Exotic Mortgages Begin to Reset - Look Out Below!

The Daily Reckoning – Weekend Edition
April 28 – 29, 2006
Baltimore, Maryland
by Kate "Short Fuse" Incontrera


For those still not convinced that a real estate bubble exists in the United States today, consider this fact:

Last year, more than 40% of the buyers in the real estate market were in it for the first time.

That means almost half of all home purchasers have never previously owned a home – and with good reason. They couldn’t afford to.

But lack of money and knowledge never stopped the masses at the height of a bubble. Especially when lenders were waving the promise of "creative financing" under these subprime borrowers noses. Few could resist the lure of adjustable-rate mortgages or interest-only loans.

And the evidence of the aftermath of this ‘buy now, think later’ mentality is everywhere. The number of foreclosures is up nationwide. Rising interest rates have made it harder for homeowners to keep up with their mortgage payments. After all, ARM’s increase monthly payments right behind interest rates, pushing a once-affordable mortgage payment just out of reach.

No one has been more affected by defaults on loans and subsequent foreclosures than Wayne County, Michigan. The Detroit News reports:

"After recording more than 9,000 foreclosures in 2005, Wayne County ended January with 3,364 homes in active foreclosure, the highest of any county in the nation by more than 1,000.

"Katherine Ben-Ami…an attorney for the Wayne County Sheriff’s Office…supervised the auction of 379 foreclosed Wayne County homes in 35 minutes on Wednesday."

These foreclosures don’t just affect the homeowner. The lenders are then stuck with the home, and can lose up to $50,000 per house as they sell them at below-market prices. That, in turn, lowers property values in the neighborhood, pushing more homeowners out, and eventually hurts property tax collections for local governments.

379 foreclosed homes. In ONE day. This would make Wayne County ground zero for the real estate bubble, an example of the absolute worst-case scenario. But watch out for the ripples of defaults to be felt throughout the country.

Short Fuse
The Daily Reckoning

P.S. The only thing that continues to keep this real estate bubble afloat are the overseas lenders who have socked away nearly $2 trillion worth of U.S. Treasuries and dollar reserves. Unfortunately, these foreign investors are starting to give up on America – already, the Chinese are talking about "shifting away from exposure to the dollar." Once they do, we will be in full economic crisis mode – and you’ll want to make sure you have the proper "wealth insurance."

— Daily Reckoning Book Of The Week —

Automatic Wealth: The Six Steps to Financial Independence
by Michael Masterson

A Note From Bill Bonner:

A little over a year ago, I read Michael Masterson’s book, Automatic Wealth: The Six Steps to Financial Independence.

Of course, the title Automatic Wealth made me suspicious. But I am a fan of Michael Masterson, and when I read the book I was impressed. Masterson manages to go beyond the theory to tell us exactly how real people make real money in the real world. That, I think, is his genius. And it’s what made the book a Wall Street Journal bestseller.

Now, Michael’s has written another great book. It’s called Automatic Wealth for Grads… And Anyone Else Just Starting Out.

I have several children in college…or just graduating. I’m giving it to all of them, trying to make up for the advice that I never had time to give them…and wasn’t too sure about anyway. It is one of the most practical, down-to-earth guides ever written for those struggling to get a great start in life. And for a little over $14, you just can’t beat it.

Along with a mortar board and diploma, Auto Wealth for Grads could very-well become a staple of graduations for years to come. I’d recommend it as a graduation gift for anyone on your spring list.

THIS WEEK in THE DAILY RECKONING: Caught a bit of spring fever? Did you end up spending more time at the golf course than at your desk this week – and missed an issue of the DR? No worries…you can find this week’s offerings, below…

"Can Do" Money      04/28/06
by Bill Bonner

"How do you ensure yourself a position at the Fed? Take a cue from Greenspan: keep breathing – and keep creating money out of thin air. Bill Bonner explains in this DR Classique, first published on April 25, 2003."

The Loser in a Win-Win World     04/27/06
by Dan Denning

"It’s a weird and dangerous situation we’re in. Global interest rates are rising. That means liquidity is tightening. It’s getting more expensive to borrow money all over the globe."

Cash is Trash        04/26/06
by Puru Saxena

"You can rest assured that parking your wealth in the ‘safe haven’ of cash is the quickest route to the poorhouse! It is sad but true – cash is trash!"

Forgiving – Or Forgetful?     04/25/06
by Chris Mayer

"Russia is a veritable storehouse of Mother Nature’s useful goodies. Russia is the largest, or among the largest, producers of palladium, platinum, diamonds, nickel and gold. Russia is also rich in oil and gas."

Chinese Golden Eye      04/24/06
by The Mogambo Guru

"I beg you to please, please, please tell me what in the world is the attraction of these certificates, linked to gold, denominated in dollars, to rich Chinese people?"

FLOTSAM AND JETSAM: The United States’ debt and deficits are getting larger by the day – and yet the dollar is managing to keep its head above water? How is that possible…and how much longer can it continue? Dan Denning explores…

Dollar, Debt, Deficits
by Dan Denning

The "three Ds" are still with us. The debt and the deficits just keep getting larger. The rhetoric in Washington keeps getting louder. And Americans keep saving less.

Yet for all that, the dollar has not yet cratered. True, it’s fallen relative to gold, which is great for gold. But the large crisis of confidence that comes when investors realize an asset is far riskier than they imagined has not yet set in.

If sheer numbers (the appalling size of U.S. deficits both as a percentage of GDP and in real terms) doesn’t do it, plain old incompetence might. Global savers have poured money into U.S. markets because they appear safer and returns are higher. But along comes a brouhaha like the port deal with a Dubai company, and the whole situation suddenly changes.

If there’s a more effective way of telling foreign investors their money isn’t welcome here than what Congress did with the Dubai charade, I’m not sure what it is, unless it’s the Unocal affair from the year before. But Congress had better be careful what it wishes for.

If you tell people that their money is no good here, they may just stop trying to spend it here, particularly in the U.S. Treasury market. It’s a bit of a paradox. The growth of the global economy can no longer be driven by American consumption.

That means the best growth will come from Asia, energy, and resources. But some of the easiest and most convenient ways to invest in those themes are through stocks and ETFs listed on American markets. It’s not a bad deal, really: Think globally, invest locally.

It’s not all smiles, either. The rise in energy prices may be leading to a cyclical contraction in the world economy. There is money to be made in contraction, too. But it means there is often more risk than reward in certain asset markets. For now, I think we’ve got the asset, as well as the particular investment mix, right.

Did I get China right? I’m more and more convinced that the economic energy China has unleashed (and the real energy its economy requires) may unleash a disruptive political storm soon, which will in turn disrupt global commodity markets.

I also wish I had more time to go back to India. It is probably the one market on Earth where it’s possible to find a dollar’s worth of earnings selling for less than a dollar. There are thousands of stocks in India, yet only a few hundred are covered by analysts. It’s a great place to look at if you are a Buffett-style value investor.

One thing I know that I did get right is that a nation still does not get rich consuming more than it produces or spending more than it saves. That has not changed in the last year, despite the best efforts of many smart people to explain what is economically inexplicable.

And so the Migration rolls on. Perhaps the next phase is to write more specifically about what kind of global firms will succeed in the world we’re going to live and invest in. I am pretty confident that despite the new kinds of risks we face in the next few years, there will still be opportunities. And though it surprises me, I’m actually beginning to get a little intrigued with some particular technological solutions to the problem of energy efficiency.

[Ed. Note: Our trade deficit alone just topped $804.9 billion…at that record level, the trade deficit accounts for a full 6.4% of our total economic output – the worst ratio in the world. Including all those countries we’re supposed to be bigger, better, and richer than. Past research shows anything above 5% pushes the needle into the red.

Does America, the business, sound like the risk-free guaranteed moneymaker it used to be? Increasingly, less and less. And once our foreign investors start realizing this, the you-know-what’s going to hit the fan.