AIG is the next in line for the Federal Reserve food stamp program.  As the Federal Reserve decided to stand steady on rates, the markets did an unusual move.  It actually moved up on a no move when everyone around the world was expecting a cut.  Now, it is obvious why the market dipped by […]
Related Posts:
■Washington Mutual: WaMu up to Bat. 11 Bank Failures for 2008. 8,430 Still out There. Southern California Housing to Ben Bernanke: Do we Qualify for a Bailout?
■We’re All Homeowners Now: 10 Reasons to be Cautious About This Housing Rescue Plan for Motherland USA.
■Two Faces of Housing Panic: Schadenfreude and the Lender of Last Resort.
■Lehman Brothers: The Rise and Fall of Lehman Brothers. A History that Goes Beyond the Great Depression.
■The Genesis of the Credit Bubble: Advertising, Deception, and $163 Billion in Subprime California Loans Resetting in 1 Year.

AIG is the next in line for the Federal Reserve food stamp program.  As the Federal Reserve decided to stand steady on rates, the markets did an unusual move.  It actually moved up on a no move when everyone around the world was expecting a cut.  Now, it is obvious why the market dipped by triple digits briefly after the Fed announced the no cut and ended triple digits higher.  The market was extremely volatile today given the Lehman Brothers bankruptcy over the weekend and the unknown factor with insurance giant AIG - well as it turned out it was only unknown to the vast public since the Fed was getting ready to put more taxpayer money at risk.

For the past decade, we have become accustomed to the market having a brief rally after every Fed rate cut.  This became a Pavlovian conditioned response to a society addicted to easy credit.  Our society needs a major 12-step program on how to get off debt and given the current market conditions, this is going to prove extremely difficult simply because Americans are saddled with enormous amounts of debt.  Paulson just this weekend supposedly drew the line about allowing firms to fail.  That line was barely drawn and the Fed was back to their usual antics.  AIG will get a loan of $85 billion from the Fed.  Another firm that is supposedly too big to fail.  Haven’t we heard this story already?  Moral hazard to the next dimension folks:

“(New York Times)  With time running out after A.I.G. failed to get a bank loan to avoid bankruptcy, Treasury Secretary Henry M. Paulson Jr. and the Fed chairman, Ben S. Bernanke, convened a meeting with House and Senate leaders on Capitol Hill about 6:30 p.m. Tuesday to explain the rescue plan. They emerged just after 7:30 p.m. with Mr. Paulson and Mr. Bernanke looking grim, but with top lawmakers initially expressing support for the plan. But the bailout is likely to prove controversial, because it effectively puts taxpayer money at risk while protecting bad investments made by A.I.G. and other institutions it does business with.” [emphasis added]

We have hundreds of pieces moving currently and much of what is going in the economy is fluid.  Recently the U.S. Dollar has been rallying against other currencies.  Many claim this is an anomaly and the dollar will once again continue declining.  You have to put this in perspective first.  The U.S. Dollar was falling because all eyes were on the U.S. and our current economic problems which are very large indeed.  Yet the idea that somehow the world was going to do well in light that many of the other large economies ran on similar economic systems is mind boggling.  In addition, the U.S. Dollar is still a reserve currency and takes up 63.3% of all exchange reserves:

Now the myth that was floating around for many years was that the United States was going to go into its own abyss while the world somehow boomed on its own.  According to many of these people, the United States was contained.  Did Ben Bernanke give them his early 2007 speech about the subprime market being contained?  The recent turn of events are as follows:

(a)  U.S. Dollar rally

(b)  Commodities falling

(c)  Inflation moderating

(d)  Housing still declining

These events are occurring because the world has not decoupled.  That is, we are still very much intertwined and when the larger economies sneeze, the smaller economies get a severe flu.  In fact, in places like the U.K., Spain, Ireland, and Australia they have housing bubbles that are comparable or even larger in size.  Many of these countries are simply one or two years behind the United States so if we are in the third inning to use the baseball analogy these countries are barely seeing the players take the field.  This reality has taken the market over and many people are returning back to the perceived safety of the U.S. Dollar which is still by far the world’s reserve currency.  Decoupling is a myth.

This realization has also pushed down commodities as many investors unwind previous trades.  The meteoric rise of oil this year was simply stunning.  When oil hit $145.29 the entire conversation in America seemed to revolve around oil.  “Hey man, did you see that gas hit $4.25?  It cost me $140 to fill up my Hummer with spinners.  I think I might have to ride with only one spinning rim and sell the rest off for fuel.”  Now that oil is back under $100 a barrel and the subsequent Lehman Brothers debacle, the focus is now shifting to Wall Street.  It was fascinating to see that to most Americans, the difference between $4 $3.75 gas and $3.50 was the centerpiece of economic stability.  Yes, their home just lost $50,000 in equity but they just paid $15 more at the gas pump so let us focus on those $15.  Penny wise and extremely pound foolish.  This is more a psychological gimmick because we tend to feel things we interact with on a routine basis.  You buy gas often.  You shop for food often.  You don’t buy and sell homes that often (unless you live in California and ended up flipping houses each time you filled up for gas).  If anything, this drop in energy should at least refocus the public’s attention to the main issue of the economy.  That is, the suffocating debt of mortgages and the turmoil in the credit markets.  Make no mistake that the drop in oil is going to help the bottom line of many Americans but remember that the drop comes because the economy is in disarray.  That is, demand is falling and people are buying cheaper more fuel economical cars thus slamming the U.S. automakers into the ground.  Many of the big domestic cars were built on a model of $2 gasoline.  I’m not sure if we’ll ever see that again.

Back to the decoupling myth, let us first take a look at GDP for the top countries:

*Source:  Wikipedia

The United States makes up 25% of the world GDP.  If we combine the Eurozone and the United States, we then have 56% of the world GDP.  Throw in Japan and now we are 64% of world GDP.  Japan is in a recession.  The U.S. is in a recession.  Many countries in Europe are teetering on recession and given many regional housing bubbles, they will also tilt into recession.  How can anyone believe in decoupling?  But what about China, Australia, Brazil, or Mexico?  Let us take a quick rundown of the largest stock exchanges around the world:

In fact, the United States in relation to many of these other markets is fairing better.  You need to remember that the credit systems are now global.  Let us go back to AIG for a second.  AIG currently as of midyear had reported $441 in credit default swaps.  More that 75% of these were held by European banks.  Is that decoupling?  The financial innovations were spread around the world.  Fannie Mae and Freddie Mac which seem like wholesome American companies have enormous amounts of their debt floating around the globe.  Is it any wonder that China expressed “concern” when it looked like the government wasn’t going to be bailing them out?  The fate of the current global economy is at hand and given the amount of debt floating out there, we can only guess what is floating out yonder.

Moral Hazard

The idea that the Fed will now be taking equities in exchange for Treasuries is simply another panic move.  The Fed in yet another extraordinary move announced that the “23A Exemption” that limits a 10% passthrough of financing to affiliates will be “temporarily” suspended.  Banks can now take stocks to the discount window.  This is outrageous given the fact that the Fed’s balance sheet is already badly deteriorated from the ongoing credit crisis:

Source:  Wikipedia

With AIG getting a cool $85 billion we can only imagine how the above graph is going to look in a few months.  Since the Fed introduced the alphabet soup of facilities to exchange Treasuries to battered institutions in late 2007, you can see that the Fed is now in possession of billions of questionable assets.  Institutions took them up on this.  The fact that they are now willing to accept equities is baffling and against their own rules.  But the fact that they aided in orchestrating the Bear Stearns bailout back in March they have been making things up as they go along for a few years.  Some would rather not talk about moral hazard but that is avoiding the essence of what got us here.  If we don’t address the foundation of the economic philosphy, we are bound to end up in similar situations over and over.  These folks are your “but Armageddon will be unleashed if we don’t do [August rate cuts, Bear Stears, Fannie Mae and Freddie Mac, AIG…” crowd while they fail to confront the brutal facts and set the concrete for a better system.

The fact that the Fed allowed Lehman Brothers to collapse caught so many off guard because they have become used to the new economic philosophy of crony capitalism that is permeating the United States.  Before you get too excited that the Fed and the U.S. Treasury are now taking a hard stance, the fact that they are now taking equities should bring you back to this bipolar method of conducting business.  There is no rhyme or reason to what they are doing.  Why let Lehman Brothers fail but not Bear Stearns?  Frankly both should of failed on their own and the government should take on a role to protect the American taxpayer.  We are beyond the moral hazard argument.  With moral hazard, people that believe they are protected from risk will act differently as if they had no protection and all risk was assumed by the individual.  For example, say an accident costs a person $500 but insurance only pays $400 the person has an incentive to avoid the accident.  But say the same accident costs $500 but insurance will pay $700 then there may even be an incentive for the person to have an accident.

The housing market is a perfect moral hazard example especially with the innovation of all the toxic mortgage products.  Let us run this scenario out to explain.  Say you wanted to buy a home in California.  All you hear about is $100,000 a year appreciation for doing nothing except flipping homes and cruising on your Hummer while dreams of $1.99 a gallon gas float in your mind.  But you are cautious and are weary.  You open up your WaMu bank statement and see you only have $50.  Your dream initially is dashed.  You plop down at the couch and turn on the TV.  Low and behold, you see a fancy epilepsy causing mortgage commercial saying you can buy a home with no money down.  No money down?  You pick up the phone and make a call to setup an appointment with a “certified mortgage loan consultant.”

You meet the broker and find out that yes, it is true that you do not need a penny to buy a home just a willing heart and a quick pen to sign.  There is a home on your street going for $500,000 which only last year, was selling for $400,000.  Your thought process is such:

Buy?

Plus:  Maybe $100,000 a year appreciation

Downside:  Home goes down and I’ll just let it go since I put nothing down.  Cost is zero except for bad credit.  What are they going to go after?  The $50 in your WaMu account?  Bwahaha!  WaMu may not be around by that time anyways!

This is better luck than gambling on the lottery.  You buy the home and maybe you take in some wicked appreciation.  The home reverses, you only lose your credit which given the current market means absolutely nothing.  You basically had a call option on your home.  If the home went up and you were happy, you sold your option for a nice profit.  But what is happening is the price has gone down and as many of you know a large number of options expire worthless.  You’re only out maybe the closing cost of the place.  Not a big price to pay for tens of thousands in “potential” gains.

Now take this to the next level.  Many of the investment banks where levered 30, 40, or even 50 to 1.  This was absolutely insane.  Even Fannie Mae and Freddie Mac were levered this high.  That is, for every $1 in capital they were able to control in some shape or form $30 in so-called assets.  That is why a place like WaMu with a market cap of $3.96 billion can have $309 billion in assets.  This is like having $20,000 in the bank but having $2,000,000 in assets and maybe $1,800,000 in debt (i.e., homes, car, etc).  Yes, you technically have a lot but you need to finance the monthly payments.  And say you are forced to sell which WaMu for example is gong to face with their stunning Pay Option ARM portfolio:

Now, you realize that those $2,000,000 in assets are only worth $1,500,000 yet you have $1,800,000 in debt.  You are essentially financially bankrupt if you cannot cover your payments.  Talk about a tremendous mess.

The Disappearing American Dream

I know that everyone has their own perception of what the American dream really is.  Yet for this past decade the real estate and financial industry captured the dream and turned it into homeownerhip.  This became the pinnacle of the dream for most Americans.  Since many people think debt and wealth are synonymous, they had no problem leveraging their future for this dream.  After all, it was ingrained in the psyche of nearly every American.  And let us be honest.  Most people do not follow finance.  They wouldn’t know the difference between an option ARM and a 15-year fixed mortgage if it bit them on the rear.  In fact, simply by looking at the political debate, you would think that all Americans care about is gas, abortion, and no taxes.  This simplifies the debate to the most basic and unfortunately most trivial level.

I would argue that the current financial turmoil, the government entitlements, the retiring onslaught of baby boomers, and the failing housing market are the pivotal financial issues for the next 10 years.  Yet looking at the current discourse, you wouldn’t know this.  In this article I highlighted the difference in the current tax plans of both Senator Obama and Senator McCain.  Yet if you listen to the mainstream media, you would get a completely different message.  The “no taxes” mantra is a bygone phrase from the Reagan era of supply-side economics.  That is old and outdated and simply does not reflect the current economic turmoil.  Things go full circle in history.  The Glass-Steagall Act of 1933 which appeared during the Great Depression which was designed to control speculation was repealed by the Gramm-Leach-Bliley Act in 1999.  The bills compromising the act were introduced by Senator Phil Gramm who said only this year that we are in a “mental recession.”  Was the bailout of Fannie Mae and Freddie Mac and the bankruptcy of Lehman Brothers all in your head?

The pendulum today has swung much too far and these free market capitalist have turned out to be nothing more than crony capitalist and welfare recipients who want the government to stay out when they are manipulating the market for profit but when things go sour, want a government handout.  The same government handouts they rail against when they say “no taxes” and “cut government waste.”  Blatant hypocrisy.  Both sides share in the blame but currently one team has many more strikes against them.  In the end what is assured if things continue as they are, our overall country will be financially poorer and that is definitely not a sign of progress.

It is unfortunate that the current financial system has been made a mockery out of.  Ultimately it is the average American citizen that will suffer.  Instead of having political and economic discourse it turns out to become a bread and circus theatre to appease the masses.  I think most Americans can feel the American dream slipping away because of the gambling and semi-laissez faire attitude on Wall Street that has raided the taxpayer’s bank account which is already broke to speculate on absurd financial “innovations” which turned out to be snake oil dressed with calculus equations.  If we are to find a silver lining it is that the current economic turmoil has once again shifted the economy back as the number one focus for Americans.  Not talking about this is not going to solve it.  Silence is not golden here.

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AIG Bailout: Federal Reserve Bails AIG out with $85 Billion - World’s Foreclosing Balance Sheet: The Myth of Decoupling, Moral Hazard, and American Dream Disappearing.

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Related Posts:
■Washington Mutual: WaMu up to Bat. 11 Bank Failures for 2008. 8,430 Still out There. Southern California Housing to Ben Bernanke: Do we Qualify for a Bailout?
■We’re All Homeowners Now: 10 Reasons to be Cautious About This Housing Rescue Plan for Motherland USA.
■Two Faces of Housing Panic: Schadenfreude and the Lender of Last Resort.
■Lehman Brothers: The Rise and Fall of Lehman Brothers. A History that Goes Beyond the Great Depression.
■The Genesis of the Credit Bubble: Advertising, Deception, and $163 Billion in Subprime California Loans Resetting in 1 Year.

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Filed under: Financial Crisis

There’s been a lot of talk about how the proposed bank bailout is somehow socialist. Senator Jim Bunning recently said that the bailout is “financial socialism,” as well as just being plain old “un-American.” Congressman Ron Paul has made similar statements, and some of the bloggers here at BloggingStocks have joined in the chorus as well (here and here).

Now, I understand that the bailout violates the much loved principles of ‘free markets’ and ‘democratic capitalism’, but we can’t let this violation muddy the meaning and history of different economic forms. In the long history of capitalism, socialism has represented an alternative that fundamentally challenges the capitalist structure of political and economic power. This bailout does no such thing.

If the bailout were truly socialist, it would result in long-term state ownership of the banking industry. No such option is on the table. Even getting a minority, non-controlling interest in the banks in return for the massive public investment has been controversial and thus far impossible.

Socialism has a long and complicated and even contradictory history. But the basic principle is pretty clear: economic activity should benefit all citizens and not just a small upper class. Accordingly, in a socialist state, major industries should be publicly owned and wealth should be shared. There are plenty of examples of socialism in action, including the state-owned industries in much of Europe after World War Two, as well as the fairly weak political forms of the welfare state in the U.S., including the Social Security system.

It is tempting to interpret the bailout in a corporatist framework. Corporatism in the name given to various economic and political forms in which power is jointly held by government and private corporations. Although corporatism has been found in different times and places, including West Germany in the 1950s and, arguably, in the U.S. during the New Deal and World War Two, the most famous type of corporatism is fascism. According to Mussolini, “Fascism should more properly be called corporatism because it is the merger of state and corporate power.” Fascist corporatism is distinct in its opposition to labor, its worship of the state and its leader, and its embrace of violence.

Although there are disturbing parallels (the Iraq war, the irrational adulation of Bush and the Republican party on the far right, the government-backed suppression of dissent, the opposition to labor unions), the proposed bailout is probably best understood as an expression of typically American capitalist politics. Famed investor Jim Rogers comes closer to the truth when he described the bailout as “socialism for the rich.” But socialism for the rich isn’t socialism — it’s just another form of capitalism, one in which the rich are shielded from significant loss by the state.

A better term then is state capitalism. And to make clear who wins in this form of economy, we could say state corporate capitalism. In this common form, private corporations are allowed to aggressively pursue profit while the state shields firms and their managers from the danger of systemic meltdown. Arguably, this is how the American economy has been structured for at least the last hundred years.

Though our politics are filled with talk about ‘free capitalism’, there isn’t much of it to be found on the ground. The most important sectors of the economy — energy, military, transport, pharmaceuticals, communications — are all protected or underwritten by the state in one way or another. We tend not to see this in the everyday economy, though, blinded by the ideology of free markets and democratic capitalism. It is only during economic crises that the truth becomes evident to a substantial portion of the population. And as the bailout makes clear, state corporate capitalism is not easily changed or challenged.

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This guest post is from: Constantine von Hoffman, a veteran business journalist and writes the blog CollateralDamage.biz, a humorous look at marketing, business and his dog.  If you’d like to submit a guest post drop me an email.

Every news story about the bailout makes it sound as if Friday is some sort of do-or-die deadline. It’s not. It is just the day Congress wanted to adjourn so they could get home and do some campaigning. Given the magnitude of the crisis and the size of the pig in this particular poke, it’s time for Congress to get its priorities in order. If ever there was a piece of legislation that needed to be carefully considered, this is it.

Senate Majority Leader Harry Reid has said that one of the reasons for adjourning is that “no one knows what to do” at the moment. Senator, that means this is exactly the time when you need to stay at your job and figure it out.

Personally, I have deep doubts about the Paulson/Bernanke plan. It seems like a case of throwing more money at a problem that has already not responded to the amazing amount of money thrown at it. Whether or not this is the case, it certainly is a hasty and desperate move and deserves a thoughtful consideration. It obviously needs more oversight. Just the idea of whether the government should buy these assets at a premium or discounted price needs some very close examination.

These issues and many more make it essential that Congress not adjourn now. We, the people, need our representatives to be fully informed before making a decision like this. This is the one duty Congress has, the one reason we vote for them in the first place. This duty easily trumps the mere career issue of whether or not they get some extra time in the home district.

If these reasons weren’t enough, let’s put to rest the notion that most members of Congress even need to campaign. Unless we take a notable deviation from history, something like 90+% of them are going to get re-elected. As the historian Thomas Patterson has noted: “Only about three dozen of the 435 House seats were actually in play in 2002. In nearly twice that many districts, there was literally no competition: the weaker major party did not bother even to nominate a candidate. And in several hundred other districts, the competition was so one-sided that the result was known even before the campaign began. As was the case in 2000, the victors in House races won by an average margin of more than two to one.” The percentages are even worse in the senate.

House Speaker Nancy Pelosi has defended the adjournment by saying that lawmakers can always be recalled to Washington “if there is a need to do so.” Mrs. Pelosi, the need is already here. The time is now and your duty is clear. If Congress adjourns now it will be the most irresponsible action by a politician since Nero fiddled through the burning of Rome.

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Filed under: UAL Corp (UAUA), Oil, Delta Air Lines (DAL)

Few actors understand the pluses and minuses of hedging better than traders . . . and airlines. In an ironic twist, some airlines could be financially hurt by falling oil prices. That’s right: hurt by falling oil prices.

United Airlines (NYSE: UAUA) is one such airline. United said it could lose up to $294 million in Q3 if oil prices average $95 per barrel, marketwatch.com reported Wednesday. Oil rose $2.44 to $109.05 in mid-day Wednesday trading. United purchased fuel caps averaging around $111 per barrel this year and $118 for 2009. In other words, the caps mean United would be compelled to pay more for oil than the market price, due to the established contracts.

American Airlines (NYSE: AMR), and the slated-to-merge Northwest Airlines (NYSE: NWA) / Delta Air Lines (NYSE: DAL) are other carriers that could be hurt by oil hedges, marketwatch.com reported.

Hedges, caps: An attempt to create fixed expenses

Stock Analyst C. Leonard Bauer told BloggingStocks Wednesday most airlines “merely seek to break even with their fuel hedges and caps, not profit from them.”

Continue reading Oil hedges mean falling crude prices could hurt some airlines

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CNBC grills S&P on their assesment on CDO’s as AAA rated debt and their role in building up the massive credit bubble and now their quick degredation of the same assets which has led to the implosion.  Their point: if you were so off on the initial rating how can you be certain of the new ratings that you’re handing out?

A great point.  Many people point to the ratings agencies as one of the biggest culprits in this entire debacle.

Must watch TV:

http://www.cnbc.com/id/15840232?video=859038023

Hat tip The Big Picture.

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Filed under: Forecasts, Bad news, Consumer experience, Market matters, Housing, Recession, Financial Crisis

More bad news for the housing market today, as the Federal Housing Finance Agency announced that home prices in July were 5.3% lower than they were in July of last year.

The main culprits leading to lower July prices are, as usual, the large supply of homes available, tighter lending standards, and record foreclosures, that have resulted in sellers slashing prices in order to sell their properties. On a month to month basis, prices fell 0.6% from June to July of this year.

The drop in prices was seen universally in all regions. The only area of the country that saw prices rise on a year over year basis was the West South Central regions.

The credit crisis over the past year has already claimed a couple big name companies, and prompted the Bush administration to suggest a $700 billion bailout for the financial industry.

Continue reading Home prices take another dip in July

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Filed under: Time Warner (TWX), PepsiCo (PEP), Amazon.com (AMZN), Marketing and advertising, Walt Disney (DIS), Procter and Gamble (PG), Kraft Foods’A’ (KFT), Media World, Technology

Science-fiction has proffered worlds where advertising is instantaneously and specifically delivered to individuals, sometimes through such wondrous devices as brain implants. As we move along the timeline, it’s interesting to see how much of that isn’t actually fiction anymore, but indeed, science. Take the following article, for example. It discusses a cafe that has screens next to cash registers that attempt to increase sales by displaying images of appropriate add-on items. One of the examples given was of a pastry suddenly appearing on the screen upon the order of a coffee.

That doesn’t sound so bad, but what about the following? The article mentions that an Israeli business, YCD Multimedia, has a technology that can scan the faces of customers and then utilize algorithms to reveal demographical information about them, such as gender and a rough idea about age. The rest becomes obvious: advertising can then be matched to the demographic, yielding the ultimate in instantaneous targeted marketing. There apparently are some trials underway in this country, but they seem to be on the lowdown.

Now, we all know the problem here. Do you really want to walk into a retail store and be scanned? Do you want a piece of software converting you into zeroes and ones for the sole purpose of extracting money from you in the form of promotional advertising and/or offers? Maybe a big needle should extend out of the cash register and poke you in the finger so that a DNA sample can be taken and analyzed so that, a nanosecond later, it’ll know exactly what your likes and dislikes are and go from there. Actually, I’m just being funny on that last one, I put that in a short sci-fi story I wrote a while ago about the dark side of retail and customer service.

Continue reading Will Big Brother advertising help shareholder value?

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If you haven’t noticed, Wall Street is having a bad week.  It would seem that the reality on Main Street is finally catching up to the Wall Street casino.  Many Americans are only starting to pay attention to the economy.  Why is this happening?  What went wrong?  To be honest, the current financial system is […]
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■Bank Failure: IndyMac Bank. Lessons from the Great Depression Part XIV. Bank Failures.
■California Housing Report: Southern California Inventory Dropping but Foreclosures Keep Coming. Los Angeles and Orange Counties Plagued with Problems.
■Fannie Mae and Freddie Mac: Government Sponsored Entities Finding Their way Back Home with a Bailout.
■Housing Bread and Circus: Foreclosures, Employment, Bazookas, and the World’s Largest Mortgage Bailout.

If you haven’t noticed, Wall Street is having a bad week.  It would seem that the reality on Main Street is finally catching up to the Wall Street casino.  Many Americans are only starting to pay attention to the economy.  Why is this happening?  What went wrong?  To be honest, the current financial system is a mixture of loan sharking and legitimizing a Ponzi scheme as a true and stable system.  Think how idiotic some of the new financial innovations are.  If you are wondering why A.I.G. was bailed out it is because it would expose the world to a balance sheet that is completely exposed with these new products.  You can add Bears Stears, Fannie Mae and Freddie Mac, and AIG to the now growing list of bailouts.

Let us simplify one aspect of this economic mess.  You sell an insurance policy to your friend that should Generic X company go into default, he will receive $1 million.  Your friend fearful of shady Generic X corporation decides to invest in the place (moral hazard time!) and would have not ventured to do so if he did not have insurance.  Feeling confident he invests and, life goes on.  Well as it turns out, Generic X is a very funny institution.  It turns out they were giving loans to burger flippers for nice $500,000 McMansions.  Generic X suddenly goes into a tailspin and defaults since those housing loans are defaulting in massive numbers.  Your friend gives you a ring to redeem his policy and the conversation goes as follows:

“Hey buddy.  It looks like I’m going to need that $1 million since Generic X just bit the dust.”

“Really?  Wow.  Didn’t see that coming.  Funny story.  Remember when I sold you that insurance?  Well, as it turns out we weren’t really betting on Generic X failing so we never really had the money.”

“Say what?  But isn’t that why we bought insurance?  To protect against a loss?”

“Yeah.  We sort of thought the same thing and bought insurance from Crapco Insurance and as it turns out, they were betting that Generic X wouldn’t fail either.”

“So what are you telling me?”

“We don’t have the money.”

“So what am I suppose to do with this policy?”

“I don’t know.  But I heard the Fed is exchanging all kinds of things for Treasuries so you might want to give the head guy over there a call.  I think his name is Ben Bernanke.”

Call it what you want but this is a Ponzi scheme.  Ponzi schemes pay old members with new member money acting as if they were really investing.  Things go well so long as you can keep finding new members (i.e., housing prices keep going up).  But once your momentum catches up with you (i.e., prices reveres) the entire system comes crashing down imploding on itself.

In this article we are going to talk about 3 major economic stories.  Given the massive amount of news, anyone trying to make sense of the current economy and attempting to follow all the headlines must feel like drinking water out of a financial fire hydrant.  We are going to examine WaMu and their current problems.  We are also going to look at the banking system and problems that we will face.  Finally, we’ll tackle the Southern California housing numbers that put a massive Viagraless exclamation mark to a summer selling season.

Whoo Hoo!

Washington Mutual, the nation’s largest thrift has now put itself up for sale with the help of Goldman Sachs.  Has anyone taken a look at these two companies recently?  You have to wonder if someone else needs to find someone to help in a sale:

You may be thinking that WaMu with a $3.4 billion market cap is cheap.  You want to know why people are balking at this sale?  How about having $239 billion in outstanding loans with $52.9 billion in Option ARMs!  The same toxic brew that is sitting here in California waiting to unleash the next leg in the housing market.  We have $300 billion in option ARMs here in the state waiting to recast or hit anniversary dates on a state that has arguably one of the worst housing markets in the country.  You want to know where those $52.9 billion in Option ARMs are sitting?

$26.3 billion are in California and $6.8 billion in Florida.  Now you can understand why that $3.4 billion market cap isn’t so cheap anymore.  In addition, WaMu has a ridiculously large home equity portfolio which is another negative:

Yet another strike.  But you may be thinking that those option ARMs are doing okay.  Wrong:

The Option ARM portfolio is seeing exponential growth in defaults and late payments.  Any company seeking to buy WaMu would be absolutely insane to do so with such high exposure to the most toxic of mortgages.  The only way a sane deal would get done is if the Fed or U.S. Treasury somehow allow only the good to be sold off like the residential component while shipping this sludge onto the U.S. taxpayer.  Take a look at some of the Real Homes of Genius in California, many that were purchased with exotic mortgages and ask yourself if you want your tax dollars at risk for this.

Make no mistake, a failure of WaMu would be enormous.  IndyMac Bank, another model of responsible lending when it got taken over by the FDIC had $32 billion in total assets.  This little bailout cost the FDIC $8.9 billion which ate up about 17% of their insurance fund.  How much in assets does WaMu have?  How about $309 billion with $239 billion of that being loans.  Either way, someone is going to pay.

8,430 Commercial Banks - Many are Unsound

According to the FDIC as of August 22, 2008 there were 8,430 FDIC-insured commercial banks in the United States.  As of this year, 11 have already failed:

Keep in mind that the list of troubled banks put out by the FDIC jumped to 117 from 90 this past quarter.  Even by their own admission, they stated that they did not see IndyMac Bank coming and this one failure cost more than all the other 10 combined!  Given that many of these banks lent money out in a similar fashion as WaMu did, it is almost a certainty that many more will be failing.  Why?  Well once you see the Southern California housing numbers you will understand why.

The financial sector for a very long time was only about 5 percent of the economy.  Now, it is estimated to be about 25 percent.  I’ve argued that since 2000 over 30 percent of all job growth was somehow related to real estate.  Many of these bank failures will add to further unemployment.  WaMu alone has 43,000+ employees.  Lehman Brothers had 26,000.  What do you think this is going to do to the unemployment numbers?  Just take a quick look at some of the banking and financial stocks and you’ll quickly realized that many of these people will not be absorbed into the economy.  Good high paying jobs.  Yes, much of it depended on the casino like world of Wall Street and the delusional accolades of the housing bubble but this still doesn’t answer the employment question.

Many of these banks are capital impaired.  They have “assets” in the form of loans but in terms of capital, are very poor.  They have been overly generous in estimating the value of their assets and that is one reason why the bankruptcy of Lehman Brothers has caused so much chaos.  They dared to look at the Medusa balance sheet and as it turns out, they did turn into stone.  Their worst fears were confirmed.  Why do you think they are doing everything to keep this from happening again?  There are now talks that Morgan Stanley is in chatting it up with Wachovia.  They are doing everything to keep the books closed because we all know what we will find once they are opened up.

Southern California Housing - Pathetic

Only one word can describe the summer selling season for Southern California.  Pathetic.  First let us take a look at the raw numbers:

The median price for a Southern California home is now $330,000.  That is off from $500,000 which was reached only one year ago.  That is, $170,000 has been lopped off for the entire region in the space of one year.  And this was during the high volume summer season!  What is going to happen with the slower fall and winter season and we start seeing a much larger number of option ARMs recast into ridiculous payments?

If you look at the sales numbers, you can see that the Inland Empire once again dominated the entire sales activity.  San Bernardino and Riverside made up 33% of all Southern California sales in August.  Foreclosure sales made up 45.5% of all sales.  I know many are going to want to argue that the median price is not a fair reflection since only lower priced distressed properties are pulling the figure lower.  Well when 50% of the sales are distressed properties the market becomes distressed properties.

Sales have jumped up because people are trying to spot a bottom.  Some investors still think that in no time, we’ll be back to the glory days of this decade and they’ll be able to flip these homes.  Have they not been watching what is unfolding on Wall Street?  All you are hearing now is REGULATION.  Meaning, easy access to credit so you can buy homes with zero down are gone.

These numbers are nothing to clamor about and the slight uptick in sales is attributed to the summer selling season and bottom callers jumping in thinking this is it.  This is not it.  I stick by my 10 reasons why California will not see a price bottom until May of 2011.  Everything that is unfolding on Wall Street simply reinforces my thesis.  Let us say prices do bottom out, who is going to buy the place?  California now has one of the nation’s highest unemployment rate and since you have to now verify your income, that $330,000 is actually too high for the median household income of the region which comes in at about $55,000 to $60,000.  $330,000 is still 5 to 6 times the median household income.

I’ve talked to a few people recently and psychologically this is going to be a culture shock.  They know no world where credit is difficult to obtain.  It is a shock that they are receiving letters from their lenders telling them that their home equity line of credit has been shut down.  This is the new reality.  As I discussed in a previous article, the world markets are getting pummeled following our lead.  In Russia they shut down the stock exchange!  Globally there is $75 trillion in real estate, $53 trillion in total GDP, and $675 trillion in derivatives.  You do the math.

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Washington Mutual: WaMu up to Bat. 11 Bank Failures for 2008. 8,430 Still out There. Southern California Housing to Ben Bernanke: Do we Qualify for a Bailout?

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Related Posts:
■Real Homes of Genius: Today we Salute you Glendale. When Prime is no Longer Prime and WaMu Dilution.
■Bank Failure: IndyMac Bank. Lessons from the Great Depression Part XIV. Bank Failures.
■California Housing Report: Southern California Inventory Dropping but Foreclosures Keep Coming. Los Angeles and Orange Counties Plagued with Problems.
■Fannie Mae and Freddie Mac: Government Sponsored Entities Finding Their way Back Home with a Bailout.
■Housing Bread and Circus: Foreclosures, Employment, Bazookas, and the World’s Largest Mortgage Bailout.

Via [DrHousingBubble]

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