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Wednesday, November 07, 2007

Guys, It's Over

In the last few days the remaining supports just got knocked out of the credit system. Things look quiet just because people are in shock. It's that brief moment after major injury before your nervous system conveys the pain signal to your brain.

This is pretty much the death knell:
Cuomo is demanding Fannie Mae and Freddie Mac, the two biggest U.S. providers of home loan financing, hand over details of loans they buy that may show appraisal values on homes were illegally inflated.

The attorney general said he uncovered a ``pattern of collusion'' between lenders and appraisers and said he is targeting banks beyond Seattle-based Washington Mutual. Fannie Mae and Freddie Mac agreed to supply documents, Cuomo said, giving the attorney general access to information on some of the $11.5 trillion of mortgages they own or guarantee.

``We believe it is widespread, it is prevalent,'' Cuomo said today at a press conference. ``In this case follow the money, the old expression, is follow the mortgage.''
If the appraisals were fraudulent, in theory Fannie would put them back to the originators. In practice, this will work just about as well as it did with New Century buybacks.

All correlations have gone to one, which means that a loss in one section of the debt system is reflected in other portions within two months. Insurers, those who wrote credit default swaps, and those who are holding the stuff are now locked into a self-feeding cycle of writedowns. Revalue the MBS and ABS (there is a big, big problem with some of the CC and auto ABS, as well as a growing commercial problem). This causes revaluation of CDOs. A lot of these valuations were somewhat supported by the bond insurers, who are now getting written down, which starts the whole cycle all over again.

Nikkei fell last night to close nearly into the 15,000s, and it is likely to get there this week. (If it sticks there I think it's a problem. Japan isn't showing much in the way of growth signs.)

The worst of it is that there is worse debt in a lot of countries than there is in the US. In 2008 rolling series of defaults take out banks in multiple countries - unless their countries can shore them up. We've entered an era of worldwide deflation which will be hard to correct. As these losses have to be covered, capital has to be pulled back by selling assets or by raising capital, which devalues the holdings of current shareholders.

Building projects are being halted and the next major impact on some of the regional banks are defaults on C&D loans.

The details no longer matter, but you can follow them at Calculated Risk. The entire system of debt is interrelated, so it no longer matters who goes first. Just about everything gets pulled into the whirlpool. The whirlpool ends when the debt is written down to match expected cash flows. But durations will now extend, which means pricing must continue to drop.

It's questionable as to whether T-Bills can hold their current price gains for much longer in some of the durations. On one hand, there is a shortage of strong value reserve instruments. But there is also a developing shortage of cash to buy them if they have to be sold to supplement cash flow. The effect should be correlated with longer durations. The FHL system may be looking at its first losses.

PS: You think this doesn't have an effect on companies like Cisco? As more and more of their profits have come from emerging market countries, more and more of their profits have become dependent on lending.

PPS: Diesel at $3.30, Gas all grades up to $3.06. Here comes inflation with a vengeance. Gas is up around 82 cents YoY, and diesel is up about 80 cents YoY. Heating oil is rising rapidly too. To understand the impact on grocery stores and retailers, few families with kids get by on less than 20 gallons of gas a week. The average is more like 25-30. Using 20, that's 16 extra dollars a week. Assuming no further increases, that adds up to around $150 - $200 cash less available to spend for Christmas for most families. The grocery stores will take a terrible hit as customers pinch pennies on food to try to cover the shortfall.

As amazing as it is on a rational level $4 gas is going to be the top line story.

The "over" is the last 30 years of US financial experimenting in velocity and leverage. The only consolation is that rubes like China are going to get caught in the same trap and won't have the systems in place to get back out.
Have you looked at Yahoo finance today? You'd think things are just peachy keen, except even they are having problems hiding the bad news. Gas is $3.26 a gallon out here. Man, do we live in interesting times or what?
Rob, I am not sure that is a consolation.

Teri, we are good at denial as a nation, but everyone does notice when suddenly the money is cut short.

Yes, interesting and apt to be historically notable times.
Sign me up for the "It's Over" theory. I could be wrong of course, but I do think today marks a turning point.
Dear Mama,
I enjoy your blog and the comments on CR. Is this your first "It's over" call? Just curious.
Just think, if the democrats (we like to misname them enviro whacko's) hadn't spent the past 35 years blocking all drilling in the country and constructon of refineries we would have gas at less than a dollar right now. Just keep electing the socialist/communist posing as democrats. You will pay big time for listening to the propaganda of the democrat controlled news media.

Firefighter..did you catch Hillary's comment recently blaming *global warming* for rising energy costs?

Of course, in actuality the things one would do to reduce energy costs and the things one would do to reduce CO2 tend to be diametrically opposed. Natural gas is good for power generation if you want low CO2; coal is much better if you want cheap. High gasoline prices are good if you want to reduce CO2; not so good if you want to help people meet their budgets.

Is she too ignorant to understand these tradeoffs, or so demagogic that she flat-out lies about it?
Paul - it is my first "It's Over" call. I am rather surprised by these events. The real economy is going to be less affected than financial stocks and companies, but the real economy is genuinely slumping. There seems to be almost no growth impetus in either the US or Japan, the world's number 1 & 2 GDPs. Growth in Europe is going to slow. The UK will have to start cutting interest rates next year.

In 2006 I thought that the economy would go into recession (by classical standards) in 2007 and that the recession would become pretty sharp in 2008, and I believe it has based on sales taxes, and that 2008 will be pretty rough. But I believed financials would compensate earlier for bad credit. They didn't, and now we are getting a worse credit crunch than I anticipated.

The other thing that surprised me was that we haven't seen that much of the mfrg kick from the weaker dollar. We will get some, but as other economies slow, now it will be less than I thought.

Our remaining options now are only to rationalize our environmental policies which have come close to destroying a very vibrant economy. We need to get our heads out of our butts damned quickly.
Firefighter - I do think the environmentalist fanatics have done great damage.

The two major stupid mistakes we have committed are using guestworkers (most of whom are illegal) to deflate earnings of domestic workers, and unbelievably bad energy/environmentalist policies.

I am and have been hugely in favor of nuclear energy. I am and have been in favor of opening up new drilling fields domestically. I also believe that the legal structures in some environmentalist legislation are deeply flawed, because they really shift the decision-making process to the courts. These decisions involve trade-offs, and the courts are uniquely unfitted to deal with tradeoffs. Congress must do it.

There is no energy project in this country, no matter how environmentally innocuous, (think of the wind generation project off the Kennedy compound) that cannot be stopped by litigation. There are very few that haven't run up against it.
Mark - since the beginning of the year, every one of my selected indicator areas have developed signs of deep stress. In 2006 I told myself that I would know we were in a recession if growth and especially job growth in the NC Triangle area dropped out, and this summer it moved over to the yuck camp.

There is very little growth impetus in our economy, and a bunch of negative growth impetus. We are a long way from a turn.
"If the appraisals were fraudulent, in theory Fannie would put them back to the originators"...what if the fruad were perpetrated by the mortgage broker, but the originator failed to do due diligence to uncover it? Could it still be put to the originator, or would the recourse be against the broker (who probably has minimal assets)?
David, there are chains of recourse.

Everyone has contracts that state in print that everyone's doing everything right and by the book. So in theory Fannie could put the loans back to WaMu, who would then pick up their contract and try to make eAppraiseIT cover it.

See Tanta's post which explains exactly what will happen. OTS is going to have to get involved at WaMu, too.

We are a long way from a turn.

I probably should have been more specific with my "turning point" comment. The turning point I think I see is that the majority of investors are finally starting to notice that things aren't as good as they once thought. The poster child for triggering some of this could be John Chambers (Cisco). Last quarter he'd never seen a stronger global economy. This quarter he's blaming the banks and the mortgage mess. Cisco was down 9.5% today.
(Hi MOM)


"Just think, if the democrats (we like to misname them enviro whacko's) hadn't spent the past 35 years blocking all drilling in the country and constructon of refineries we would have gas at less than a dollar right now."

You really think that it was the Greenies who nixed US refineries?

Try again.

Greenies are a piss-puddle on a plate compared to the refinery companies.

Gasoline is gasoline no matter where it's refined, except that building your refinery in Absurdistan means that you can pay Absurdistan wages and only have to meet Absurdistani safety and environmental laws, and need only worry about the Absurdistani lawsuits...should something go wrong.

Believe me...the reason that no refineries were built here is the same reason new factories aren't built here.

Foreigners are cheaper.
I'm all for open an unfettered debate, but as (the only??) environmentalist here, I admit the level of "wacko" comments and Hillary-bashing seems awful high considering she/Dems haven't even won 2008 yet, and turned these states into the US-SSR.

MOM, I may skip the comments from here on in, but still think you're basically on-the-ball, and write damn good about some damn screwed up things. Keep knocking 'em down!

(Oh, and I support nuclear power...)

No David, I would say that I am an environmentalist. The Chief and I are sort of running a wild bird refuge. One inescapable fact of life is that you need a lot of energy to protect the environment.

It burns me up that there has been such opposition to things like wind farms. I know they are at best a very minor piece of the solution, but energy is a jigsaw. It seems to me that failing to do what we can to escape using fossil fuels is putting pressure on the underdeveloped world that causes them to produce massive amounts of pollution. It seems to me that we have exported pollution.

As for Hillary, of the leading Dem candidates she seems the most qualified. But she also seems very corrupt to me. I get this weird Nixonian vaguely paranoid vibe from that campaign, and since I remember the Nixon era well, it makes me terribly nervous. My read of her is that she is genuinely idealistic (and apparently Nixon was too), but self-righteous to the point that she feels it is okay to cut ethical corners in the service of a higher goal. That's terribly dangerous.

State your case in the comments, David. There's a paucity of genuine discussion of important issues on EVERY level. Our national dialogue is glib and shallow; it has been resting upon name-calling and stereotypes rather than pragmatic, reasoned and detailed approaches to problems.
Washington pushes back on Cuomo:


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