Nausea Rules

March 12, 2007
      Here's an idea: when the securities markets go south along with the rest of the US economy in 2007, maybe the smoothies on Wall Street should receive end-of-year "cash-negative" bonuses, meaning instead of a check for, say, $25 million the day before Christmas, they get an invoice saying "please remit $25 million." Who to? Good question. One might suggest the nearest firefighters' or teachers' pension fund -- except the idiots who run those retirement funds bought mortgage-backed paper with their eyes open. Okay then, let's say the Wall Street boys send their checks into Amtrak. Maybe then the cafe car between Albany and New York City will re-open so that in the course of a 2.5 hour trip a person might get a drink of water.

     A tsunami of nausea seems to be sweeping across the media now in recognition that the Potemkin edifice of mortgage finance is imploding like a discarded Las Vegas casino. What it comes down to is that several species of newly-engineered financial Frankenproducts have been based on loans for houses that will never be paid back. Not just a few loans. Massive numbers. These, in turn, have been bundled, swapped around, and leveraged into other plays which now depend, for instance, on x-number of unemployed car dealers and underpaid busboys ponying up the "vig" for some piece-of-crap collateral that will soon be a third its previously appraised value. It will be easier for the car dealers and busboys to walk away from these deals than it will be for the smoothies who used all this bundled bullshit to hedge credit default swaps and play the yen-to-Euro carry trade game to wiggle out of their positions. And the unwinding of all this fraud will almost certainly leave the nation economically spavined.

      The amazing thing is how standards and norms for lending collapsed as completely as they did the past five years. One day you had bankers who retained a notion that lending per se required some prudent evaluation of the borrower's character and of the thing or enterprise borrowed for -- and the next day these protocols vanished. Once again I challenge the punctilious physicists out there by asserting that this astounding transformation is the product of entropy. Basically, you get a given system -- e.g. the US economy -- over-stoked on cheap energy (and even at $3 a gallon gasoline is cheap), and the system will throw off gobs of entropy. The more profligate the energy consumption, the more entropy results. It then expresses itself in various kinds of disorder, meaning anything from the immersive ugliness of the American built-up landscape to the behavior of people formerly attuned to such governing principles as moral hazard to retain the functional legitimacy of their livelihoods.

     It is really a sort of systemic disease, generating poisons that seep into the far corners of the organism affected, in this case the USA. It will be manifest in the personal ruin of individual families, the collapse of institutions, the rising crime rate, and the rapid physical decay of things built too carelessly to be worth caring for.

     I went around some neighboring towns here in upstate New York to look at the real estate yesterday. I was impressed by how uniformly crummy everything was -- and not only because it is nearly spring and layers of old dog shit are being revealed in the melting snowbanks. In the old houses priced above $300-K, the rotting sills and delaminating surfaces are plain to see. Of course, the buildings are worth something, but my guess is less than a third of the asking price by any realistic valuation. But at least these things were made of materials generally found in nature. The new houses were all glue and vinyl, and of course they were mostly built in places dissociated from any town itself, meaning the hapless owners will have to own multiple cars to live there and make multiple trips per day -- not a good prospect for the years ahead.

     The story will be the same all over the nation. The owners of these things will get into terrible personal financial trouble. The property market will re-value the buildings, discounting all the previous wishful thinking about price. And the financial markets will stagger and collapse as the process thunders through the mendacious operations that all this wishful thinking spawned.

Comments

[Mark Ontkush]

"Maybe then the cafe car between Albany and New York City will re-open so that in the course of a 2.5 hour trip a person might get a drink of water."

This was definitely good for a laugh/tear combo. I took the train from Albany to Boston some months ago and waited three hours for it to arrive from NYC. Just like I waited three hours 20 years ago when I went from Albany to Buffalo for college.

[Red]

Nah, all we have to do is tune in to the cable news financial gurus and they'll tell us that everything is A-OK and opportunities are everywhere to be found!

[Dave]

Good post !

A coversation yesterday with rural, newly relocated Dr. in the Sayre Pa. conveyed to following. He needed house saw one the asking price was 260, he bid 180 the refused he came back at 185 the grabbed it. Price collapse in beginning to accelerate in the Pa. region who knows when it will end ! dave

[Tim]

On the front page of yesterday's paper was a sticker offering "builder incentives" for new "homes." Such incentives include SUVs, which fact seems to indicate an accelerating entropic spiral in the suburban lifestyle. We also notice more signs having an "international previews" sign in front to give a property to the widest plausible exposure to potential buyers.

[Daryl]

A timely essay. They halted trading on New Century this morning. 34 subprime lenders have shut down, stopped writing loans or are otherwise in serious trouble.

[Dumas]

Even as recently as the 4Q of 2006 around 1/3 of all home mortgages in the US were sub-prime and Alt-A (approx. 16% of each).

Alt-A are loans where the borrower may have a decent credit score does not (or cannot) provide proof of income like a W-2, but states that his income is X.

In subsequent studies it has been found that 90% of such borrowers overstated their income by 5% or more. Problem is...60% of them overstated their income by 50%. In the mortgage business Alt-A loans are known as "Liar Loans".

[george]

If the state of Michigan is any indication of where were headed, were in for a nasty ride. It's being hammered by a rapidly declining population, atrophying property values, a booming mortgage foreclosure business and a tidal wave of businesses moving out of the state. Did I mention Michigan had a near-idiot governor who makes the current administration in Washington look like a model of administrative competency?

[Speed]

James, your link to The Daily Reckoning should be sans "the" (it should be www.dailyreckoning.com)

[Dumas]

For clarification:

...Even as recently as the 4Q of 2006 around 1/3 of all home mortgage ORIGINATIONS in the US were sub-prime and Alt-A (approx. 16% of each).

[Eligere]

And . . . the rats abandon the ship. Halliburton is moving its headquarters to Dubai.

I think this is interesting, I mean apart from whatever tax advantages they will almost certainly realize. Apparently, that "giant" Jack in the gulf was, as predicted, largely fanciful. And our nation's embargo against Cuba, moving into its 45th year, has just come a cropper; we won't be participating in their oil patch. It looks like the oil services behemoth thinks that this side of the world is played out. I can't say I'll miss them.

[1988dylan]

It will be easier for the car dealers and busboys to walk away from these deals then it will be for the smoothies who used all this bundled bullshit to hedge credit default swaps and play the yen-to-Euro carry trade game to wiggle out of their positions.

Should be: easier THAN it will be for the smoothies... I'm usre it was just a typo. Great Post, Jim. You are 100 percent correct. The situation is exacty as you describe.

[J.F. Mamjja]

That post makes me glad I'm not directly in the speculative real estate market. However it makes me uneasy because it seems like we are all in it indirectly whether we like it or not.

It also raised in my mind 4 questions.

1. Since the U.S. economy is built on quicksand, why do China, Japan, Europe & the Middle East still accept worthless greenbacks? What do they hope to buy with this paper since the U.S. no longer manufactures for export. (Besides armaments)

2. Since the U.S. has somehow conviced the rest of the world to do their work for them, (Energy from the ME & West Africa, manufactured goods from China, customer service outsourced to India) why is this bad? Isn't it the capitalist dream to get others to work for you so you can spend your free time on esoteric activities?

3. Since the rest of the world is in effect working for the U.S., why are the American people so overworked? Food production rests upon mechanization and underpaid Mexican workers. Clothing is made cheaply abroad. Trinkets are made cheaply abroad. All that's left is doling out the food and trinkets and building houses. Houses. Hmmmm. I may have answered my own question here. This is the esoteric activity. But still don't they realize they are wasting their lives on concerns far removed from real life?

4. If and when the workers in these other countries get tired of working for the U.S., how does the U.S. plan to keep them in line?

[Laura Louzader]

I have news for you all. It will NOT be easy for the "car dealers and busboys" or clerks or hairdressers or whover to walk away from these deals if they lied about their income in order to obtain the loan.

When you lie about your financial qualifications in order to obtain a loan you otherwise couldn't have qualified for if you had stated the true facts of your financial situation, that is BANK FRAUD and it is a FELONY and you are in DEEP DOGGIE-DOO.

Meanwhile, the loan shark rep who talked you into falsifying the loan app is only looking at civil penalties at best.

Many hedge fund managers will lose their jobs and investors will lose their money. However the people who will get the worst of it will be the hapless homebuyers who take the biggest burning. At best, if they were upfront and truthful, they will lose their homes to foreclosure and have to deal with trashed credit ratings and the loss of whatever they put down. At worst, if they are like the Target store clerk who claimed to make $84K a year to obtain $600K worth of primary and secondary financing, they are looking at prison terms.

Is this fair? No, it is not. However, people here in the US need to relearn personal responsibility, which is something nobody from the top to the bottom of our society knows anything about anymore.

[Dude]

J.F.,

Yep, we work 100 hours more per year than the Japanese, 200 hours more per year than the Germans and ya wonder what we're doing? House building and doling-out the "stuff" is done by illegals.

And as to your #4 - Halliburton's cranking out detention centers throughout the US for those who don't want to toe the line.

[Dumas]

Dear Laura,

Five will get you ten that the said "liars" will hire attys. who will claim their clients are not to blame, because the lending officers showed them how to properly calculate their incomes based on their "guidelines". And since financial professionals are by law deemed to have fiduciary responsibility, it's all their fault.

Bet you there will be tens of thousands of such cases - and many will win, too. If I were a lawyer i would already be beating the bush for such biz.

[John Hunt]

This just appeared on the late morning AP wire:

"Stocks showed little movement Monday as further cracks appeared in the subprime lending sector, stirring concerns that a blowup among companies making loans to consumers with poor credit will spill over into other industries."(snip)

"....New Century warned in a filing with the Securities and Exchange Commission that all its lenders had cut off short-term funding or announced plans to do so. New Century said it would need about $8.4 billion should it be forced to repurchase all outstanding mortgage loans under its financial agreements. The company said it doesn't have sufficient liquidity to meet its obligations for repurchasing mortgages."

Buckle up!

[Weaseldog]

In the mean time, we still don't who is buying TXU. But the unknown new owners, promise us that our rates will go down.

My assumption is that the buyers are remaining anonymous, because they are from UAE. Folks would get riled up, if they knew they'd be buying their electricity from Arabs.

But isn't the logical progression of deregulation and globalization one that leads to just a few foriegn owners, owning everything?

[Kevin]

It will NOT be easy for the "car dealers and busboys" or clerks or hairdressers or whover to walk away from these deals if they lied about their income in order to obtain the loan.

The sad thing is, they probably didn't lie about their incomes. When I bought my house in 2002, I was making 34K before taxes and was approved for a loan of $250K--if I wanted it.

If I would have bought a house like that, every dime I made would've gone to a house payment. I can eat Ramen Noodles, but would probably get very sick if that was what I would have to eat 3 meals a day.

[German Mike]

Laura said:
"At worst, if they are like the Target store clerk who claimed to make $84K a year to obtain $600K worth of primary and secondary financing, they are looking at prison terms."
Damn, you want to lock up all the loan liars that go belly up? There's the next building boom. Toll brothers & other builders are saved due to prison construction boom. ...not gonna happen. Investors/suckers are getting screwed as usual....buyer beware. I see multi-trillion dollar bailouts for Freddy & Fannie in my crystal ball, courtesy of the American taxpayer.
Still all is well in LaLa-land, stocks are holding up for now, oil is down sharply and the trade deficit is still considered a sign of strength.

[bookworm]

$300 K is not worth $300 K either. It is worth not more than $233 K. But hopefully, the value of the land the houses stand on will be more stable than the value of the dollar.

[Laura Louzader]

Hey, I don't want to lock them up. I think the whole thing is absolutely awful!!

I am only stating a fact, that you could be looking at a prison term for doing this.

I hope they can all weasel out, really, because the lenders are the ones who deserve to go to jail.

However, that is not how things work in this country. We protect big-money thieves while punishing thier victims, and that will happen here.

In the case of people who declared their real incomes they can prove, but were merely overwritten, they will only take a bath and get their credit ratings destroyed.

However, if you lied about your income, line up a lawyer. Keep in mind the lender has more lawyers than you do.

As I said, it is not fair and it is not right. I hope the result will be a decent regulatory structure for lenders, but I doubt it given the political power they have. I really, really hope the hapless morons with the lender loans walk free, but given our penchant for punishing the small, weak, stupid victim while letting the big, strong, sharp per walk free and hold on to his ill gotten gains, I have little hope.

I only hope that people wake up and realize that they must take responsibility for themselves. You are an adult, you are literate, you know how to sign your name. Be an adult.

[RJ]

Great writing Jim..

[Dumas]

Dear Laura,

Vox Populi Deus Irae.

If it gets really ugly the politicians will drop the big banks so fast your head will spin.

Look at what happened to Enron, over a few hundred bucks of monthly electric bills. Housing is a quantum leap above that...

Regards

[German Mike]

Maybe some indentured serfdom of the fiscally irresponsible would put this country back on solid financial footing. Let's start with the loan liars, their loan officers and the CEOs of several subprime lenders. Throw in a few deficit spenders from politics for good measure and we'd be writing black ink in a decade or two....just a dream.

[1988dylan]

Non-qualifying home mortgages allowed home buyers to get the mortgage and disclose little information regarding their financial condition in exchange for higher interest and other fees. If lots of customers who default get hauled off to prison, who will keep the economy rolling? These people will be renters who will at least pay rent and utility bills if nothing else. The most unfortunate individuals and families will join the ranks of the homeless.