A lot of people here just don't understand the problem we are facing today. I keep hearing percentages on how small the sub-prime markets are and how small the percentage of homes that in default are and how great the foreign economies are doing etc.
These are not the issues.
There are a number of issues including those, but the main issue is system by which past credit was created, packaged and sold to investors is history. It's gone and will never return in its current form and as we sit here today there is nothing to take its place. If you want a jumbo loan today and have great income and credit it will cost you 200 basis point more than a month ago.
This system was created after the S&L crisis in the 80's to shift the risk from the banks and S&L to the private markets. It was designed to avoid having to ever bail out the financial system again. It worked fine until people got greedy and started to put together creative packages to hide the risk and the rating agencies went along with the game plan.
Now that there are incredible losses showing up in the system there is a complete lack of confidence going forward. Without confidence the system doesn't exist period end of story.
It's not just with sub-prime mortgages, it's with virtually every type credit including even credit card receivables with their zero interest teaser rates just like you had with the mortgages, or the auto loans with zero down and pay nothing for 6-12 months. It's ALL CREDIT not just sub-prime mortgages.
It was the system that cause the credit bubble that was the driving force to the economy over the last 7 years or so because the system allowed for excess risk as long as WS could sell the paper. Well.......in case no one has heard the paper isn't selling and for those who have to sell they are getting 66% of their money back on AAA rated paper.
The "credit crunch" is coming from the fact that:
1. The banks are going to have to fund the LBO paper they committed to and can't sell to private parties.
2. The fact that most of the banks have off balance sheet SIV's that acquired these toxic packages that paid above normal interest rates and they funded it by issuing very short term asset backed commercial paper and they were making a profit on the spread. In case you're not watching over 800 billion of that paper has rolled over with no buyers and WS has had to go to the fed and get special approval to make loans to their brokerage subsidiaries to fund this CP as it comes due. There is still over 2 trillion dollars of this paper coming due in the next 45 days. That was trillion with a T.
3. No one fully understands how much exposure each bank has to this off balance sheet toxic paper so banks are not willing to loan money to each other which has frozen the money markets.
4. Many of the issuers of CP have back up lines of credit with the banks just in case the very thing that has happened does happen and those lines of credit are being funded as the CP matures.
This is a lot more than a simple credit crunch that can go away as quickly as it started, these are real losses and it will take years to correct the problem not days, weeks or months.
I've seen some very well educated guesses that the losses will run over $800 billion, but as time goes on the that number keeps increasing. My guess is the losses will exceed a trillion dollars and I feel this is very conservative.
In my mind the odds of a recession are as close to 100% as you can get. In case there is still any doubt in anyone mind please read the following:
fxstreet.com
Here are a few of the points:
Since 1953 there have been nine instances where year-over-year employment growth declined to 1.2% or less, and all nine occurred shortly before or after the start of a recession. There was not a single false signal.
Since 1960 there have been seven instances where year-over-year housing starts were down 30% or more, and six of the seven instances occurred shortly before or after a recession. There was one false signal in 1966 when a recession was narrowly averted and the S&P 500 dropped 25%.
Since 1960 there have been eight instances where the Conference Board leading indicators declined year-over-year, and seven of those instances were followed by recession. Once again the false signal occurred in 1966.
Of the last nine recessions, none were forecast by the consensus of economists, and even now, according to a Wall Street Journal survey, only 11 of 55 economists said there was at least a 50% chance, despite the depressed housing industry and credit market upheavals.
Summarizing the above numbers on employment, housing starts and the leading indicators, we have 24 data points, and 22 (92%) point to recession as opposed to two false signals. On the other hand the consensus of economists is 0 for 9. We see no reason why the recession signals will be false this time in light of the continuing collapse in housing and the re-pricing of risk in various markets throughout the globe.
In case you still feel this is a simply credit crunch I suggest you study the following:
paulvaneeden.com
Here is a summary:
Executive Summary
1.) The U.S has a credit crunch. Because of the recent turmoil structured finance has come to a halt. It accounted for possibly 40% of aggregate mortgage finance flows and a significant share of other finance flows in the U.S. economy.
2.) But credit crunches can come and go quickly, like in 1966 or 1980.
3.) There has been a loss of confidence in the credit markets. But losses of confidence can come and go quickly - like in 1998. Some of this has already happened. Some ? but certainly not all ? of the short term money market crisis
has abated in response to central bank actions.
4.) I believe the current situation is neither a credit crunch only nor a loss of confidence only. I believe it is an old fashioned credit revulsion.
5.) Credit revulsions are a response to real credit losses resulting from real failures of borrowers to pay. Most of the credit revulsions of the pre war period and the credit revulsion of 1989 ? 1992 took a considerable time to repair. In some cases they set the stage for deep economic contractions and a compounding of the credit crisis.
6.) The most famous example of this was the first banking crisis in 1930 which turned a severe recession into a great depression. The only U.S. postwar example was Credit Crunch Page 2 9/5/2007 the credit revulsion of 1989-1982. It contributed to the 1990 recession and resulted in a very sub par initial economic recovery.
7.) The most famous example of a credit revulsion in the postwar period is the Japanese banking experience from the bursting of the bubble in 1990 to the final onset of recovery in 2003. It was credit revulsion that kept Japan in stagnation
and recession for more than a half decade despite a zero interest rate policy and unprecedented fiscal stimulus.
8.) If one compares the situation of 1989-1992 in all respects to the present situation there is a prospect for aggregate credit losses of almost a half trillion dollars.
Though in great disarray, today?s markets have yet to discount such an outcome.
9.) The ?inflation? in the prices of structured credit instruments above the ?underlying? as a result of the structured finance process adds a second layer of
potential loss which also may not be fully discounted by today?s agitated markets.
10.) If the intensification of financial distress leads to deep house price declines and perhaps a recession aggregate credit losses relative to U.S. GDP may be much higher than in 1989-1992. Such losses could be compounded by the unwinding of
the ?inflation? in structured product prices above the underlying.
11.) Unlike credit crunches, credit revulsions tend to have a long tail. And they do not always respond to a large policy ease. They didn?t in 1930. They didn?t in Japan. They did in 1989-1992, but with a lag.
12.) So far it appears the U.S. financial problem is largely in the (albeit very large) non bank sector. This makes it more like the U.S. in 1989-92 and unlike 1930 in the U.S. or Japan in the late 1990?s.
13.) Let?s hope that 1989-1992 and not something more adverse is the appropriate precedent for today.
The markets may continue to rally into a fed rate cut, but as soon as the markets realize that a rate cut will not solve the evolving problems it will tank.
Jim |
