Well it seems that in the case of Fannie Mae and Freddie Mac, that the bankrupt chaff has been kept in with the previously untainted wheat as the American government embarks on a $200 billion dollar rescue that does not resolve the housing crisis but will only shore up the cracks shown thus far in the mortgage backed securities (MBS) market. The reaction was predictable, with the equity markets seeing an opportunity for an easy profit in a difficult year went through the roof for a day. They are now beginning a sober retracement with both Nasdaq, S&P and the Dow back in bear territory.
Both companies have now been de-listed and shareholders common stock (like those of Bear Stearns)is junk. But it needed to be done. In retrospect, it really needed to be done a year ago. But when do governments (particularly the Bush administration) ever proactively intervene to prevent damage?
Regardless of the bail-out, the housing crisis continues to worsen. According to Barclays Capital there are:
$1.2 trillion in MBS mortgages that are approaching payment recast.
Projected payment shock for interest only and pay option arms is between 40-80% of all loans.
In Alt-A (Not sub-prime but still high risk) : 15% have loan to value of 100% or more.
In Prime Jumbo (similar to Alt-A but with larger loan size) : 25% have loan to value of 100% or more.
These are what are known as underwater loans and sadly, too many people are in way over their head.
The housing and sub-prime crisis obviously have a long way to go.
What may prove to be a tipping point is a recession. An official recession is where GDP displays negative growth for two quarters. Below is a chart which plots industrial production against every recession since 1962. US industrial production is declining fast. The strengthening of the dollar, whilst reducing commodity prices will make the US less competitive in export markets. With a stricken domestic market and declines overseas, I would be very surprised if industrial production recovers in the short term to positive territory.
The effect of this could be further lay offs and redundancies in unemployment black spots and key swing states such as Michigan, Pennsylvania and Ohio.
So what happens to the repossessed property? To quote Bill Gross MD of Pimco from the 8th September 2008:
Banks are repossessing homes and then dumping them on a failing market so driving the prices down even further. US assets – stocks, bonds and housing –are falling faster at a rate of 10% per annum than any time in the past 20 years – faster than in the crashes of 1990, 1994 and 2001/02. Housing alone in the US has fallen over 15% in the past year.
“This rarely observed systematic debt liquidation is what confronts the U.S. and perhaps even the global financial system at the current time” said Gross, “unchecked, it can turn a campfire into a forest fire, a mild asset bear market into a destructive financial tsunami.”
Central banks are doing their bit and $400 billion has been raised by financial institutions, but this still leaves a lot of unwanted assets. If the government does not step in and mop up some of these, liquidity will dry up. With institutional investors’ risk appetite to acquire more assets “anorexic”, and with no other investors, there will be a continued downward spiral in prices.
Gross concluded his commentary by saying “While some will compare current government bailouts to Slick Willie*, citing moral hazard, near criminal regulatory neglect, and further bailouts for Wall Street and the rich, common sense can lead to no other conclusion: if we are to prevent a continuing asset and debt liquidation of near historic proportions, we will require policies that open up the balance sheet of the US Treasury – not only to Freddie and Fannie but to Mom and Pop on Main Street USA, via subsidized home loans issued by the FHA and other government institutions.”(Slick Willie: Willy Sutton, a famous depression-era bank robber, who, when asked why he robbed banks said “because that’s where the money is!”)
Bill Gross is one of the smartest and most respected fund managers in the world but at what point does the US government say "no more!" and turn the tap off to these corporate spongers. Maybe only in a non election year.
So what is the upshot of all this good news? The second stage of the sub prime crisis has always been about possible mass repossessions which could lead to a further massive drop in housing values not only in the US but globally.
If industrial output continues to fall and if inflation continues to rise due to a weakening dollar via a rising oil price, then the west could be in trouble. The most likely source of a rising oil price will be China, which is retooling post-Olympics for Q4. Whilst slowing, the Chinese economy is not in recession with Q2 growth reported at 10.1% and a planned minimum GDP (due to the slowdown) above 9% for 2009. For this reason amongst others, Goldman Sachs reiterated their August 19th note on September 3rd forecasting $149 per barrel for oil.
So we have stagnant or negative growth in the west with low levels of output and higher inflation and unemployment. We have falling personal asset values with tighter lending criteria for borrowing. We have a fundamental increase in the worldwide demand for commodities which can only enlarge further in the medium term should there be a global recovery.
We have OPEC tightening the oil tap. Will they increase the flow again? I think that its doubtful. We are deep into a global slowdown created by the western economies. It is at this point that we need assistance from the cartel to help get our economies back on course. If the western bloc had any sway with the OPEC nations at all, they would have increased the flow of oil now. Instead, they didn't even maintain present volumes, they reduced them. But then again, why should we expect sympathy from Iran, Iraq, Saudi Arabia, Libya, Algeria and Venezuela. Even if we look outside of OPEC for relief, the biggest producer is Russia. Oh dear indeed.
I have been a gold bug for a while now. With this environment, I think I'll stay one just a little longer.
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