynch (MER) and Countrywide (CFC) were both hit hard by their respective opponents in boxing matches earlier today. Earlier this month New Century was accused of illegal procedure in a football game with a young couple. Bank of America (BAC) stands accused of reneging in a high stakes Euchre Game. Details will follow but let's first consider the October Litigation Scorecard.

Litigation Scorecard

• October 30 - Merrill Lynch (MER) hit with shareholder lawsuit
  
• October 30 - Mozilo and Countrywide (CFC) hit with shareholder lawsuit
  
• October 25 - American Home accuses Lehman Bros. (LEH) of hitting American Home below the belt with improper margin calls in July and demanding money the company says it did not owe.
• October 24 - A couple sues New Century for illegal procedure in loan disclosure documents
  
• October 24 - HSBC sued by Canadian firm Aastra Technologies Ltd. over asset-backed commercial paper investments. Aastra's puck (assets) have been frozen since August.
• October 23 - American Home is accusing Bank of America (BAC) of reneging on swap agreements in a high stakes Euchre Game. American Home seeks $25 million for the reneg.
  
• October 19 - Luminent Mortgage Capital Inc. (LUM) is seeking a penalty kick in an international soccer match with HSBC.
  
• October 18 - Book publisher Unisystems Inc., on behalf of all all retirement plans that invested in State Street-managed bond funds sues State Street (STT) for being offsides in an investment gamble by investing pension plan funds meant for low-risk investments into high-risk mortgage-backed securities
• October 06 - Fremont sued by Massachusetts attorney general for predatory lending encroachment
  
• October 02 - In a battle between middle-heavyweights, State Street (STT) was Sued by Prudential (PRU) Over Subprime Losses

Litigation Details and Links

On October 30 Merrill Lynch was hit with shareholder lawsuit over subprime

An investor lawsuit has been filed against Merrill Lynch & Co Inc (MER.N), contending that the company issued false and misleading statements about its exposure to risky mortgage investments, the plaintiffs' lawyers said on Tuesday.

The complaint accused Merrill of issuing materially false and misleading statements about its financial exposure to collateralized debt obligations (CDOS) containing subprime mortgage securities.

The company's statements "were materially false due to their failure to inform the market of the ticking time bomb in the company's CDO portfolio due to the deteriorating subprime mortgage market," the complaint said.

On October 30, Countrywide shareholders sued CEO Mozilo, board

Countrywide Financial Corp Chief Executive Angelo Mozilo has been sued by a pension fund that accused the largest U.S. mortgage lender of helping executives pocket improper gains by artificially inflating its stock price through share buybacks.

The New England Teamsters & Trucking Industry Pension Fund accused Mozilo, other Countrywide executives and the company's board of directors of gross mismanagement for improperly using $2 billion of cash to repurchase stock.

It said the move allowed executives to sell $842 million of Countrywide shares at artificially high prices between April 2004 and October 2007, at the expense of ordinary shareholders.

In addition to Mozilo, the lawsuit names President and Chief Operating Officer David Sambol; Executive Managing Directors Carlos Garcia, Ranjit Kripalani and Andrew Gissinger III; Chief Legal Officer Sandor Samuels and Chief Financial Officer Eric Sieracki.

It also names board members Oscar Robertson, Michael Dougherty, Robert Donato, Jeffrey Cunningham, Harley Snyder, Martin Melone, Keith Russell, Robert Parry and former directors Stanford Kurland, Ben Enis, Edwin Heller, Henry Cisneros, Kathleen Brown, as well as Countrywide's auditor KPMG.

On October 25 American Home Sued Lehman Bros.

Bankrupt lender American Home Mortgage Investment Corp. has sued Lehman Bros., accusing the investment bank of essentially stealing from the company as it struggled to stay on its feet.

The lawsuit, filed Wednesday in the U.S. Bankruptcy Court in Wilmington, Del., accuses Lehman Bros. of hitting American Home with improper margin calls in July and demanding money the company says it did not owe.

When the Melville, N.Y.-based lender couldn't meet Lehman's second margin call, for $7 million, Lehman foreclosed on $84 million worth of subordinated notes issued in American Home's structured-finance operation.

"In so doing, Lehman Bros. did nothing short of 'stealing' property" of American Home, the company said.

Improper margin calls are clearly hitting below the belt.

Here's an interesting illegal procedure case from October 24: Couple sues subprime lender New Century Mortgage Co

A Lowell couple is suing their subprime mortgage lender in Hammond federal court in an attempt to rescind their $126,000 home-equity loan, alleging the company did not disclose the terms of the deal.

Kerry and Susan Burke argue the New Century Mortgage Co., which went bankrupt earlier this year amidst the subprime industry meltdown, should have disclosed their mortgage payments were due each month.

The case was filed by Chicago class-action lawyer Daniel Edelman, who said the Burkes and other people in the same situations could have their home-equity mortgages rescinded.

"If you can rescind it, you can have all the payments applied to the principal," Edelman said. "So it could solve your predatory lending problem."

The Burkes' case is based on a legal technicality. Although their mortgage paperwork states at least 11 times that the payments are monthly, a separate form called the Federal Truth-In-Lending Disclosure Statement does not explicitly make that statement.

The ability to rescind a mortgage for violating the Truth-in-Lending Act in this way only applies to home-equity loans, not mortgages used to buy new or existing homes.

On October 24, in a corporate hockey match, HSBC sued over asset-backed commercial paper, subprime

HSBC Holdings Plc’s Canadian unit became the first financial adviser in the country to be sued over investments in asset-backed commercial paper that were frozen following the U.S. subprime mortgage industry collapse.

Aastra Technologies Ltd., which makes telecommunications equipment, filed the suit today in Ontario Superior Court, alleging HSBC and adviser Nicolas Del Sorbo gave bad advice in recommending asset-backed commercial paper investments.

The assets have been frozen since August. Asset-backed commercial paper consists of short-term notes issued by special-purpose trusts created to hold longer-term investments.

Del Sorbo “acted negligently in failing to perform the necessary investigations'’ of the investments, Aastra said in its complaint. “But for Del Sorbo’s representations, Aastra would not have made the investment.'’

On October 23 American Home Units Sue BofA For $25M

Three affiliates of bankrupt American Home Mortgage Holdings Inc. have accused Bank of America NA of reneging on swap agreements in which they are entitled to more than $25 million.

Broadhollow Funding LLC, Melville Funding LLC and a unit of American Home filed an adversary suit on Monday in a Delaware bankruptcy court which seeks to hold BofA accountable for a shortfall in their sale of American Home...

I have inside knowledge on this one. I know for a fact that the game being played was Euchre. Those who guessed Bridge simply guessed incorrectly. $25 million for a reneg in Euchre is indeed quite high stakes.

On October 19th HSBC was sued over subprime bond valuation

U.K. banking group HSBC is being sued by U.S. real-estate fund Luminent Mortgage Capital Inc. over allegations the bank's U.S. mortgage-trading operations took advantage of the recent credit crisis to profit at the fund's expense, according to a report in the Wall Street Journal. Luminent is claiming that HSBC applied an improperly-low valuation to several subprime-mortgage bonds that were used as collateral for loans, the newspaper reported. The complaint says HSBC bought the bonds at a deep discount to their fair value, the Journal said.

On October 18th State St. Sued Over Subprime Investment "Gamble"

State Street Bank and Trust Co. and its advisory firm have been hit with a purported class action for allegedly investing pension plan funds meant for low-risk investments into high-risk mortgage-backed securities which tanked after the subprime mortgage meltdown.

On October 6th, Subprime lender Fremont sued under predator law
The Massachusetts attorney general's office has sued Fremont Investment and Loan, once the state's second-largest subprime lender, accusing it of using predatory lending practices to sell loans to some borrowers who eventually lost their homes or had to file bankruptcy.

The attorney general is seeking fines from Fremont for violating the state's 2004 antipredatory lending law, which bars lenders from making loans that customers are unable to pay, as well as compensation for borrowers.

In a statement, Fremont General Corp., the Brea, Calif., parent company of Fremont Investment, said that it continues to work with regulators around the country to modify loans for customers struggling to make their payments. The company said it is "regrettable that the Massachusetts attorney general has abandoned these cooperative efforts to help borrowers keep their homes."

The above is a clear case of encroachment. Fremont is accused of sticking its neck into disallowed territory.

On October 2 State Street Sued by Prudential Over Subprime Losses

Prudential Financial is suing State Street because of $80 million in losses in two State Street funds caused by "undisclosed, highly leveraged" investments including subprime mortgages. Prudential says the losses were in accounts held by 28,000 individuals in 165 retirement plans that it markets.

Obviously the above is a boxing match between two middle-heavyweights.

This is but a drop in the bucket of an upcoming firestorm of litigation. Have your scorecards ready. Be sure to keep track of all the penalties. Also note on your scorecards the sport or game being played.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Stock Buybacks: A Good Thing Or Slipped DISCs?

When a company announces share buybacks, is that a sign that good things are coming? Does management really know what it is doing? Do analysts following those CEOs know what they are doing? If a guy is a CEO he must know what he is doing, right?

Let's explore those questions starting with a February press release from Ambac (ABK), followed by set of Emails I received last weekend from a contact at Morgan Stanley. The Emails are about stock buybacks and internal research at Morgan Stanley related to Ambac.

Here is the press release from Ambac.

Feb. 12, 2007--Ambac Financial Group, Inc. (ABK) today announced the closing of 6.15% $400 million Directly-Issued Subordinated Capital Securities (DISCS(SM)). The DISCs were sold at a discount to par to yield 6.199%. Ambac will use all of the net proceeds from the offering and additional funds to purchase $400 million worth of shares of its common stock. The common stock will be purchased through an accelerated share repurchase agreement.

Morgan Stanley Comments Feb 2007

Ambac Financial announced AMC that they have closed on a $400mln offering of Directly-Issued Subordinated Capital Securities (DISCs).

This is a positive surprise since most investors did not expect/saw any meaningful share repurchases in 1Q06 or 4Q06.

Ken Zerbe is increasing his price target following his recent meeting with the CEO of ABK. Ken felt the meeting was positive and provided him with greater confidence in the long-term story of ABK. His price target increases from $98 to $100 and EPS estimates remain above the street at 2007 $7.97 and 2008 $8.78.

My contact at Morgan Stanley, who for obvious reasons wishes to remain anonymous made the following sarcastic comments at the time of the stock buyback announcement.

Ambac Financial, a New York-based insurance and financial services company, has just issued $400 million worth of new debt in complex hybrid debt notes, so-called Directly-Issued Subordinated Capital Securities (DISCs). ...

Why issue 400mln worth of debt to buy 400mln worth of stock, when one can issue 800mln worth of debt to buy 800mln worth of stock? Another question for another time would be: if the company generates so much extra cash flow to pay the very substantial cost of this transaction plus the very substantial interest on the debt, why not just buy the stock in the open market with its own cash?

Think about the complexity of the deal; think about the work that has been done by lawyers, underwriters, analysts, brokers, compliance people, technology professionals, etc. All of them need to be paid. Think about the very complex nature of this debt, which will be sitting in someone's books as an asset; think about all the even more complex derivatives that will be, without question, created based on this debt.

Heck, we should all be grateful to ABK: This deal, as absurd as it is, has done its small part to maintain all this complexity for another 15 minutes.

Inquiring minds are wondering what the CEO and former CEO (current director) were doing with their own money shortly after the buyback announcement.

Director (former CEO) Phillip B. Lassiter Dumps Shares



click on chart for a sharper image

Current CEO Robert Genader Dumps Shares



Click here for all Ambac insider transactions over the last 2 years

Ambac (ABK) Daily Chart



Flashback August 16, 2007

Morgan Stanley cuts Ambac target on possible CDO losses

The brokerage, which has an "overweight" rating on Ambac, cut its price target on the stock to $92 from $100 and said Ambac could face losses of $1.3 billion to $5.0 billion. Analyst Ken Zerbe said he was building in a subprime/CDO loss expectation of $1.8 billion pretax, which he assumed the company will take beginning in 2008 through 2011.

Let's do the Math

At current share prices Ambac has lost $200 million+- on share buybacks, not counting interest on the debt and transaction fees.

Meanwhile, former CEO Phillip B. Lassiter somehow had the foresight to dump $10.37 million worth of shares that would now be worth $5.18 million+-. In addition, current CEO Robert Genader had the foresight to dump $10.20 million worth of shares that would now be worth $5.00 million+-.

Clearly these guys are worth the big bucks because they alone know how to make these kind of mission critical decisions.

Non-Performance Rewarded

Professor David Nelson is asking Does Executive Compensation Pass the Smell Test?

Page after page has been written about Merrill Lynch (MER), the $8 bln loss and the failure of risk managers at not just Merrill but many of the U.S.' top financial institutions.

When Robert Nardelli was ousted as Chairman and Chief Executive of Home Depot (HD) he received over $200 mln in severance compensation. Now we find that Stan O’Neil, the controversial and soon to be ex-CEO of Merrill Lynch, would have received over $200 mln if there was a change of control at Mother Merrill.

With the company reeling from recent financial losses and the stock down significantly how does a shareholder maintain confidence that management is working on their behalf?

Forgive me for being so cynical but why should anyone think management is acting on behalf of shareholders? Time and time again, history has proven otherwise. Insider greed has never been greater.

What do we have to show for it?

• Overbuilding of houses by homebuilders (TOL, WCI, PHM, DHOM, CTX, etc).
• A "Dancing Price", SIV problems, and Enron Accounting at Citigroup (C).
• Banking problems everywhere related to mortgages.
  
• Two Bears Stearns (BSC) hedge funds go to zero.
• Enormous shareholder dilution in the number of options granted to insiders at Google (GOOG), Broadcom (BRCM), and for that matter many tech companies.
• Countrywide (CFC) CEO Mozilo cashes out $1 billion worth of stock a while running the company into the ground.
• Earnings are "managed" to beat the street by a penny practically everywhere even if it means holding assets off the balance sheet, stuffing the channel with merchandise, playing games with pension assumptions, stretching to the limit accounting practices, etc..
• Insiders have been bailing like mad, and in some instances borrowing money to do so.
  
• Dividends are in the sewer.

If corporations want to align themselves with shareholders there are numerous things they can do. Here are four of them.

1) Increase dividends
2) Stop managing earnings
3) Reduce executive compensation
4) Reduce option expenses

Imagine there was one major homebuilder that instead of buying more and more land at ever increasing prices was instead paying huge dividends for the past 5 years. Who would be ahead of the game now? The answer should be clear, both the corporation and the shareholder. Arguably the CEO would be behind because of stock options.

Stock options encourage excessive risk taking to the point of ridiculousness. But when the inevitable collapse comes, the CEOs don't care, they have all cashed out hundreds of millions. In the case of Countrywide, over a $billion. It's sad to say, but in many corporations shares were repurchased with borrowed money even as insiders were bailing.

Question: With the company reeling from recent financial losses and the stock down significantly how does a shareholder maintain confidence that management is working on their behalf?

Answer: One can't. If you start with that assumption you will be far better off.

Addendum

Thanks to EconShift for the following information:

The selling plan used by the Director was implemented on Jan 31st, 2007. That was while the DISC was being finalized.

The selling plan for Genader was cleverly implemented after the fact on March 31st 2007.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Problems Delayed Are Not Problems Solved

Reuters is reporting Stressed US borrowers use plastic to delay default.

In August 2006, Reeves and her husband bought a $214,000 home with almost no money down, leaving them with a monthly payment of $1,636 -- higher than they planned on, especially with her husband's furniture sales job largely commission-based and business not good due to the U.S. housing slowdown.

But as part of her efforts to avoid defaulting on the mortgage, Reeves said she has "maxed out" all her credit cards, spending to the limit on basic needs. "Now all I'm doing is making the minimum monthly payments."

"When credit conditions dry up, marginal borrowers turn to plastic," said Merrill Lynch North American Economist David Rosenberg. "We're seeing signs of that already."

In an October 5 research note, Rosenberg called rising credit- card delinquency rates as the "next skeleton in the closet."

"Our biggest concern right now is that there are lot of people who will face a choice between bankruptcy or foreclosure," he said. "Either way, it's going to suck."

HOLDING OFF THE TIDE?

Nancy Barba -- a financial counselor at a local community group, the Resurrection Project -- helped Johari Reeves negotiate her latest attempt at a repayment schedule for her mortgage.

"The credit cards will be a problem later," Barba said. "But right now, the main concern is the house."

How much bad advice is being given by credit counselors to keep them in their homes? If Barba is any guide, perhaps a ton of it. Postponing problems is not a solution, it merely makes them worse. And certainly maxing out credit cards to pay the mortgage is not clear thinking.

In this case, the problem is the house. Reeves cannot afford it. With maxed out credit cards, a small reduction in a loan rate is not going to help much either given Barba's admission that "credit cards will be a problem later".

Reeves ought to be talking to a bankruptcy lawyer. Instead, Barba is doing everything possible to keep the albatross around Reeves' neck.

Barba says "Right now, the main concern is the house." In actuality, the main concern should be how to get rid of the house, not how to keep it. The house has to go. It can go now or it can go later after more money is wasted making minimum payments on credit cards.

Life would be so much simpler if Reeves started all over renting an apartment she and her husband can comfortably afford, while saving money for a rainy day (or a house they can afford sometime down the road). Instead they are paying usurious credit card rates and sinking further behind on a house that is likely declining in value.

Everyone is doing their part to make people debt slaves forever. Even financial counselors are in on the act.

Mike Shedlock / Mish

Pent Up Housing Supply

Recent data shows U.S. Home Vacancies Rise to New Record.

A record 17.9 million U.S. homes stood empty in the third quarter as lenders took possession of a growing number of properties in foreclosure.

The figure is a 7.8 percent gain from a year ago, when 16.6 million properties were vacant, the U.S. Census Bureau said in a report today. About 2.07 million empty homes were for sale, compared with 1.94 million a year earlier, the report said.

New foreclosures have risen to a record, led by defaults in adjustable-rate loans to people with tainted or limited credit histories, according to the Mortgage Bankers Association. Home- price declines and tougher lending standards are making it difficult for owners who fall behind in mortgage payments to sell or refinance into better loans.

The U.S. homeownership rate fell for the fourth consecutive quarter to 68.1 percent, seasonally adjusted, from 68.9 percent a year ago, the report said.

Let's stop right there. Did you catch it?

• A record 17.9 million U.S. homes stood empty in the third quarter.
• A mere 2.07 million empty homes were for sale.

Let's do the math.
There are 15.83 million vacant homes just sitting there. How long can that last?

That is a huge potential supply of homes that for some reason or other is not listed yet. I suspect many of those are REOs (real estate owned ) by banks and mortgage companies like Countrywide. Every passing month those REOs sit on the books waiting for higher prices is lost property taxes, upkeep costs, and balance sheet impairment.

Every month the figures get worse. For example, Countrywide has 13,000+- REOs for sale, but they also have 82,000 foreclosures. That alone represents significant pent up supply as those foreclosures become REOs. See Option Arm & REO Problems At Countrywide for more information.

Add to that pent up supply are those with a second home who want to sell it as soon as they can "get even" on it. In the meantime those people are "content" to rent. That contentment will turn to sour milk given enough time, or any problems necessitating a sale sooner rather than later.

This kind of supply can last for years. In fact, as home prices sink, this kind of supply can grow as people become disgusted with the idea that "real estate prices always goes up".

The siren song from Realtors is that now is the best time to buy ever. Straight up it's easy to see that is a lie. The best time to buy was 10 or more years ago and the best time to sell was in 2005. It's still a long way down from here. Rising inventory, falling prices, and pent up supply should be proof enough.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Basket of Insanity at OPEC

I am somewhat leery of this news source, but let's presume for a moment that OPEC will study currency basket for pricing.

OPEC is likely to discuss creating a basket of currencies for oil pricing at its next summit due to the steady decline in the dollar, Venezuela's Energy Minister Rafael Ramirez said.

"The need to establish a basket of currencies ... will probably be a point of discussion in the next OPEC summit," Ramirez told reporters during an evening event in the presidential palace.

Consider for a moment the US Dollar Index
Here are the relative weightings

• Euro 0.576
• Yen 0.136
• Sterling 0.119
• Canadian Dollar 0.091
• Swedish Kroner 0.042
• Swiss Franc 0.036

Imagine that you were to buy gold and had to consider the value of the Swedish Kroner, the Yen, the Pound, etc. No one buys gold this way. Gold is priced in dollars but people go into the nearest gold dealer (or online dealer) and buy gold in whatever currency they want, 24 hours a day, 7 days a week. Pricing gold in a basket of currencies simply makes no sense. The quote is always in one currency, but the currency can be ANY major currency.

Pricing oil in a basket of currencies makes no sense either, even if one eliminates oddballs like the Swedish Kroner. I am assuming that "basket" means some sort of blended price just as the U.S. dollar index is.

People buy things with local currencies. It makes no more sense to price oil in a basket of currencies than it does to price a loaf of bread at the grocery store in a basket of currencies.

I expect dollar bears are gloating over this nonsense. However, even if OPEC was to proceed with this insanity, it simply would not change a thing. In less than a day there would be individual quotes for oil in any and every currency individually, just as there is now.

Practical Example of the Silliness of Basket Pricing

If bread or T-Bone steaks in the U.S. were priced in Euros (or a basket of currencies) tomorrow, would it change the price in dollars? The answer is of course not. All that would happen is that the frequency of quoted price changes would increase.

For example, if T-Bone steaks were advertised at $4.99 lb for a week they would remain on sale at $4.99 lb for as week even though a quote in Euros or a basket of currencies would change daily. It would not make any sense to advertise T-Bone steaks in a basket of currencies because no one is carrying a basket of currencies in their wallet or their checking accounts. It would also be enormously confusing to consumers.

Hopefully, this simple example shows it would actually be complete foolishness for butchers and bakers to price bread and steaks in a basket of currencies. The same applies to oil.

Pricing Units vs. Reserve Units

Pricing oil in Euros or Yen would not matter one bit. Given that currency conversions are instantaneous, 24 hours a day, 7 days a week, as a practical matter oil is already priced in any currency anyone wants. One does not need dollars to buy oil.

Furthermore, if one is sure the Yen or British Pound is going to rise vs. the dollar then one should hold Yen or Pounds (not dollars) to buy oil with. Yes, it really is that simple.

I have said this before and I will keep saying it until everyone understands it: It does not make any difference what currency oil is priced in, and that logic can be expanded to include baskets of currencies.

However, It does however matter where the oil producers hold their reserves. I failed to bring up this point in What Factors are Affecting the U.S. Dollar?

Pricing units are one thing, willingness to hold dollars is another. Indeed, decreasing willingness by the oil producers to hold dollars likely accounts for some of the recent strength of the Euro.

Furthermore, this decreased willingness by the oil producers (and other countries including China) to hold dollars is part of a growing anti-dollar sentiment. Sentiment, at least in the short term, is the most powerful force driving currencies.

Misguided Mad Dash Into Euros

Fundamentally speaking, the ongoing mad dash out of dollars into Euros is misguided.

My rationale is:
1) Europe is printing money faster than the U.S.
2) Credit in Europe is expanding as fast as in the U.S.
3) Interest rates are higher in the U.S. than Europe (at least for now).

A mad dash into Yen would make more sense from a monetary perspective, but that play is avoided because interest rates in Japan are too low.

Eventually, all currencies (except gold) go to zero. The only difference is the speed at which they get there. Warranted or not on relative merits, the U.S. dollar is winning the race among major currency pairs.

Politics Vs. Need

Let's return the article for one last look:

"The need to establish a basket of currencies ... will probably be a point of discussion in the next OPEC summit," Ramirez told reporters during an evening event in the presidential palace.

As discussed above there is absolutely no "need" for OPEC to do anything.

Given that both Venezuela and Iran already hold no dollar reserves, it is highly likely this story is nothing but a political ploy by Venezuela, with no practical relevance.

Ignoring the political aspects, if OPEC actually does have a discussion on pricing oil in a basket of currencies that is not dismissed in 1 minute flat, they are wasting time at best or proving themselves to be complete fools at worst.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Drop in Revenue Growth at State and Federal Level

The White House budget chief is seeing a drop in revenue growth.

The federal government is seeing a drop in the rate of growth of revenue as the debt crisis starts to slow economic growth, said Jim Nussle, the White House Budget chief. Asked on CNBC if the White House was seeing a drop in revenue growth, Nussle replied: "we're starting to." Private and government economists are forecasting a slight slowing in the U.S. economy, but are not projecting a recession, Nussle said

In California Schwarzenegger's Fiscal Discipline Shattered by Subprime Slump

Four years after Arnold Schwarzenegger was elected governor of California, vowing to "tear up the state's credit card," the actor and former body-builder is about to charge $7 billion to taxpayers' accounts.

My Comment: Using the words "Fiscal Discipline" and "Arnold Schwarzenegger" in the same sentence together is a joke unless there is a "negative" in the sentence somewhere.

California is selling notes tomorrow due in eight months to help pay its bills until tax revenue comes in, the largest short-term loan since Schwarzenegger took office and almost five times more than last year. Debt is increasing after cash receipts fell $777 million below the state's projections during the first three months of the fiscal year that started July 1.

My comment: Selling bonds with a promise to pay back later is Schwarzenegger's answer to every problem. In March, Schwarzenegger asked for $500 billion to rebuild California.

Sound Bytes From The Above Link

• It will take $500 billion to "rebuild California the way it ought to be".
• $500 billion is "too big for people to digest, so you don't talk about that" even though he is talking about it.
• California needs $500 billion even though it has "done tremendously with the revenue increases".
• California will not issue less debt even if the economy slows.
• California "could face lower tax revenues" but he opposes tax hikes.

The day of reckoning has now arrived. Will he keep spending money he does not have while refusing to hike taxes to pay for it all?

Schwarzenegger is losing the revenue cushion he used to plug budget deficits as home foreclosure rates increase at a faster pace than the rest of the country. The rise in IOUs is an early sign that finances are deteriorating after four years of revenue growth won credit-rating upgrades and spurred gains of more than 20 percent on California bonds.

"A California budget crisis is beginning to recur, and the big increase in short-term seasonal borrowing is the classic leading indicator," said Richard Larkin, a municipal bond analyst at J.B. Hanauer & Co., a Parsippany, New Jersey-based money manager that oversees $10 billion.

My comment: California never left a budget crisis. All it ever did was forestall the day of reckoning. Even that "plan" is now failing. It is going to take increasing revenue to be able to pay back the bonds that were already issued. Now what?

Schwarzenegger, 60, may have to cut spending, said H.D. Palmer, his budget spokesman. The state needs to borrow to shore up its reserves after ending last year with about $6 billion less in cash than fiscal 2006, Palmer said.

My comment: Schwarzenegger has vowed to not cut spending even if revenue growth slows. Schwarzenegger claims he will not raise taxes either. Right now, he is keeping his words. To get by he is playing various shell games.

His latest scheme is to use lottery proceeds to expand health care. Given that lottery proceeds now fund education, the governor's proposal would replace money from the lottery that now goes to education with funds from the state's general fund. Schwarzenegger did not say what would be used to fund the shortfall in the state's general fund.

In the three months ended Sept. 30, the state has spent $10.2 billion more than it received in taxes and fees, according to Controller John Chiang. Officials project a $6.1 billion budget gap in fiscal 2009 between mandated expenditures and projected revenue, up from $1.5 billion in the current year.

My comment: That's quite a feat for someone who vowed to "tear up the state's credit card".

No 'Upside'

Investors require an extra quarter of a percentage point in yield to own California debt instead of top-rated municipal bonds, down from a high of 63 basis points in July 2003, according to data on 20-year bonds compiled by Bloomberg. That was during the height of the budget crisis under Davis.

The bonds have gained 20.8 percent since Schwarzenegger took office in November 2003, compared with 19.9 percent for the broader municipal market, according to indexes compiled by New York-based Merrill Lynch & Co.

"There doesn't appear to be much upside potential,'' Brennan said.

My comment: No upside in California bonds is correct. California will likely default at some point, but that could be many years away. In the meantime however, Moody's, Fitch, and the S&P are going to have to start lowering California's debt rating. That will increase the state's borrowing costs looking ahead.

The state had the third-highest foreclosure rate in September, or one for every 253 households, according to RealtyTrac Inc., an Irvine, California-based company that has a database of more than 1 million properties from 2,500 U.S. counties. Only Nevada and Florida had higher foreclosure rates.

Home sales have declined 23 percent this year, the California Association of Realtors said Oct. 10. The trade group estimates a decline of 9 percent in 2008.

My comment: The foreclosure party in California is just beginning. Unemployment is going to rise and commercial real estate prices will plunge as well.

Schwarzenegger campaigned on a promise to rein in spending without raising taxes. "We tore up the credit card," he told lawmakers during his first State of the State speech in January 2004. "Never again will government be allowed to spend money it doesn't have. Never again will the state be allowed to borrow money to pay for its operating expenses."

My comment: Obviously every bit of that is a lie, except perhaps for not raising taxes.

Revenue drops are now being seen in many states, not just California. See Grim Forecast for State Budgets for more details.

Amazingly enough, no one sees a recession coming, even though it is likely we are already in one. I am not the only one who feels that way. U.S. "undoubtedly in recession" says Jim Rogers.

Officially, the U.S. is not in a recession, but housing already is and retail spending is quickly headed there. In real (inflation adjusted) terms, retail spending is also in a recession. Revenue declines are looking recessionary as well. Finally, the first 2 percent of GDP is hedonics and imputations and fictional reporting that increases every year.

Whoever the next president is will backdate the start of the recession as much as possible, to prove it did not start on their watch. So even if the official stats don't show it now, GDP will be revised to show it a couple years down the road. That is the way the game is played.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Mammoth Short Squeeze in Countrywide

Countrywide posted an enormous $1.2 billion loss but Mozilo's statement that Countrywide projects return to profit sent shorts scrambling for cover.

Countrywide's quarterly net loss, its first in 25 years, totaled $2.85 per share and reflected about $2.9 billion of write-downs and credit losses. A year earlier, profit was $647.6 million, or $1.03 per share. Analysts on average expected a loss of $1.65 per share, according to Reuters Estimates.

The company wrote down $1 billion related to capital market disruptions. It set aside $934.3 million for credit losses, up from $38 million a year earlier, as more borrowers fell behind on payments, particularly on adjustable-rate and prime home equity loans. Other credit costs totaled $981 million.

'PERFECT STORM'

Countrywide said the third quarter represented an "earnings trough." It forecast fourth-quarter profit of 25 cents to 75 cents per share, and a profitable 2008, with a 10 percent to 15 percent return on equity. It also said it has negotiated $18 billion of "highly reliable" new liquidity.

Countrywide said borrowers were behind in payments on 29.08 percent of subprime loans it services as of September 30, up from 23.71 percent in June. The delinquency rate rose to 5.76 percent from 4.56 percent on prime home equity loans, and to 4.41 percent from 3.35 percent on conventional first mortgages.

"We've seen the perfect storm," Chief Operating Officer David Sambol said on the conference call.

It appears that Countrywide attempted to throw in everything but the kitchen sink into those "one time losses". But even with that strategy it is premature for Countrywide to be acting as if the "perfect storm" is over. Those increases in delinquencies are going to translate into increased foreclosures and increased REOs (Real Estate Owned) sometime down the line.

One has to laugh at the statement that the third quarter represented an "earnings trough." After all, a $2.85 per share loss is quite a "trough". The estimate was a loss of $1.65 per share. It's quite amazing to see a $1.20 per share earnings miss be treated as such magnificent news.

In addition, Countrywide appears to be bragging about securing another $18 billion in "highly reliable" credit lines. Instead investors ought to be worried about the possibility that Countrywide will again need those credit lines.

Finally I am noting that S&P credit analysts downgraded Countrywide one notch to "BBB-plus", the third lowest investment grade. Why it is investment grade at all remains a mystery.

However, the market as spoken and those issues are now "tomorrow's business".

Today the market has responded as if it believes those "one time" charges are a thing of the past and the perfect storm is now over. We will see.

Meanwhile, practical investors are wondering if there is a practical way to look at earnings. Indeed there is. In case you missed it, here it is, from Mr. Practical himself.

Practical Earnings

Back in the 1960s stock analysts began to compute operating earnings. Companies were regularly reporting gains from activities separate from their core business, so analysts began subtracting gains and losses from earnings that they did not expect to repeat. In those days operating earnings were almost always less than net earnings so analysts were being more conservative by computing price to earnings ratios in this manner.

Since 1990 this relationship between operating earnings and net earnings has completely reversed: operating earnings are almost always higher than net earnings because companies regularly show losses that they say are not recurring. Yet for anyone who cares to open their eyes, those losses seem to recur very frequently.

If you really study today’s PE ratios and compare them to yesterday’s methods, stocks are at least 20% higher in valuation.

As today’s banks take “write-off” after write-off, some as large as last years total earnings, the market seems to be finally catching on that these losses are not one time and are the direct result of core business activities gone bad.

But don’t forget the manufacturing companies that are doing the same thing. We long ago gave up as archaic looking at dividend yields and book value as tools to value stocks.

Perhaps as a measure of risk, you should check your favorite stocks for these. Maybe it has a lot more downside than you guessed.

Mr. Practical

The bulls won today with a Microsoft (MSFT) and Countrywide Financial (CFC) sponsored love fest. Let's see how long it lasts.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Economic Zugzwang: Whoever Moves Loses

Curve Watcher's Anonymous is once again eying the yield curve and mortgage rates following yet another set of horrible existing home sales and news home sales numbers.

See Housing - The Worst Is Yet To Come for my take on future home sales, prices, and a possible hint at where the bottom might be.

See New Home Sales; Price Capitulation? for Prof. Depew's take on the magic of reporting new home sales.

Yield Curve As Of 2007-10-24



click on chart for a sharper image

There has been a strong rally in treasuries (lower yields) in conjunction with consistently weak economic data. However, in spite of a 100 basis point (1%) cut in the discount rate, and a 50 basis point (.5%) cut in the Fed Fund's Rate as compared to a year ago, Curve Watchers are noting that 30 year mortgage rates are almost exactly where they were a year ago, and 1 year ARM rates are substantially higher than a year ago. 15 year fixed rates are lower than a year ago, but only by a mere 11 basis points.

The picture is even worse than it looks however, because the above rates are for prime borrowers with a reasonable down payment. Subprime borrowers are facing resets substantially higher. Someone struggling to make a home payment at a teaser rate of 3% is going to be in serious trouble at 9%.

So the idea that these rate cuts are going to do anything to help borrowers in trouble is seriously misguided. However, that is not stopping Bernanke from trying. Certainly the market is now expecting the Fed to cut rates.

With that in mind, Curve Watcher's Anonymous is noting a striking similarity between recent yield curve action and that in 2001. Let's take a look.

Yield Curve 1999 - 2007



click on chart for a sharper image

In the above chart

$TYX is the yield on the 30 year long bond.
$TNX is the yield on the 10 year treasury note.
$TYX is the yield on the 5 year treasury note.
$IRX is the discount on the 3 month treasury bill.

Take a good look at the above chart. Haven't we seen this series of plays before?

There's only three small problems. The last time the Fed embarked on a slash and burn campaign lowering interest rates, the U.S. dollar index was sitting near 120, gold was near $300, and oil was near $20. Now the dollar index is under 80, gold is over $700, and oil is over $80.

The second problem is the Fed created a housing bubble (and lots of jobs) the last time they tried slashing interest rates. Who needs a house now that does not already have one (or two or three)? Should the Fed dramatically lower rates again, where are the jobs going to come from?

The third problem is that drug induced highs need stronger and stronger doses to maintain the same high. There is not much room below interest rates of 1 to even think about a higher high.

High energy prices and falling home prices are two things of concern to consumers. The irony of the situation is that the only way oil prices are likely to sink is if the U.S. heads into a recession and/or the dollar strengthens considerably.

The Irony of Bernanke's Predicament

High energy prices and falling home prices are two things of concern to consumers. The irony of the situation is that the only way oil prices are likely to sink is if the U.S. heads into a recession and/or the dollar strengthens considerably.

Bernanke is acting to prevent said recession by cutting rates. Good luck with home heating season is coming up. If Bernanke does not cut rates, it will hasten the recession. A recession is badly needed I might add, but Bernanke does not see it that way.

In addition the U.S. Dollar is likely to rally if the Fed pauses because rate cuts are priced in. Given that the dollar and the stock market have been inversely correlated for quite some time, if Bernanke acts to shore up the dollar by failing to cut rates, the stock market is likely to take a big hit.

I call this situation Economic Zugzwang.
There are no winning moves.



Trébuchet
Bernanke, it's your move.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

When Will Housing Bottom?

Those looking for a housing bottom anytime soon are likely to be disappointed. Let's see why from three different angles:

• Mortgage Rate Resets in Conjunction With a Consumer Led Recession
• Historical New Home Sales
• Historical Housing Starts
  

On the basis of mortgage rate resets and a consumer led recession I mentioned a possible bottom in the 2011-2012 timeframe.

See Housing - The Worst Is Yet To Come for more details.

Let's take a look at housing from another perspective: new home sales historic averages and housing from 1963 to present.

New Home Sales 1963 - Present

New home sales reached a cyclical high in 2004-2005 approximately 50-60% higher than previous peaks.This happened in spite of a slowdown in population growth and household formation as compared to the 1960-1980 timeframe.

From 1997-1998 and 2001-2002 to the recent peak, the average sales level was 1.1 million units, or 45-50% higher than the 40 year average. This translates to an average of 300,000-400,000 excess homes for nearly a decade, and arguably as many as 3-4 million excess homes.

Such excess inventory may require as many as 5-7 years at recessionary average sales to absorb this inventory. The following charts are from a friend who goes by the name "BC".



click on chart for a much sharper image

Housing Starts 1959 - Present



click on chart for a much sharper image

Flashback Of The Week

Here is the flashback of the week with thanks to Toddo on Minyanville for the link.

October 27, 2005
Bernanke: There's No Housing Bubble to Go Bust

Toddo's comment: "Don't you feel better knowing Bernanke's on the case?"

My comment: Was that a blatant lie or is Bernanke the dumbest PhD in history? Also note his timing. Bernanke made that statement right as the bubble was busting. Housing peaked the summer of 2005.

Cycle Excesses Greatest In History

The excesses of the current cycle have never been greater in history. The odds are strong that we have seen secular as opposed to cyclical peaks in housing starts and new single family home construction. With that in mind it is highly unlikely we merely return to the trend. If history repeats, and there is every reason it will, we are going to undercut those long term trendlines.

There will be additional pressures a few years down the road when empty nesters and retired boomers start looking to downsize. Who will be buying those McMansions? Immigration also comes into play. If immigration policies and protectionism get excessively restrictive, that can also lengthen the decline.

Finally, note that the current boom has lasted well over twice as long as any other. If the bust lasts twice as long as any other, 2012 just might be a rather optimist target for a bottom.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Downshift In Consumer Spending Mindset

Talbots, a specialty retailer, slashes fall forecast, sees a loss.

Talbots Inc. on Wednesday revised its forecast for the fall season, citing weaker than expected sales in its namesake brand, and said a gloomy economy is weighing on consumers. Talbots said in addition to its lackluster sales, it's being hit by an increasingly conservative "consumer spending mindset," dismal industry outlook for the holidays and an uncertain economic environment.

The company also said it will be out of compliance with its financial covenants.

For the third quarter, Talbots (TLB) expects a loss in the range of 20 cents to 25 cents a share, including 7 cents a share of one-time expense related to executive compensation and professional consulting fees. For the fourth quarter, Talbots currently anticipates a loss per share in the range of 5 cents to 10 cents, including 9 cents a share of one-time expenses.

Earlier this month The Gap (GPS), Target (TGT), J.C. Penny (JCP), Wal-Mart (WMT), Nordstrom (JWN), and the Children's Place (PLCE) all lowered earnings estimates blaming "warm weather".

See Cargo Decline Portends Consumer Weakness and Heat Cools Retail Sales for more on the lame weather excuse.

The key sentence in all of this is easy to piece together: "The consumer spending mindset is increasingly conservative." One by one, and store by store, consumers are throwing in the towel. This does not bode well for retail store expansion, holiday sales, or hiring plans. It also does not bode well for an economy 100% dependent on an ever increasing expansion of credit.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Housing - The Worst Is Yet To Come

The housing industry plunged deeper into recession as existing home sales plunge 8 percent.

The U.S. housing industry plunged deeper into recession last month as the August credit-market collapse made it harder for buyers to obtain loans.

Sales of previously owned homes fell 8 percent in September to an annual rate of 5.04 million, the fewest since records began in 1999, the National Association of Realtors said in Washington. The decline was almost twice as steep as economists forecast, while the median price dropped the most in almost a year.

"The worst isn't behind us, the worst is here right now," said Jonathan Basile, an economist at Credit Suisse Group in New York.

The inventory of single-family homes represented a 10.2 months' supply, the most since February 1988.

Pending sales plunged 6.5 percent in August to the lowest level on record following an 11 percent plunge in July. The measure tracks contract signings, while the figures on sales of existing homes are based on closings, which usually occur a month or two later.

The real-estate agents' group this month reduced its sales forecast for the 10th time this year.

D.R. Horton Inc., the second-largest U.S. homebuilder, said Oct. 16 that orders in the fiscal fourth quarter plunged to the lowest in almost six years as customers backed out of purchases and banks restricted lending.

There is no rational basis for anyone to suggest the worst is right here right now. But that does not stop anyone from trying (and they have been trying for months on end).

Once again the NAR is putting lipstick on a pig with their report Mortgage Availability Improving But Hampered September Existing-Home Sales.

Temporary problems in the mortgage market are easing and are expected to free some pent-up demand, but disrupted existing-home sales and distorted prices on sales closed in September, according to the National Association of Realtors®. Even so, prices rose in the Northeast and Midwest.

My Comment: Pent up demand? The only thing there is pent up demand for is selling. People are so far under water they are praying to sell at a higher price to avoid foreclosure.

The third quarter finished better than expected, with a 5.42 million annual rate of existing-home sales versus the 5.38 million forecast by NAR.

My comment: If you set the bar low enough, eventually you can stumble over it.

Lawrence Yun, NAR senior economist, said the decline is understandable. “Mortgage problems were peaking back in August when many of the September closings were being negotiated, and that slowed sales notably in higher priced areas that rely more on jumbo loans,” he said.“

My comment: Once again there is no rational measure or reason for suggesting that mortgage problems peaked in August.

"It appears raw inventories are stabilizing, but the housing supply is a bit inflated now because the sales pace does not reflect underlying market conditions – sales were dampened by the mortgage cancellations," Yun explained.

My comment: The inventory of supply of is now 10.5 months up from 9.6 months is August. Is this stabilization? One of the reasons raw numbers appear to be holding is people are pulling listings off the market praying for better prices. Many people who want to sell cannot sell because they are too far under water. These people represent pent up selling demand not pent up buying demand.

“Once the pent-up demand begins to move, we’ll see housing supplies begin to ease and then prices will edge up.”

My comment: What year is that? We have upcoming issues with mortgage resets as the following chart shows.


Subprime resets peak this year but Alt-A problems which are just as big do not peak until 2011. In addition the overall economy is slowing dramatically. There is going to be consumer led recession to deal with. Unemployment has bottomed this cycle and is bound to rise dramatically. That will further pressure housing prices in a very significant way. The worst (by a long shot) is yet to come. Remind me to start looking for a true bottom in 2011-2012. Perhaps we get a bounce somewhere along the way.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Bad Breadth and Smelly SOX

Of the 400 NASDAQ points we're up this year 206 came from three stocks

• Apple (APPL) 127
• Research in Motion (RIMM) 47
• Google (31)
  

Tip of the hat to Toddo for that fact.

The Nasdaq Index was up 47+ points Tuesday. Inquiring minds are asking how many stocks participated in the rally. The answer was 47 (headed into the close).

Tip of the hat to Professor Bennet Sedacca for pointing this out.

Smelly SOX



Click on chart for a sharper image.

The $SOX is up for the year but barely. It would not take much at this point to put it into the red.

Broadcom Daily Chart



Click on chart for a sharper image

Broadcom is 9.25% of the $SOX. So even within Ole Smelly, it pays to be selective. However, after hours Broadcom was down 11% to $37.35 so we may find out Wednesday that semiconductors are no longer positive for the year.

Semiconductor PEs & SOX Weightings

Altera (ALTR) PE 24.81 - 5.17%
Advanced Micro (AMD) negative - 3.05%
Broadcom (BRCM) - PE 97.36 - 9.25%
Intel (INTC) - PE 25.21 - 5.91%
KLA (KLAC) - PE 20.32 - 11.84%
National Semiconductor (NSM) PE 24.44 - 5.83%
SanDisk (SNDK) PE 101.07 - 9.78%
Xilinx (XLNX ) PE 24.58 - 5.75%

Those seven make up 57% of the $SOX index and I see no bargains even after this substantial pullback from the summer highs. Where's the value?

Other Notable PEs

Amazon (AMZN) - 139
Google (GOOG) - 55.91
Research in Motion (RIMM) 81.39
Apple (AAPL) 52.57

Are the implied growth rates of those four remotely justifiable?

When Will Good News Sold?

I keep waiting for good news to be sold. We have seen bad news finally start to matter in the S&P 500, but good news as in today's Apple earnings has been bought to excess as evidenced by excessively bad breadth.

Perhaps Wednesday is the day, perhaps not, but the after hour's indication following Tuesday's narrow rally tech love fest are pointing that direction.

Lets see if it holds, but it appears that Amazon was priced for far more than perfection. Here is the headline: Amazon.com 3Q Profit Skyrockets

• Earnings for the quarter ended Sept. 30 skyrocketed to $80 million, or 19 cents per share, from $19 million, or 5 cents per share, during the same period last year.
• Analysts polled by Thomson Financial forecast a profit of 18 cents per share.
• Revenue climbed 41 percent to $3.26 billion from $2.31 billion in the year-ago quarter. Analysts had predicted $3.14 billion in sales.
• Shares of Amazon.com fell $9.30, or 9.3 percent, to $91.52 in after-hours electronic trading, after adding $9.53, or 10.4 percent, to close at $100.82 Tuesday.

Nasdaq index buyers are dancing the same tune as Citigroup (C) CEO chuck prince who right before the mammoth SIV problem started last summer stated “When the music stops, in terms of liquidity, things will be complicated. But as long as the music is playing, you’ve got to get up and dance. We’re still dancing".

Buyers escaping the mess in financials are now rushing head over heels into the Nasdaq Index without bothering to see what the risks are in technology. For more on this idea see Todd's post Are We At Risk?

Reminiscent of Spring 2000, the Nasdaq index is once again priced for perfection. One thing is certain: Perfection Can't Last.

Addendum:
This post was written very early in the morning. As of 11:00 AM Wednesday, almost off all the Google lovefest has been given back.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Option Arm & REO Problems At Countrywide

Option ARM Delinquencies are Countrywide's New Scare.

Subprime mortgages aren't the only challenge facing Countrywide Financial Corp., the nation's biggest home-mortgage lender. An analysis prepared for The Wall Street Journal by UBS AG shows that 3.55% of option ARMs originated by Countrywide in 2006 and packaged into securities sold to investors are at least 60 days past due. That compares with an average option-ARM delinquency rate of 2.56% for the industry as a whole and is the highest of six companies analyzed by UBS.

My comment: Be prepared for a massive rise across the board on option ARM problems. Another good place to start looking for these problems is at BankUnited. See Disaster At BankUnited for massive increases in negative amortizations stemming from borrowers making minimum payments less than interest due.

Among option ARMs held in its own portfolio, 5.7% were at least 30 days past due as of June 30, the measure Countrywide uses. That's up from 1.6% a year earlier. Countrywide held $27.8 billion of option ARMs as of June 30, accounting for about 41% of the loans held as investments by its savings bank.

It now appears that many borrowers who moved into option ARMs were attracted by the low payments and may have been staving off other financial problems. More than 80% of borrowers who are current on these loans make only the minimum payment, according to UBS.

My comment: this stems from making loans to people who never really qualified for the loans. Option ARMs are history, but the damage has been done.

Countrywide says its potential losses on option ARMs are partially covered by insurance.

My comment: Exactly how good is that insurance? At some point a major insurance company or reinsurance company is going to blow up and cause a cascade of defaults.

Of the option ARMs it issued last year, 91% were "low-doc" mortgages in which the borrower didn't fully document income or assets, according to UBS, compared with an industry average of 88% that year. In 2004, 78% of Countrywide's option ARMs carried less than full documentation.

My comment: Right now the 2005 and 2006 vintages are the worst performing loans. However as home values continue to plunge, loan to values even on earlier loans are going to soar. People (and banks) that thought they had a cushion will find out their safety net is simply gone.

Countrywide also allowed borrowers to put down as little as 5% of a home's price and offered "piggyback mortgages," which allow borrowers to finance more than 80% of a home's value without paying for private mortgage insurance. By 2006, nearly 29% of the option ARMs originated by Countrywide and packaged into mortgage securities had a combined loan-to-value of 90% or more, up from just 15% in 2004, according to UBS.

My comment: There are only two words to describe this. Those words are greed and stupidity. The only other possibility is that Mozilo knew exactly what he was doing and was driving up share price based on short term unsustainable growth.

In one California branch office, employees could win prizes, such as a trip to Hawaii, for selling the most option ARMs.

My comment: See Countrywide Reaps What It Sowed for a look inside its lending practices.

We Don't Want It. You Keep It.

To prevent foreclosures and REOs, Countrywide Launches Program to Refinance or Modify Mortgages.

Countrywide Financial Corp., the nation's largest mortgage lender, said Tuesday it will begin calling borrowers to offer refinancing or modifications on $16 billion in loans whose interest rate is set to adjust by the end of 2008. Its shares fell more than 4 percent.

"Unprecedented times call for unprecedented remedies," Countrywide President and Chief Operating Officer David Sambol said in a statement. "We are determined to assist borrowers who have the willingness and wherewithal to remain in their homes, but need a little help to do it."

[Translation provided by Kevin Depew in point #3 of Five Things: "This House is Your House. Seriously, We Don't Want It. You keep it]


The Calabasas, Calif.-based company said it would reach out to borrowers who are current on their loans but are facing an imminent rate reset to discuss options. Countrywide said it would refinance about $10 billion in loans and modify another $4 billion.

It also plans to contact borrowers of some $2.2 billion who are late on their loans and having trouble paying because of a recent rate reset. In total Countrywide's plan would reach out to about 82,000 borrowers for some kind of relief.

So far this year, Countrywide has completed about 20,000 loan modifications -- a figure that represents less than 5 percent of the more than 500,000 loans the lender reports were behind in payments as of last month.

The figure amounts to about 24 percent of the roughly 82,000 loans the company said were in foreclosure as of September.

500,000 delinquent loans & 82,000 foreclosures

Let's consider the REO (Real Estate Owned) situation.

The Countrywide Foreclosures Blog is reporting Countrywide Financial REO's Off The Charts! at 195,495. All 195,495 listings are posted on the blog, state by state and the source was Countrywide's Owned Properties website.

That is a stunning number but it is either way off base or Countrywide is not fessing up on the number of foreclosures. Officially, Countrywide says there are 82,000 foreclosures.

Countrywide has since modified its version of the data and the official total is back in the 13,000 range where it was a couple of days ago. Given 82,000 admitted foreclosures, 13,000+- REOs seems on the low side.

Some of the blog comments are interesting.

Go Browns:
I just did a random sample on properties they're advertising as "bank owned" with no broker assigned in my state. Most are old REOs that have since been sold to a new party that is NOT in foreclosure, at least not in the public record. This appears to be a screw up. big shocker there....

Bubble Sitter:
A few of the houses on the goof list are ones I have seen and they have sold. Many are ones currently for sale and have a broker assigned. The ones with "no broker assigned" may be unsold additions to the list. I do know of a couple of houses in foreclosure with CFC that are not on the list! My conclusion at this point is the 89,000 REO listed with no broker assigned are going to be on the market soon.

Anonymous:
My home is definitely REO by Countrywide. It's already gone through the foreclosure process. It never appeared on the Countrywide site and still hasn't as of today even though the foreclosure happened months ago. I think it's going to end up at a second auction with one of the brokers soon. Long and short of it they are underreporting their foreclosures and I'm proof of that.

Anonymous:
***UPDATE***
Countrywide is playing with the numbers. My home is listed as of last night and lists the correct realtor whose sign was in the front yard. Today and every other day it's not there, so they are 100% playing games with their data.

I went ahead and checked about 5 other listings. Several are accounts they serviced that have foreclosed and are not re-sold, 1 was like mine.

Whatever got added last night, I'm going to guess at least 5-10% are legitimate foreclosures not reported. Worse, some are like mine that have NEVER been reported and are 1/2 a year old.

Anonymous:
I visited three Yorba Linda properties mistakenly (?) posted on CFC's website on 10/23, and observed all three are vacant properties in various states of distress compared to owner occupied properties. These properties were never listed as CFC REOs prior to 10/23.

Is 195,495 an accidental master list posting of foreclosures for all the properties Countrywide services? Are some of the listings part of the bailout program?

Whatever the answer is, Countrywide made a mistake somewhere. Countrywide has done nothing but make mistakes for years, so another one on the pile should not be so surprising.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/

Disaster At BankUnited

Reuters is reporting BankUnited 4th Quarter Earnings Plummet.

BankUnited Financial Corp (BKUNA) reported a 73 percent fall in fourth-quarter earnings, which was also significantly below analysts' estimate, as loan loss provision quadrupled and non-performing assets rose eight-fold.

The bank holding company posted a profit of $6.4 million, or 17 cents a share for the quarter, compared with $24.2 million, or 63 cents a share, a year ago.

BankUnited's Press Release contains more disasters:

• Option-ARM balances totaled $7.6 billion. Option-ARMs are 70% of the residential loan portfolio and 60% of the total loan portfolio.
• $6.5 billion in Option-ARMs had negative amortization of $270 million
• The growth in negative amortization was $48 million, compared to $46.4 last quarter.
• Total net charge-offs were $5.6 million compared to $1.1 million last quarter.
  
• The provision for loan loss totaled $19.1 million, compared to $4.6 million last quarter.
  
• Real Estate Owned (REOs) rose to $27.7 million from $7.4 million last quarter.
  
• Non-performing assets rose to $208.5 million from $124.4 million last quarter.
  
• Allowance for loan loss was $58.6, compared to $45.1 million last quarter.
  
• Allowance for loan losses as a percentage of total loans rose to 0.46% from 0.36% last quarter.
  
• Allowance for loan losses as a percentage of non-performing loans fell to 32.4% from 38.5%
  

Bank United Residential Loan Portfolio



click on chart for a sharper image

Even ignoring the huge percentage of reduced doc loans, Stated income and no doc loans are 51% of the residential portfolio. Full doc loans are a mere 18% of the portfolio.

$7.6 billion of their portfolio was in option arms. $6.5 Billion of that $7.6 billion is now negatively amortizing. Their total residential loan portfolio is $10.1 billion. Let's do the math. 64% of their residential loan portfolio is negatively amortizing. Here's more math: 51% of their entire loan portfolio is negatively amortizing.

People are clearly struggling to make payments. At the same time property values are falling dramatically. Unless there were re-appraisals (there weren't) the Loan to Value (LTVs) and the potential for losses are both way higher than reported.

Miraculously, in spite of all this, the allowance for loan losses on a percentage basis fell by 6%

The growth in negative amortization was $48 million. Accounting rules being what they are, negative amortization is counted as "noncash interest earned" and immediately falls to the bottom line. It is doubtful that BankUnited collects anywhere close to the full amount.

This company is in serious trouble.

Mike Shedlock / Mish
http://globaleconomicanalysis.blogspot.com/