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Strategies & Market Trends : The Residential Real Estate Crash Index -- Ignore unavailable to you. Want to Upgrade?

To: Think4Yourself who wrote (200537)	5/6/2009 11:58:00 AM
From: Jim McMannis	Respond to of 306849

Stress Tests: What's That Light? It's a train. market-ticker.denninger.net The "rumor" floated over the weekend and this morning was that some of the banks might need $10 billion under the "stress" scenarios. That they might be able to raise, and it has been part and parcel of fueling the rally. Not so fast, grasshopper. S&P yesterday afternoon stuck virtually the entire sector on Credit Watch Negative and that was just the start. There are now some independent analysts out there with their own numbers on "required capital", and they're ugly. Friedman Billing Ramsey came out and said they believed that Bank of America needs $60 billion all on its own, while Egan-Jones piped up and said the number was $100 billion! SNL Financial, a research firm, thinks the number is $50 billion each for Citi and Bank of America - minimum - and might be closer to $70 billion for Bank of America. Nor does it end there. Wells is projected to need $66 billion and JP Morgan needs $33b, according to these folks. But if you think those numbers are a horror show, the real ugliness isn't found there. It is in fact found in all the foreclosed-but-unsold and not-yet-foreclosed "but will be" housing stock. Through the nation I am getting reports, some hard and some anecdotal, that lenders are sending out NODs (default notices) and then sitting on the process intentionally. Why would they be doing that? Simple: Most lenders who have these notes either in a security or as "whole loans" they were unable to pawn off on someone when the securitization market collapsed are holding them at "par" - the total amount outstanding. If they sell they are forced to realize the loss; so long as they have a "reasonable belief" it will perform or be bought out (e.g. a government-sponsored and funded refinance) they can carry it this way if it is held to maturity. This of course makes their books look much better than they really are when you've got $500,000 in cash out against collateral that the market values at $150,000! Then there is the Option ARM inventory and, most troublesome, the HELOC's (mostly seconds used for purchase and cash-out transactions) behind them. There have been opinions floated that the "ARM" decimation is mostly a nothing, since short-term rates are so low and will remain that way for a reasonable amount of time. This is true but misleading - with Option ARMs the nuclear destruction does not come from a reset of the interest rate but rather the recast when the loan ages or reaches (typically) 110% of the original principal value. At that point what was either an interest-only (or even not a full interest) payment is forced to a fully-amortizing payment on the balance of the original time. For many of these loans this is set to happen at either three or five years post-issue, which means we're just starting to see the loans written in 2006 turn into many-headed hydra about now. The importance of this event is that the increase in payment is absolutely insane - it is not at all unusual for payments to double, and there are few if any of these loans where the jump will not be at least 50%. The IMF says there's roughly double the embedded loss in the system compared to what has been recognized and written down. I think they're conservative - my original estimate for housing market losses was somewhere around $2.5-3 trillion for residential alone. So far the tally is up in the high hundreds of billions, meaning that there are a lot more cockroaches still to be found in the banking system - and they're doing their best to hide from the light. Can that succeed? Not a prayer in Hell. Those Option ARMs and any seconds behind them are doomed. There is no possible way to refinance them as most are over $100,000 underwater. The seconds written on top to get around conforming limits or avoid PMI are in fact worth nothing as the first has priority in a foreclosure action and there's not enough there to even satisfy the first! To put this in perspective there are condos out in Las Vegas that sold for $500,000 that now can be had for $50k or so. You'd think that's a great deal. You'd be wrong, because half the complex is foreclosed, the association is on the verge of bankruptcy and as a consequence the special assessments will be rolling in soon - and they won't be small! Now add to this the basic business model in the consumer credit sector - jack up everyone's credit card interest rates. This is effectively an attempt to cost-shift those who cannot pay and are defaulting onto those who (still) can. It is doomed to fail because those who can pay off the card will immediately do so and close the line, while those who can't default under the increased burden. This looks good for a little while but the math is never wrong, and this sort of path forward either collapses under its own weight or eventually will draw a strong government regulatory response. Either way what the banks are doing can't work; 36% interest charged against someone who is paying zero because they defaulted is still zero, but all your customers who can pay it off and leave will do so to avoid being bent over the table. The continued refusal by our government to put these financial institutions where they belong - in front of a bankruptcy judge where priority is honored, the capital structure is crammed down and the assets sold off for whatever the market will bear - is leading us inexorably toward economic Depression. Both President Bush and now Obama are proceeding under the (false) hope that if they can hold things together for a little while the economy will turn and it will all be ok. The "green shoot" people are all predicting positive GDP in the 3rd and 4th quarter. What they're not talking about is what the real number was for the 1st Quarter - there was a trade balance shift credit in there worth nearly 3%; take that back out and we weren't -6% annualized, we were -9%! The bad news is that the trade balance shift is actually bad for the economy and signifies extreme weakness yet it shows up as a positive contributor to GDP due to how the math works. Nice eh? But that was likely a one-time change, which means the second quarter could get real interesting. Here is the reality folks: 1.Until continuing claims start to come back into a reasonable range and the U-6 "frustrated" employees find work, the consumer credit picture cannot materially improve in terms of default rates on all sorts of credit. The consumer is 70% of the economy. 2.When that happens we will still be left with an economy that is missing the "pulled forward" demand represented by home equity extraction and rabid, unsustainable granting of all forms of credit. This is likely in the 3-4% of GDP range, and that adjustment will be permanent! 3.The excess debt in the system not only hasn't been flushed it has to a large degree been hidden and/or shifted to The Federal Government! Defaulting it there doesn't do anyone a damn bit of good - in fact, it spreads the damage to everyone instead of keeping with the people who made the bad bets on both sides (borrower and lender.) This is pure insanity, but it is what our government has done because we "the sheeple" keep believing we can have something for nothing. 4.There is no way to "fix" the bank balance sheets without massive dilution. Either you convert preferred to common, you issue new common, or you sell performing (cash-flowing) assets. The first two dramatically dilute everyone holding the common stock and the latter takes a pole-axe to the earnings side of the balance sheet, having the same effect on shareholders as the first two. The recent runup in bank stock prices, doubles in many cases or more, is not only unsustainable it is something right out of The Three Stooges. To those who think that the banks will "all be ok" and "we will muddle through and have economic recovery in 2010" I politely suggest that you're smoking something legal only in California. Bluntly, the excessive debt must be flushed from the system, and since we can't pay it down the only option is to default it through bankruptcy, as I've said since this mess began. Until that happens any "recovery" will be fleeting at best - and a false hope. Disclosure: No position in any stock named; considering several shorts