Singing the Vegetable Opera

March 5, 2007
     The jive-finance economy had a few acidic burps last week -- or, at least, that's how it may seem in the days ahead as the equity markets finally upchuck the toxic notional junk "money" they have been gorging on in recent years. Has there ever been a financial collapse with brighter or louder warning signals?

     I suppose the expectation (or hope) is that the quasi-mythical "plunge protection team" -- a "working group" of federal reserve officials and bankers -- will jump in and administer some soothing pepto-bismol, but frankly I don't see how that's possible this time. The poison at the bottom is a fetid mass of "non-performing" mortgages, billions upon billions of loans that strapped borrowers are not paying back, loans which, in the meantime, have been rolled over, rebundled into jive "securities" (ha!) and sold, and rolled over again and used as "leverage" for massive exotic bets and bloated arbitrages involving mere abstract figments of electronic digital pulses completely removed from any reality-based productive investment activity.

     Among the leaders at the supply end of this racket has been General Motors -- that's right, the company that used to manufacture cars, the company about which one plutocrat once remarked what was good for [it] was good for the country. In fact, General Motors' main source of earnings for a long time now has been money-lending, not car-making (which only loses money). They started decades ago with GMAC, their own car-loan operation -- which makes sense if you are serious about selling cars -- but in the 1990s, with foreigners way out-selling GM's shitty cars, the company's financial wizards decided to venture into home loans and thus Ditech was born.

     That's right, Ditech, the outfit that advertised incessantly on TV, promising that house-buyers could sleepwalk their way into mortgage approvals -- and thus frustrate all the smarmy, over-fed, punctilious bankers who obstructed such requests with pain-in-the-ass qualifying protocols and burdensome paperwork. Last week GM put off filing regular required financial reports because of disarray in its Ditech operation. Ditech is responsible for as much as $80 billion in mostly sub-prime house loans -- i.e. given to people with dubious prospects for repayment. But GM's Ditech is but one of scores of entities now choking on non-performing paper (and many of Ditech's rivals are now bankruptcy road kill).

     What makes matters far worse is that all this wildly reckless lending has been in the service of a suburban sprawl-building juggernaut that will itself represent another layer of grotesque liability for the United States. The crash of the house-selling bubble, based on absurd asset inflation for things built badly in the wrong places, is coinciding exactly with a permanent oil crisis that will only exacerbate the locational disadvantages of houses built in the newest and furthest suburbs.

     Evidence now conclusively shows that Saudi Arabia's oil production was down 8 percent in 2006 over 2005, even while the number of oil rigs went up substantially -- indicating that the Kingdom is drilling as fast as it can and still losing ground. (Production slipped from 9.9 million-barrels-a-day to about 8.4 mm/b/d.) Mexico's Cantarell field is crashing (minimum 15 percent annual decline and possibly much steeper rate, meaning in a year or two the US will cease getting oil imports from its number two foreign supplier). The North Sea is crashing, too. Russia is about show steep decline. Iran is past peak. Iraq, as every six-year-old knows, is the world's clusterfuck poster child. Indonesia (OPEC member) is now a net oil importer. Venezuela is past peak and full of loathing for the US. Nigeria is collapsing politically. No amount of corn is going save the Happy Motoring utopia, and that's really all our economy is now based on.

      When the financial markets factor all this in -- and they really haven't yet -- I think we'll see a lot more of what they like to call "downside action." These things are all connected. The housing bubble was set into motion by $10-a-barrel oil at the turn of the millennium. Perhaps as much as half the jobs created since then have been in house-building, house-selling, house-buyership-enabling, house furnishing, and other things house-related. The whole final suburban blow-out enterprise has been a fantastic blunder. Now it's unraveling and the only "performing" loans will be the ones paid to the accounts receivable department in hell.
      It ought to be an interesting week in the markets.

Comments

[Abrey Myers]

Dear Jim: Very timely subject for your commentary this week. Aaron Korwne's Mortage Implode website now lists 30 subprime lenders that are no longer operating independently (i.e., are in trouble) or have closed. Fremont General has just shut down rather than face criminal charges by the FDIC. New terms to learn: warehouse lender and warehouse lines (lines of credit from big banks because subprime borrowers aren't good for the money).
Link: http://ml-implode.com

And on the NYT online, from a few days ago, a story about possible things to come in America? Don't think it can't happen here. (Cairo Journal: In Arab Hub, the Poor are left to their fate). Link (may require registration, free): http://www.nytimes.com/2007/03/01/world/middleeast/01cairo.html
Also a corresponding video in the NYT main World section online page, 'Government is Irrelevant'. Eerily confirms your link from Dmitry Orlov about his satire on surviving collapse.

Things are slowly starting to happen, but happen they are. Keep on keeping on, Jim.

Abrey

[Abrey Myers]

Correction: Name is Aaron Krowne, site is called Mortgage Lender Implode-o-Meter. The 'o' is a picture of an imploding building.

[edgar]

Well said Jim. All true. With Paulsen at the Treasury does that now mean that what's good for Goldman Sachs is good for America? Or did Bushco just help him get out with his $500 mil? What a bunch of crooks.

[Scott]

A very authoritative voice was on Bloomberg yesterday reassuringly denouncing the hype that sub-prime mortgage defaults are going to cause economic problems. The analyst insists the risk is spread out over enough institutions as to be irrelevant to meaningful analysis.

As far as oil goes there is also unprecedented differences of opinion as to supply/demand fundamentals that one would be inclined to think analysis is now largely political rather than transparent.

I am surprised you left out the inflationary downside potential for ethanol production on food prices this year. Projected inflation increases have been set at 2-3% due to higher feed costs in beef,dairy and poultry production. This is not easily glossed over as food costs are part of the FED's core price index that it uses to measure inflation. Broader markets have priced in rate decreases for later in the year and it is doubtful that the FED will have wiggle room to lower rates in the face of higher energy and food prices putting even more pressure on housing and financial markets abilities to spread risk.

[Jerry Johnson]

Oh my, what happens after the market closes on the Friday after the due date for calendar 10K's!

New Century apparently has a going concern problem with their auditors. Fremont must jettison something to avoid the same problem. If you were a depositor at Fremont would you pull down your money? An old fashioned bank run high tech? Move it out ASAP, like Monday morning.

I mused a bit about GMAC yesterday. Might they have a going concern problem unless they jettison something? Ditech as a subsidiary of Rescap,a subsidiary of GMAC Financial Services owned by GMAC. Time to file with an assignment of the stock for the benefit of creditors. A subsequent event that could avoid going concern problems? Of course, this might undo the entire 51% sale of GMAC which could cause a going concern problem for GM? The accountants do have a knotty problem here and all they are worried about are the Journal Entries? The cash flow unwinding still comethin the next year or two.

A twenty percent decline sell off next week?

[ross]

GM asked the question, "who is a greater threat to freedom, Bush or OBL?"

That's easy, as Bush has vastly more power than OBL, (who if he isn't dead, is more a bogeyman construct than a living breathing threat) Bush is. By extension, the WOT is a fraud, a hoax perpetrated by those who could not otherwise enact their agenda except under extraordinary circumstances.

JJ and Dumas, there is a pertinent article at www.dollarcollapse.com about the burgeoning woes of the banking sector.

[cmarie]

Thanks for the links Abrey.

Excellent post Mr. Kunstler, keep up the good work.

[Dumas]

Dear Ross:

Thks. for the link.

I have been following the CDS market for several months now and it is the scariest thing going. Peak Oil is NOTHING compared to this.

Buffett has called them financial weapons of mass destruction and Financial Times dubbed them "counterfeit bonds".

Notional amounts outstanding have gone from $900 billion in 2001 to $26 TRILLION in June 2006, likely closer to $35 trillion by now.

We all know what is happening to the sub-prime market mortgage. If THIS baby goes off...Financial nuclear winter.

Watch the CDX indexes closely.

Regards

[hermit]

I just e-mailed a copy of you post to my son over in N.Z. I'm just hoping that he has the good sense to call his broker on Tuesday, and get out of the Market this time. I tried to get him to get out in 1999 but he wouldn't listen, and lost half his investment. Maybe this time he'll heed his old mans advise. Hate to say it but if what J.J. is predicting this coming week comes to fore then it may just be the SHingTF.

[Jerry Johnson]

Hermit, just wondering. I can smell going concern problems, especially when they start surfacing over a weekend.

Like, Dumas I have been looking into CDS's. That $26 trillion of notional value is a contract to buy someone elses portfolio. Many will not be able to honor the contract. There is an aspect of CDS's that is not discussed much. They are cross insurance to generate fees. Self insurance on an aggregate basis. When one sells a contract to buy a portfolio if conditions are met income is derived. When one buys a contract, want to bet it was capitalized to the tranche covered and amortized much of the time? The net is bottom line is boosted. These would not be eliminable , as in a consolidation, because the parties are different. Banks , whoever, buy and sell from each other. There is a large plurality , if not majority of these products , that taken together do not shift risk. One portion breaks sufficiently and the mess goes down. The legitimate notional contracts might have a hell of a time paying off.

Read about the New Century Conferance call in the implode-o-meter link.

This weekend though, it is very clear that the major accounting firms are in a hell of a bind. They cannot give a break to anyone. It is a virtual certainty that these delayed 10k filings involve more around going concern than anything.

It might be a qualified going concern based on shedding subsidiaries in some cases. The GM situation could be heavily impacted by loan guarantees to warehouse banks.

Certainly some warehouse banks face grabbing bad paper problems.

[hermit]

a correction to the correction:

Correction: Name is Aaron Krowne, site is called Mortgage Lender Implode-o-Meter. The 'o' is a picture of an imploding building.

Posted by: Abrey Myers | March 03, 2007 at 10:53 AM [kill]​[hide comment]

http://ml-implode.com/

[hermit]

Thanks JJ for the tip, i've got it up on another page so i'll go over and give it a read, and probably pass it along to him also.

[German Mike]

Scott,
"The analyst insists the risk is spread out over enough institutions as to be irrelevant to meaningful analysis."
I am sure there's plenty of risk to go around. There're still some 1200-1400 sqft houses for sale in my neigborhood...if you got about $500K to burn. No joke. Once the buyer defaults the bank is stuck with a piece of property that's maybe worth 25% of the original purchase price. At least here in Miami.
Rough week for the markets as the day of reckoning draws closer. Gold & Silver dropped too, probably under pressure to cover margin calls.

[Dave]

Great Post !
This is going to very interesting week on this blog that's for damn sure ! Thanks to everbody for making this site such a rich source of so many areas of information links. It really very helpful.
My daughter just started a public school position in the Wilkes_Barre, Pa. area. She told me this morning that two hundred new students have just turned up in the high school in the last few months. Children for the most part coming out of inner cities in Jersey. Seem the flight back to the cities is starting and the underclass is being force into the hinterlands which is what my god forsaken part to country is with its 9$ buck an hour "good" jobs and lousy health care system. The march of the zombies is beginning in earnest. Now just wait for the millions pouring out the burbs back to the cities everwhere with an alread entrenched underclass trying to hold on. Revolution anyone !

[asoka]

Great post, Jim!

This could be the week that the shit really does hit the fan and the whole economic house of cards comes crashing down.

Meanwhile the climate change drama continues. Part 2 of the UN report says:

According to the IPCC (Intergovernmental Panel on Climate Change), "more than 85 percent" of the data show "changes in a direction that would be expected as a reaction to warming." In other words: Researchers found evidence of environmental changes due to the greenhouse effect caused by mankind in nearly 9 out of 10 cases surveyed.

The researchers consider it "very unlikely" that the changes observed could be naturally occurring phenomena. They argue that the patterns of regional climate warming and environmental changes match up well with each other. And a similar consistency exists between the scientists' observations and what climate models have predicted would happen as temperatures rise.

Nature Under Threat

The UN experts go beyond the current situation. They also explore how populated regions and ecosystems will develop in the future as the world becomes warmer.

Many natural resources are likely to fall victim to climate change according to the IPCC draft report:

Some 20 to 30 percent of all species face a "high risk of extinction" should average global temperatures rise another 1.5 to 2.5 degrees Celsius from their 1990 levels. That could happen by 2050, the report warns.
Coral reefs are "likely to undergo strong declines."

Salt marshes and mangrove forests could disappear as sea levels rise.

Tropical rainforests will be replaced by savanna in those regions where groundwater decreases.

Migratory birds and mammals will suffer as vegetation zones in the Artic shift.
The IPCC expects the following world regions to suffer the most due to climate change:

The Arctic due to the greatest relative warming

Small island states in the Pacific as sea levels rise

Africa south of the Sahel zone due to drought

Densely populated river deltas in Asia amid flooding

This list alone makes abundantly clear that mankind will not escape these changes unscathed.
--SPIEGEL ONLINE

[edgar]

All those no load mutual funds are gonna take a hit when the lenders and builders go belly up. Oh well, it's easier to buy the whole market index then try to pick winners, right? Besides, when you take a position that big, and so does everyone else, who are you going to unload your crap holdings onto? Bwahaha! It's gonna be a lousy year for everyone, yeah, trust your economic advisor. Bwahaha!!

[Jerry Johnson]

When large publically held or regulated companies do not timely file their 10k the issue is well defined but the resolution is exceedingly unpalatable.

Clearly, all these mortgage problems have several related problems.

First. What are the repurchase obligations of conditional recourse securities value as compared to the liability. This is to accurately reflect what is known.

Second. Based on contract terms what reserve should be established for what will be the loss on further conditional recourse security tenders.
Third. What is the proper reserve value for Mortgages held for investment by the company.

Fourth. Since these holdings and obligations are almost always held be subsidiaries or lower tier subsidiaries, what is the going concern value of these units themselves . If impared what is the effect on the consolidated group.

Fifth. If the subsidiaries are the subject of Goodwill, is the Goodwill subject to immediate expensing.
Sixth. What other prepaid assets should be expensed as well.
Seventh. If the subsidiaries are impaired do they impair the parent. If so, on what conditions would total impairment be avoidable.

Eighth. What impairments of contractural relationships with correspondents exist so as to require recording of what was here to fore a contingincy.

Ninth. Assumming impairments, what current costs need to be accrued to implement removal of the impairment.

Tenth. Does reflecting the above items also induce other impairments in loan covenants and do these prevent the rendering of an opinion on the financial statements.

This is what is underway today in probably all of the big accounting firms. There could very well be some Sunday night bankruptcy protection filings because all this is not done in a vacuum. Some bankers could be looking to cover their own behinds and are hard nosed about loan covenant waivers etc.

Can you imagine what confirmation letters to MBS holders are with respect to tenders back to originators? Huge, everything imaginable.

[Scott]

Here's some interesting remarks from the FED chairmanhttp://www.bloomberg.com/apps/news?pid=20601087&sid=ax2XxQsuANu8&refer=home

My guess is that he will not remain in his position for long, his statements are entirely too straightforward.

[Scott]

Are we running out of avenues for debt creation? The globalized economic model of debt creation to produce infinite supplies of everything seems to be currently in a reset mode as resources do not appear to be nearly as infinite as they once did.

We can bullshit ourselves about the complexities of modern finance all we want but we are ultimately trading real goods and services not the financial instruments we have created to represent them.

As the global pie of goods and services becomes more clearly defined the financial instruments used to represent them become more abstract. Many in the world of finance believe that debt can chase debt forever hence the notion that risk can be spread indefinitely. We are witnessing the beginning of a long process of deleting files so to speak as some economic theorists are fond of pointing out the fact that our monetary system is but meaningless entries on a computer that can be reset at any time.

Of course you can't discuss U.S. or even global economics without mentioning China and the subject of debt backing up is no different as China holds so much of it. The current manifestation of globalization seems to be defined by the U.S. consumer and the Chinese producer with the carrot at the end of the stick for the Chinese being rapid development and productive use for it's ample excess labor. The U.S. it would seem has been rewarded for it's role in globalization with a number of vehicles for debt creation financed of course by China's willingness to buy American debt. The latest vehicle for debt creation, the housing boom, seems to have run it's course.

At some point if not already the Chinese will give up on the current model of financing the American consumer because it is becoming apparant that growth in China is more difficult WITH the American consumer than without.

The need to maintain the status quo is a two way street but when resources get tight it will be easier for China to transition away from America than it will be for American markets to be weened from foreign investment and resources.

[David Mathews]

Oh no, Europe:

"Swiss Accidentally Invade Liechtenstein

"ZURICH, Switzerland (AP) -- What began as a routine training exercise almost ended in an embarrassing diplomatic incident after a company of Swiss soldiers got lost at night and marched into neighboring Liechtenstein.

"According to Swiss daily Blick, the 170 infantry soldiers wandered just over a mile across an unmarked border into the tiny principality early Thursday before realizing their mistake and turning back."
http://www.nytimes.com/aponline/world/AP-Mistaken-Invasion.html

If Switzerland has imperialistic ambitions ... oh my, this world is really in bad shape.

[edgar]

Moody's sez Merrill Lynch, Goldman Sachs, et al, will be bailed out by the gubbermint. Surprise, surprise, (rolls eyes), dies. Why don't the crooks just steal the money in a straightforward manner, instead of using shenanigans that bankrupt the country as well? Spend the money fast, boys, I think the rabble is putting an edge on ye old guillotine as we speak.

[Scott]

This conspiracy theorist thinks the fix was in for tuesdays fall in equities. http://www.fallstreet.com/mar107.phps.

[edgar]

Bad link, Scott.

[Scott]

OOPS!http://www.fallstreet.com/mar107.php

[German Mike]

In 50 or a 100 years when historians & financial analysts will study the early 21st century they will ask themselves "What the hell were they thinking? Did they really expect the gravy train would ride forever?"