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26 09 2008

Dear America, If This Bailout Fails, you will Fail. 2008 Financial Fear Mongering Tour.

Posted by: admin in Real-estate news

As I eagerly await the bread and circus theatre to resume tomorrow, has anyone seen any details on the $700 billion plan? The plan ushered over the weekend by Henry Paulson was an absolute joke and mockery to our economic system. He back peddled and stated that he wanted to keep it as “simple” as […]
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As I eagerly await the bread and circus theatre to resume tomorrow, has anyone seen any details on the $700 billion plan? The plan ushered over the weekend by Henry Paulson was an absolute joke and mockery to our economic system. He back peddled and stated that he wanted to keep it as “simple” as possible so discussion in Congress would move much smoother. What in the world is simple about asking that any actions taken by the U.S. Treasury are not reviewable by a court of law? There was a quick firestorm from economist, bloggers, and anyone with an ounce of commonsense how absurd the 3 pages bailout was. Even with the additional modifications to the plan of CEO compensation, equity sharing, and oversight no one is asking the most important question. Why in the hell do you need $700 billion? The mainstream media seems to be neutral about the bailout.

Ben Bernanke, Paulson, and Bush went on their financial fear mongering tour basically saying that if you don’t pass this bailout, the world as you know it will implode on itself. Little do they know that in many cities people are already struggling and have very little to lose if they haven’t lost everything already. This is what the President had to say:

“I’m a strong believer in free enterprise. So my natural instinct is to oppose government intervention. I believe companies that make bad decisions should be allowed to go out of business. Under normal circumstances, I would have followed this course. But these are not normal circumstances. The market is not functioning properly. There’s been a widespread loss of confidence. And major sectors of America’s financial system are at risk of shutting down.

The government’s top economic experts warn that without immediate action by Congress, America could slip into a financial panic, and a distressing scenario would unfold:

More banks could fail, including some in your community. The stock market would drop even more, which would reduce the value of your retirement account. The value of your home could plummet. Foreclosures would rise dramatically. And if you own a business or a farm, you would find it harder and more expensive to get credit. More businesses would close their doors, and millions of Americans could lose their jobs. Even if you have good credit history, it would be more difficult for you to get the loans you need to buy a car or send your children to college. And ultimately, our country could experience a long and painful recession.”

Holy crap! If you put it that way, why don’t we raise the amount and give Paulson $10 trillion? God forbid you take my credit cards away. You mean we are going to lose additional jobs on top of the 605,000 that have already been lost this year?

So this is something that is already happening. Now we get the ultimate fear mongering of seeing your stocks decline. Some Americans are living paycheck to paycheck let alone investing. Let us see the raw numbers here. How many Americans own stocks?

57 million households own stocks directly or through mutual funds. Given that there are 105,480,101 or so households, that means 54% of people will be impacted by a decline in stock values directly in their portfolio. What this also means is that 46% of Americans do not own any stocks. But how much money do American’s really have saved in retirement accounts? Given that the median household income for U.S. households is $46,326, let us run these quick numbers:

401(k) Median Amount

20 year olds

(Salary Range)$40,000 - $60,000 = 401(k) Median Amount $16,393

30 year olds

$40,000 - $60,000 = $38,693

40 year olds

$40,000 - $60,000 = $78,834

50 year olds

$40,000 - $60,000 = $99,932

60 year olds

$40,000 - $60,000 = $97,588

Sources: Employee Benefit Research Institute, Investment Company Institute

So let us assume that the market goes bonkers and it declines by 30 percent. How much do 20 to 29 year olds lose? $4,917. What about those in their 30s? $11,607. How about the hypothetical 40s family? $23,650. A 50s or 60s family looks to lose approximately $29,900. Is there any wonder why there is a big generational gap going on here? That is why the next big issue which in fact is bigger than this bailout is the entitlement programs that will be coming down the pipeline for the baby boomers. The median 20 - 39 year old household has probably lost more simply by inflation and stagnant wages. Certainly the amount of money being thrown toward Paulson and Bernanke is nothing to justify even a horrific 30% drop. The numbers simply do not pan out. In addition, if you retire say at 62 with $97,000 and live until 75, divided over 13 years we are talking about living on $7,461 a year plus Social Security. Try managing that one.

Again, those that stand to benefit the most are in the top 5% of this country. Why do you think there has been wide opposition to this bailout? Take a look at this L.A. Times and Bloomberg poll:

“(L.A. Times) Americans oppose government rescues of ailing financial companies by a decisive margin, and blame Wall Street and President George. W. Bush for the credit crisis.

By a margin of 55 percent to 31 percent, Americans say it’s not the government’s responsibility to bail out private companies with taxpayer dollars, even if their collapse could damage the economy, according to the latest Bloomberg/Los Angeles Times poll.”

As it turns out, a large number of Americans actually have the guts to stand up for what is right. Plus, they realize that the economic plan will do very little to benefit them. Take a look at the above numbers. Approximately 30% of Americans own their homes free and clear. Many of these people do not want to bail out banks that made absurd idiotic loans while they were being prudent. In addition, many other Americans are making their mortgage payments on a timely manner. Do you think they are going to appreciate dolling out assistance to lenders that gambled their future away? Of course not.

The problem with the $700 billion price tag is no one is bothering to explain why they need $700 billion. Why not $200 billion like the Fannie Mae and Freddie Mac bailout? The only reason we get is “it needs to be sizable enough to impact the markets.” Bull. After all, if this program as I read it is setup to continually recycle loans in a garbage in garbage out model, having a $200 billion pool should be enough to take in enough crap mortgages at a major discount, throw them back on the market, and repeat the process over and over until the crisis is over. Wouldn’t that make the most sense? But of course Ben Benanke keeps using the Roto Rooter argument that the credit markets are clogged. Good! That is the damn reason we got into this mess to begin with. The fact that the President tried to instill fear about having our credit cards taken away is a blessing in disguise. People shouldn’t be spending money they don’t have. People shouldn’t have bought homes they could never afford. Forget the auto loan. Time to clean up the balance sheet of your house. And the banks and Wall Street? If the buyers were the drug users Wall Street and the lenders were the drug pushers. Let them implode. This “I’m for the free enterprise except for the largest bailout known to mankind” is absurd.

If that is the case, I would feel more comfortable pushing through healthcare for all and investing in our crumbling infrastructure. At least we’ll get something for the price tag there. Instead we are going to use the money to bailout banks? Talk about massive hypocrisy. Let us run through the doomsday scenario since many don’t have the desire to look at this.

(a) No bailout. People and financial markets initially panic. Weak institutions will no longer be able to hide the sausage and will be exposed and will collapse. In fact, a few people have estimated that nearly half of the 8,429 commercial will fail.

(b) Systematic failure of these toxic institutions. They fail and their poor risk management brings them down. They knew the risk. Making $500,000 loans on 500 square foot boxes and pocketing beacoup money is gambling. Hope you enjoyed your reckless spending.

(c) Banks that do remain, will lend but to those that meet certain standards. What is so bad about that? What we are basically being told right now is that we have to continue believing that the Great Wizard of Oz really isn’t some shady banker behind the cape. In fact, they want us to continue this model of giving money to people that don’t qualify. That is simply unsustainable. But guess what? The United States itself is now becoming the debt addicted borrower on the world stage.

(d) Standards get better and we move our economy away from this model of flipping houses to one another and obsessing with remodeling our homes as a method of economic stability. Are we a world power because we watch HGTV and have an obsession with granite countertops? Of course not. The jobs of the future are in biotech, engineering, and IT and we are going to drop $700 billion in propping up a system that rewards flipping and rehabbing homes? You know what that will do for our future economy? It is going to saddle us with so much debt, we’ll be unable to focus on anything else. Please refer to Japan to see how well it works when you zombify your banking industry after a housing bubble.

(e) The correction happens and we move on. New industries develop and new careers will come forward in time. This happens in any business cycle. When will this happen? It is hard to say but once we get back to more prudent standards we can get our country back on the right course.

So essentially that is how things will play out if there is no bailout. But say there is a bailout. What changes from above? My prediction is this is what will happen:

(a) Bailout passes. Initial euphoria on the markets which will give way to reality since Main Street has horrific balance sheets. The party will wear off quickly. We are still at record high foreclosures and nothing will stop this. Why? Because much of our economy was dependent on an incestuous relationship of, “I sell you home. I get commission check. I buy home with check. I sell other home. Use check to remodel and pay construction workers…etc etc.” It all depended on people buying and selling homes at a hyper accelerated pace. That will not continue.

(b) Once Main Street realizes that they were shafted, there will be an uproar but what will they do? Will they protest? Will they take to the streets? Who really knows. The deal at that point will turn into buyers remorse. After all, the government buying the loan doesn’t remove the fact that the loan is still bad. Let us run a scenario:

-The government buys a loan from X bank. X bank claims the mortgage is worth $400,000. The government offers a minor discount of 10% and takes the loan. They now have a $370,000 loan. The borrower has received zero savings. The government can try passing the savings to the borrower but most likely they will still not be able to make the payment. What if they can only make the payment on a note of say $200,000. Will the government modify the loan to that level? If that is the case and the root cause is helping home owners, why not let judges use cram downs and force lenders to modify loans as such with equity kick backs to lenders. That is, if the folks sell the home in a few years for a profit that cash goes back to X bank. Why don’t they go for this? Because it exposes the drug dealer (Wall Street and banks) and drug abusers (home borrowers who want a free lunch). This would make the most sense.

-The government will most likely have a foreclosure on their hand. So now what? Are they going to try to sell the home in this current market with already tons of inventory? They are going to get screwed 2 times here. First, they’ll get shafted from lenders since I doubt they’ll be offering 30 to 40 cents on the dollar which they should. So they’ll over pay once here. Many of these borrowers will default. So now, you have a home and you need to place the home on the market. Guess what, the market sucks. So now, you have to drop your price (another price hit) and accept what the market will offer you.

-We can run this further and further but you get how absurd this is. It is like we are in Wonderland and doing the Red Queen’s Race:

“Well, in our country,” said Alice, still panting a little, “you’d generally get to somewhere else - if you run very fast for a long time, as we’ve been doing.”

“A slow sort of country!” said the Queen. “Now, here, you see, it takes all the running you can do, to keep in the same place. If you want to get somewhere else, you must run at least twice as fast as that!”

There is a silver lining. The majority of Americans are seeing through this sham. Keep calling and writing your representatives since at least it stalled it long enough to keep comrade Paulson from turning this country into a crony capitalistic mortgage swap meet.

Here are the links once again:

Write your Senator

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Dear America, If This Bailout Fails, you will Fail. 2008 Financial Fear Mongering Tour.

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.

25 09 2008

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.

Posted by: admin in Real-estate news

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 […]
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■Two Faces of Housing Panic: Schadenfreude and the Lender of Last Resort.
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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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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?

25 09 2008

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?

Posted by: admin in Real-estate news

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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■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.

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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