Friday, December 22, 2006

I've moved my blog

Note: I've moved to
I will no longer be updating this blog page, but will leave it up for the time being.
Thanks, Vern

Thursday, December 21, 2006

Falling lumber prices

I'm back from a two week absence and hope to be catching up with current events.

Here is something interesting for anyone who built a house last year as I did. Lumber has dropped to about half it's value from a year ago.
Prices were about $460 L.B.F. last September to $230 Linear board feet this September.

This means that most of the materials that went into my house last year would cost me half as much now. Oh-me Oh-my!

As we haven't yet seen the real effect of a implode speculator R/E market, I expect that building materials across the board will soon follow suit, heading downward.

Wednesday, December 06, 2006

Derivatives; The Monster That Ate The Future Part II

The whole article can be read at

Derivatives Trading
Bloomberg is reporting Derivatives Trading Soars to $370 Trillion.
Nov. 17 (Bloomberg) -- The use of derivatives grew at the fastest pace in eight years during the first half of 2006, boosting earnings at securities firms and reducing costs for investors.

The face value of derivatives based on corporate bonds, currencies, interest rates, commodities and stocks jumped 24 percent to $370 trillion, according to the Bank for International Settlements. It was the biggest percentage rise since the bank began keeping records in 1998.

Trading in credit-default swaps, the fastest-growing derivatives market, helped spur record earnings for banks including New York-based Morgan Stanley and Goldman Sachs Group Inc. At London-based Barclays Capital derivatives accounted for more than 60 percent of revenue and profit, Chief Executive Officer Bob Diamond said in May."

The pace of growth is going to have continued unabated in the second half of the year," said Kit Juckes, head of fixed-income research in London at Royal Bank of Scotland Group Plc.

The amount of outstanding credit-default swap contracts jumped to $20.3 trillion from $13.9 trillion at the end of last year, the Basel, Switzerland-based bank said on its Web site today. The securities are financial instruments based on bonds and loans that are used to bet on an increase or decrease in indebtedness.

Alan Greenspan, the former chairman of the Federal Reserve, has been saying since 2002 that derivatives reduce risks by making financial markets resilient to shocks. In May he told a Bond Market Association gathering in New York that derivatives are the most significant change on Wall Street "in decades."

Modern Financial Wizardry
In other news, a spokesman claiming to represent Greenspan reported that the entire risk of all derivatives trading to date has now officially been offloaded to Mars. A Martian spokesman verified that claim and went on to state that Martian risk has been offloaded to France. France in turn claims to have offloaded the risk to the MMMM corporation better known as Madame Merriweather's Mudhut Malaysia, the ultimate guarantor of $370 trillion in derivatives.

Leverage on the trade has not yet been calculated but Madame Tandalayo Merriweather of Kuala Lumpur has emailed me personally stating " Don't Worry, My Mudhut is Priceless". The key point here is the priceless nature of the Malaysia Mudhut which is a good thing given that it has taken two years and counting to straighten out the derivatives mess at Fannie Mae alone. In a miracle of modern financial wizardry, no one it seems has any risk associated with these derivatives, given they are all backed by something priceless.

Derivatives and Ramen Noodles

From CNN Money. “Late payments on subprime loans have surged, The Wall Street Journal reported on its Web site on Tuesday, and while economists don’t expect major harm, a continued rise could hurt investors in mortgage-backed securities.”
“Based on current performance, 2006 is on track to be one of the worst ever for subprime loans, the report said. It cited the bank saying that roughly 80,000 subprime borrowers who took out mortgages packaged into securities this year are behind on their payments.”

Note the line ‘Mortgage backed securities’ These are among the instruments that end up in derivatives funds, a market that now steers $370 trillion. As I mentioned in an earlier blog, defaults in sub-prime loans could be the straw that causes a domino style collapse of this highly geared ‘funny-money’ market.

$370 trillion. You need a computer to count that high. It nears four times world GDP. Anyone not alarmed by this is not paying attention in class.
A collapse of the housing market will surely have world wide implications, but the havoc it will raise in the derivatives market could have us drawing parallels to 1929 or worse, we could all be eating ramen noodle for the next decade!

Sunday, December 03, 2006

Derivatives; The Monster That Ate The Future

"We are also frightened by the massive speculation in the financial markets with stock buybacks, mergers, leveraged buyouts, and trillions of dollars in derivatives floating around some of which we do not even know who the ultimate guarantor is. We are hoping but do not know that the ultimate guarantor of these derivatives is not Madame Merriweather's Mud Hut in Malaysia."

Ya, derivatives, somebody please explain these to me! The more I try to understand them, the less I understand. As near as I can come to it, they start with a private equity group, (Joe money bags and some of his cronies). They buy funds cobbled together with mortgage dept which was previously packaged and sold in a fund by the banks who first sold the loans. They then use the future value of these mortgages to obtain loans to fund corporate buyouts.

Now I admit this is the most basic of explanations.

The companies that are bought up are most probably further borrowed against or cut up and liquidated for assets which can be placed in the derivatives, further pumping their book values. Others are simply taken private, why I don't know.

As near as I can tell I am close to how they function. I welcome any schooling offered on the subject however.

Now the major problem I detect is the chain of financial liability. If Joe six-pack defaults on his loan or negotiates with the lender to short the mortgage, there goes the book value on that loan and its future interest profits. This presents a problem in the daisy-chain of borrowing these derivative funds engage in.

Another looming problem I detect is the economy. These funds have fueled an orgy of buyouts recently of major companies. Where will the profits come from to either make holding the newly acquired company worthwhile or make it attractive to another buyer? The short answer is, it doesn't. This looks like a ponzi scheme. If an economic downturn looks likely the private equity groups take out what equals an equity loan on the book values and then they disappear into the either. They are private groups, outside of SEC scrutiny. (You can see where I'm going with this).
With an estimated $29 trillion leveragedged in these funds I think this may be the largest threat to the world economy in modern history!

Here is what the National Bank of Australia has to say about the international phenomena of derivatives.,21985,20832000-664,00.html#

An analysis of a coming recession

Here is a good analysis of how a 2007 recession might play out from, written by Dean Baker. It’s a little longer than most of my posts so I will place the link and invite you to go there and read it. Good stuff.

Thursday, November 30, 2006

Pop Goes the Bubble!

While I don't agree with Mike's personal views , he does make some interesting points. I've done some checking and he has his facts about housing in line so it's worth the read.

Pop Goes the Bubble!
The Great Housing Crash of '07

This month's figures prove that the so-called "housing bubble" is not only real, but that its cratering faster than anyone had realized. As the UK Guardian reported just yesterday, "the orderly housing slowdown predicted by the Federal Reserve will (soon) become a full-blown crash".

All the indicators are now pointing in the wrong direction. Consumer confidence is down, inventory is at a 10 year high, and the number of homes sold in July was 22% lower than last year. As Paul Ashworth, chief economist at Capital Economics said, "Things seem to be getting worse very quickly. Freefall is a strong word, but I think it's the right one to use here." (UK Guardian)

The housing bubble is a $10 trillion equity balloon that will explode sometime in 2007 when more than $1 trillion in no-interest, no down payment, adjustable-rate mortgages (ARMs) reset; setting the stage for massive home devaluation, foreclosures and unemployment. ("By some estimates housing activity has accounted for 40% of all the jobs created since 2001". Times Online) July's plunging sales are just the first sign of a major slowdown. The worst is yet to come.

The blame for this rapidly-approaching meltdown lies entirely with the Federal Reserve, the privately-owned collection of 10 central banks who cooked up a way to shift wealth from one class to another through low interest rates.
Sound crazy?

Well, just as high interest rates cause the economy to slow down; low interest rates have the exact opposite effect by stimulating the economy through increased spending. It's all pretty clear-cut.

When the stock market nose-dived in 2000 the Fed lowered rates 17 times to an unbelievable 1% to keep the economy sputtering-along while the Bush administration dragged the country to war, gave away $450 billion a year in tax cuts, and awarded zillions in no bid contracts to their friends in big business. All tolled, the Bush-handouts amounted to roughly $3 trillion dollars, the largest heist in history, and it was carried out under the nose of the snoozing American public.
At the same time, America's debts and deficits have continued to mushroom behind the smokescreen of low interest rates.

Rather than face the recession which should have followed stock market crash, the Fed chose to increase the money supply (which doubled in the last 7 years) and lower the qualifications for getting mortgages. (I read recently that 90% of first time home buyers not only lie on their mortgage applications, but that 50% of them say that they earn TWICE as much as they really do. The applications are not cross-checked with IRS statements) Now, tens of thousands of Americans live in $400,000 and $500,000 homes without a penny of equity in them and with loans that are timed to increase dramatically in 2007. (Many of the monthly payments will double) So, how can we blame the Fed for the reckless and irresponsible behavior of the average homeowner?
Well, because they knew the effects of their "cheap money" policy every step of the way.

First of all, the Fed knew exactly where the money was going. Greenspan endorsed the shabby new lending-regime which put hundreds of billions of dollars in the hands of people who never should have qualified for mortgages. They were set up to fail just like the victims in the stock market scam who kept dumping their life savings in the NASDAQ when PE's were shooting through the stratosphere.

Secondly, the Fed knew that wages had actually regressed (2.3%) since Bush took office, so they knew that the soaring value of real estate was entirely predicated on debt not real wealth. In other words, home values increased because of the availability of cheap money which inevitably creates a buying-frenzy. It had nothing to do with real demand or growth in wages.

And, thirdly, according to the Fed's own figures, "the total amount of residential housing wealth in the US just about doubled between 1999 and 2006"up from $10.4 trillion to $20.4 trillion". Times Online.
UP $10 TRILLION IN 7 YEARS! That is the very definition of a humongous, economy-killing equity monster. In other words, the Fed knew the ACTUAL SIZE OF THE BUBBLE and chose to steer it towards the nearest iceberg without warning the public.
This is what Greenspan called "a little froth".

There is no real growth in the American economy. Figure it out. Last year Americans saved less than 0% of their net earnings while they borrowed a whopping $600 billion from their home equity to piss-away on a consumer spending-spree. Once home prices begin to retreat, that $600 billion will evaporate, real GDP will shrivel, and the economy will begin flat-lining. (Consumer spending is 70% of GDP)

The Federal Reserve's plan is so simple; we shouldn't dignify it by calling it a conspiracy. It's merely a matter of hypnotizing the masses with low interest rates while trillions of dollars of real wealth is diverted to corporate big-wigs and American plutocrats.

It might not be rocket science, but it worked like a charm.
Now, the trap-door has been sprung; the country is dead-broke and all the levers are in place for a police state. As the housing-balloon slowly limps towards earth, the new Halliburton detention centers are up and running, the National Guard is in Rummy's control, the Feds are able to listen-in on every phone call we make.

The noose is beginning to tighten.
New Orleans was just a dress rehearsal for the new world order; 300,000 million Americans reduced to grinding poverty while the economy explodes into sheets of flames.
Mike Whitney lives in Washington state. He can be reached at:

Media, the engine of the housing market

It's been claimed by some that the mainstream media is responsible for the current housing decline. This line of logic has it that hyping a previously non-existent downturn caused it to happen, sort of like a self fulfilling prophecy, or something of that nature. If this is true then it would follow that they were also responsible for the dizzying heights the housing market reached during it's bull run.

It's possible.

That being said, I think every R/E agent, broker, lender, mortgage broker etc... owes a letter of thanks to their favorite media outlet (or hell, all media outlets for that matter) for all the cars, vacations, big houses and mountains of cash they acquired by way of the medias efforts.
It was quite a party.


Wednesday, November 29, 2006

Housing has never seen a soft landing, ever

Mike Morgan at Morgan Florida had some interesting comments on housing and the economy.

It is encouraging when people take a hard look at their own industries and plot the real possibilities rather than the ‘head up the arse’ denial that comes from most anyone tied to the housing industry right now. And to all of you – closing your eyes won’t make it go away…

From Mike Morgan

Chicken Little
I’ve been receiving quite a few calls regarding the surge in home builders’ stock prices. Well, first off, I am not a financial advisor. My research and consulting services are purely information for the end user to incorporate into their financial analysis.

I think that what’s going on nationwide in housing will effect the country to levels we have not seen since the Depression. Some of you may be equating me with Chicken Little. After all, Cramer is bullish on the home builders and so is Bill Gates. Well it’s not Bill Gates making the call. It’s his financial advisors that run the foundation that are making the call. Second, even if it were Bill Gates, he’s been wrong more than right for the last few years. Bill Gates is not Warren Buffet. As for Cramer, I have no comments except to say that his show speaks for itself. I think you can read between the lines.

Finally, the market seems to have bought into the "Goldilocks" soft landing theory. Well housing has never seen a soft landing ever and I fail to see how this time can possibly be different given the affordability problems and the disparity between housing prices and rents, not just in Florida, but pretty much nationwide. With that comment, let's now turn our attention to the situation facing the homebuilders.

Catch 22
Following are the three business strategies builders are using to survive the downturn in home building.1) Reduce Inventory

Housing inventory is at the highest level we have ever seen since the beginning of time, and growing daily. Back in early 2005 Centex was the first to realize the market was in trouble. They quietly contacted real estate agents and offered double commissions and huge discounts on inventory that would close prior to their fiscal year end of March 31, 2006. As this program grew, the other home builders initially ridiculed Centex, but in their own board rooms, they quickly started cooking up competitive discounts, incentives and commission bonuses. Now it’s a free for all to see who can leap frog the other on the way down, and who can get more creative with incentives. The Catch 22 here is simple. Margins after all of this nonsense are approaching zero for most builders, and the madness has not stopped. But if builders don’t dump standing inventory now, they will have heavier losses if they continue to carry these homes and watch prices further deteriorate as the competition drives prices down further.

(Catch 222) Monetize Land
As if standing inventory was not enough of a problem, builders have two additional problems. First they have land, some of which is entitled and improved. Second they have thousands of projects that are already started, with roads, sewers and utilities already in place and paid for with lots of debt. They might be able to walk from land options and land that is not entitled, but it is not very easy to walk away from land that is already in the development process with billions of dollars of debt tied up.If the builders move forward with the developments, they are further increasing inventory. If they don't, they face problems with carrying costs of entitled land or shutting down a development that has already started. But carrying costs are not the only problems builders face.

If they have already started the development, they most likely have a time frame with the local government to complete the build out. Some local governments require builders to post a bond insuring the completion of developments. And how many homes do you think a builder can sell in a ghost town of a few spec homes? People want to live in a community, not a construction site.

(Thus we have the second Catch 22.3)
Scale Back
One would think this is the smartest option. When demand drops off, it is usually a good time to cut back on supply. But if the builders scale back, that means lower numbers for Wall Street. We’d see lower starts and lower sales and lower revenues and lower profit. Oh, almost forgot the "bonus factor". We’d also see lower bonuses to the top dogs who greedily reaped in tens of millions of dollars each during a market fueled by irrationally greedy speculators that essentially had nothing to do with their business acumen or experience.

One top builder has already announced they plan to continue building so they come out of this as a volume leader and capture branding. They’re losing money on each sale, but they’ll make it up in volume? That’s pretty expensive branding.

Once again, we have a Catch 22.
If the builders scale back, Wall Street will not see the numbers they want to see. If the builders don’t scale back, Wall Street will see some numbers, but the increase in inventory will complicate the problem with lower prices and bottom line losses will be the only numbers Wall Street will see.

Book Value
In addition to the three Catch 22 issues, Wall Street seems enamored with the low book values of the builders. I’ve got news for you. The book value numbers for this group are as misleading as a deaf and blind seeing eye dog. We’ve seen a few builders take write downs on some land, but if you crunch the numbers, it’s crystal clear that these write downs are not enough.

Look at D.R. Horton’s (DHI) recent write down in comparison to their land position. Look at Lennar (LEN) and the other builders referenced in the informative piece appearing in the October 2 issue of Barrons. Think about WCI Communities (WCI) and Brookfield Homes (BHS). Is their land old land with value, or is it relatively new land that they paid top dollar for. Finally, take a look at what happened to Kara Homes in New Jersey. A large regional builder that choked on their land and inventory. Choked right into bankruptcy.

This is where it gets tricky. It’s not easy finding out at what prices, where, and when the builders purchased land and/or options on land. For land purchased prior to 2000, the book value will most likely hold. For land purchased in 2005 or later, these guys are in trouble, and much of that land is probably worth 25-50% less than what they paid. For land purchased between 2000 and 2004, there is a grey area as to what the land is worth. The bottom line when it comes to land is that builders bought land just like the flippers bought their preconstruction homes. Price was a secondary issue. The primary concern was getting entitled land.

The crash of the housing industry is only now getting started, as it will spread virally to all of the boats it floated during the rising tide. Housing has touched every single segment of our economy, and it will darken all of those segments as the industry collapses to the worst levels we’ve seen since the Depression. The NAR and other groups producing numbers have been great cheerleaders, but when you’re pumping out misleading numbers, I don’t care how beautiful or loud the cheerleaders are, the situation is a no win catch 22 for the homebuilders no matter how one looks at it.

Monday, November 27, 2006

Things will get a lot worse before they can get better

The following is an e-mail to Mish Shedlock from one of his readers, Michael J. Dorff.
Mr. Dorff makes a very succinct evaluation of the state of recent consumer home lending and where it will most probably lead us in the very near future.

This is not a problem that will occur tomorrow or even in the near future but is happening as you read this. Maybe a very masterful magician will appear and pull a rabbit from his hat to save us from ourselves at the last moment, but I wouldn’t hold my breath on that hope. Besides, that would only postpone the reckoning that we should face now, it will only grow larger if we don’t.

Here is a synopsis of the mortgage side of things here in Orange County and for that matter California in general.What people don't see, the NAR in particular, is the upcoming train wreck. I am talking about all the sub prime loans for refinances as well as purchases that were taken out 2 to 3 yrs ago and are now all coming due to reset. My guess is that 99% of all sub prime loans are all done on a 2 or 3 yr fixed interest only type program. People thought that it made no sense to take a 30 year fixed loan those homes when the short term rates were a lot lower, but they were all wrong.

The time bomb is about ready to go off. All of the subprime loans taken out 2 to 3 years ago have margins of at least 5% or higher and usually based on the London LIBOR program.

Those loans are starting to reset now at fully indexed rates somewhere in the high 9% to 10% range. When those loans were initiated 2 to 3 years ago, they all had start rates of high 5% to low 6%. As of now, the LIBOR alone stands at 5.388 for the 6 month and 5.336 for the 1 year. Take those LIBOR indexes and add the margins to see what is going to happen.

Here is a case in point. One of my clients who took out an interest only subprime loan from another lender just received her reset notice. Her current margin is 5.25% and her index for the 6 month LIBOR index is 5.388%. This means her new interest rate will shoot up to 10.638%. Her note states that her first adjustment cannot go higher than 9.2%. So she will be at 9.2% for the next 6 months. With an initial loan balance at $251,000 at 6.2% interest only, she had a monthly payment of $1,296.83. In December her new payment will be $1,924.33 for the following 6 months before it adjusts again. This is a $627.50 jump in monthly payment. She simply can not afford this payment.

Given her low credit score near 550, she is fortunate to still have equity that will allow her to refinance at all. Even still it is a tough task because not only does she have a bad score, she also a late pay on her record. The best option any sub prime lender would give her was 8.5% but she can not even afford that. The only option left is a Neg Am Option Arm Pick a Pay Loan where her payment is based on an payment rate of 2% but with a fully indexed adjustable rate of 7.4%. She will go negative if she cannot make the interest only portion of this loan. She also needs cash, $75, 000.00 of cash. That is your typical home ATM machine at work.

These Option Arm, Neg Am Pick a Pay Loan programs were one of the things keeping the home building bubble and mortgage lending bubbles going for the last 3 years. Without these products, the market (at least in California) would have collapsed 3 years ago. Instead the bubble just got bigger and bigger and we will see even a greater collapse when it comes. Ninety percent of those who take an interest only loan can only afford the interest only part and not only that, there entire lifestyles are planned around that payment.

Lenders don't really want people to pay the principle off anyway unless there is a prepayment penalty on it. Prepayment penalties are another scam in and of themselves. You can bet the lenders have made a killing on these 6 month interest prepay penalties. Bear in mind that once someone is subprime the odds of that ever being corrected are slim. Refinancing on better terms is usually not an option. Average credit scores for this group on the whole have not improved much if indeed at all over the last few years. I would guess that 80 to 90% of sub prime borrowers stay sub prime borrowers. Those borrowers are in a hole so deep they will never cleanup their credit to get A-paper rates. To top it off, many of them end up paying multiple prepayment penalty each time they need more money. They simply can't wait for their prepay period to expire. Ultimately it is a death spiral to bankruptcy.

Ask any Realtor out there if they know or really care about the types of loans there clients are getting. They may say yes but my assumption is they just want to make the sale. Ask any mortgage loan officer if he or she cares about what loan program they put their client in. Many will say yes but the reality is that they just want to close the loan and get their commission. First greed took over. Now it is a matter of survival.

Here is another reason why these loans are pushed: Lenders pay a lot of rebate on the back end on these loans which fuels the greed even more. Mortgage professionals can make up to 3.5% back end points on these loans while their client's minimum payment stays the same. When you are talking about the high loan amounts in California, the money to be made by pushing someone into one of these programs is huge. So are the temptations. Some lenders went so far as to put on their rate sheets that the maximum a broker or mortgage loan officer can make is $50, 000.00 on a given loan.Initially investors and flippers loved these loans because their payment was so low that by the time they could flip a home there out of pocket expenses were nothing. It all works well when the market is going up. When it stops or even falls, say good bye!

Everyone is in same box. Realtors need sales, homebuilders need sales, and mortgage brokers need sales. Unfortunately those needs too often come before their clients needs. In the end, the bankruptcies and foreclosures that result from this mess will just keep adding to inventory, ultimately forcing home prices lower. We are only in the first year of decline. From where I sit things will get a lot worse before they can get better.

Michael J. DorffTrans
World FinancialHuntington Beach, Ca. 92646