Strong ARMing the Market

“It is not given to man to know his fate,” we keep saying. And yet, his fate is often right in front of him. Anyone can see it coming.

What other fate could there have been for subprime lending…except the fate we are watching right now?

Beazer Homes (NYSE:BZH), one of the biggest builders, is rumored to be facing bankruptcy. So is one of the biggest mortgage companies – American Home Mortgage Investment Company (NYSE:AHM). Bloomberg reports that the firm “lacks cash to fund new loans.”

Is this what the deflating of a credit bubble looks like? Yes, it is. And there’s plenty more where that came from.

Ludwig von Mises once said:

“There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.”

“Unfortunately, it’s too late to stop the crackup,” says our friend Mike “Mish” Shedlock. “All you can do is be ready for whatever market volatility is headed down the pike.”

It will take years for the housing slump to end, says a New York Times article. Many house buyers apparently didn’t even realize that their mortgages had adjustable rate clauses. Now, they’re finding out…and finding it difficult to cope.

Economist Gary Shilling thinks as many as half of all subprime ARMs will go bad – meaning, about 1.7 million homeowners will be forced to give up the roofs over their heads. So far, house prices are down about 3% coast-to-coast, according to the Case-Shiller index. JP Morgan (NYSE:JPM) predicts that the index will go down 15% to 20% in the next two or three years.

“The worst is still ahead,” says the NYT piece. ARMs really caught on in the spring of ’05. The peak in adjustments will hit in October of this year – with about $50 billion in mortgages up for reset.

How will consumers make the higher payments? Won’t they have to cut back elsewhere? Won’t lower consumer spending have an effect on the rest of the economy? And what about all those housing-related jobs…what will those people do? Aren’t these follow-on effects also right in plain view?

If so, U.S. Treasury Secretary Henry Paulson claims not to see them. The problems in subprime pose no threat to the rest of the economy, he says. His comments remind us of an old expression from the Soviet Union: Nothing is ever more certain than when it has been officially denied.

In fact, credit problems are turning up everywhere. For while the cheap suits were selling subprime ARMs to unsuspecting homebuyers in poor neighborhoods, the expensive suits were throwing money all over town.

We got word yesterday that France’s Oddo Asset Management Company had to close three hedge funds. And a couple funds in Australia are in trouble too.

Meanwhile, as much as $50 billion worth of mergers, acquisitions, leveraged buyouts and other corporate paper is said to be either on hold…or waiting for finance. Blackstone (NYSE:BX), the great private equity firm, got its paper off before the credit bubbles sprang a leak. But its shares are now selling for 20% below the IPO price. Competitor KKR (AMS:KPE), with an IPO in the pipeline, is rumored to be considering canceling it. And the junk bond market has just suffered its worst month in five years.

But what did you expect?

*** What is bothering Wall Street? Every headline offers another hypothesis: Subprime, says one; oil, says another; the dollar, says a third.

You never know what will cause the end of a credit expansion. Just as you never know when or how your life will end. That is the fate that is not given to man to know. But all things come to an end, lives…and credit expansions too; that is the fate we can know.

The price of oil hit a new record yesterday – over $78 a barrel. What that is probably signaling is not so much the strength in oil but the weakness in the paper money in which it is quoted. It is a lot easier to put more dollars in circulation than it is to add barrels of oil. The dollars/barrel ratio is bound to go up.

This is also true of the dollars/gold ratio – currently at about $675. We expect that to go up too…we know, we know. More than one dear reader has written in, or stopped us on the street to let us know that we may just have too much faith in the yellow metal – but we are sticking to our guns.

Another thing that is worrying Wall Street is the rising yen – partly because it reflects dollar weakness, and partly because it puts the carry traders in trouble. As long as you could borrow yen at a low interest rate…and place the money safely in, say, subprime CDOs for a much higher yield…you could enjoy “positive carry.” But when the yen rises, and the CDOs go bad, your carry goes negative. That’s why hedge funds are reporting staggering losses…and some are going out of business.

But Bear Stearns (NYSE:BSC) says it is not putting its third troubled hedge fund out of its misery – not yet at least. Instead, it blocked investors’ attempts to get their money out. Stay tuned for the next exciting chapter.

Bill Bonner
The Daily Reckoning
August 2, 2007

P.S. Australian press lord, Rupert Murdoch, has finally got the Bancroft family to agree to sell him the Wall Street Journal. The paper is a trophy for Murdoch, probably marking the peak of his career.

Family-owned businesses must be becoming relics of the past. Most firms are now under “in play” all the time – ready to be taken over, looted, stripped, leveraged, and resold to the highest bidder. Even if a business is in family hands, the son of the founder typically goes to business school and discovers modern finance. There, he learns that a firm should manage its figures so as to report steadily rising earnings…and that it should borrow money early and often…and that it should go public at an opportune time so as to give the owners a “liquidity event” that will put them on easy street.

We wonder what people do on Easy Street. Besides, the Bancroft family was already living on Easy Street. What are they going to do now?

Charity work…politics…or world improvement – what ever they take up, it is sure to be worse than running a good newspaper.

P.P.S. Finally…it is summer. The sun was out all day yesterday. In the afternoon, it was actually warm.

Europe has been having a miserable time of it. Floods…cold weather…storms…it hasn’t seemed like the good ol’ summertime. But lately, things are looking up…

More on this below…

But first some views from Short Fuse in Tinseltown…

*** At last week’s AF Investment Symposium, Capital & Crisis’ Chris Mayer gave a speech entitled “The New Silk Road.” While the old Silk Road dominated trade for a thousand years and made many a fortune, he believes that China’s current resource boom could certainly do the same.

David Bond, writing today’s guest essay, agrees with this sentiment – but feels this metaphorical road deserves a different name:

“Two years ago, I was strolling along cobblestone roads of Lijiang, a little city in China that is poised at the southernmost end of the Himalayas.

“The cobblestones of Lijiang form part of the ancient Silk Road. But it dawned on me that day, while ambling through the old city, that ‘Silk Road’ is a misnomer; that its proper name should be the ‘Silver Road.’ For if you view this famous trade route from an Asian perspective, Silver Road is exactly what it was.

“Let’s envision this mysterious part of the world as Marco Polo would have found it, in 1280 AD, at the age of 20, when he arrived in China with his father and uncle, both Venetian traders on their second trip to the Middle Kingdom…”

***  “The early bird may get the worm…but the second mouse gets the cheese in the trap.” Chris Mayer quoted Larry the Cable Guy (of ‘Git ‘Er Done’ fame) in his speech in Vancouver.

“You can be that second mouse,” Chris continued. “It’s not too late to invest in China.”

He went on to point out that while many worry about China’s economy overheating, there are still safe sectors to put your money…

“More and more people are living in the cities in China, and this will require huge investments in basic infrastructure – such as water.

“Polluted water is already the biggest cause of sickness and death in the world. Not only that, but there is the issue of getting that water where it needs to be. Population growth has not followed the location of water resources. Especially in China, which has more than 20% of the world’s population and only 7% of its water. And a good chunk of China’s population is in the dry northern regions.”

*** Attention Santa and your elves: the Russians are coming…

“Russia planted its flag on the North Pole yesterday, literally” Addison reports from our Baltimore HQ.

“President Putin ordered a mini-sub full of explorers and scientists to dive over 2 miles below the pole’s surface and plant a meter-high, rust-proof titanium flag on the bottom of the ocean.

“‘We are here to define the outer limit of Russia’s territory,’ Artur Chilingarov, leader of the expedition, told reporters, as if that wasn’t painfully clear already.

“‘This isn’t the 15th century,’ Canadian Foreign Minister Peter MacKay responded in an uncharacteristically aggressive statement (for Canuck standards). ‘You can’t go around the world and just plant flags and say ‘We’re claiming this territory.'”

“Speculators have guessed that up to 18% of the world’s oil rests under the artic circle… wars have started over far pettier chunks of land,” continued Addison.  “At the very least, a global oil grab is clearly emerging.”

Find out what else Addison and his partner in crime “Extreme” Ian have to say about today’s markets in The 5 Min. Forecast

*** And Bill’s final thought:

Finally…it is summer. The sun was out all day yesterday. In the afternoon, it was actually warm.

Europe has been having a miserable time of it. Floods…cold weather…storms…it hasn’t seemed like the good ol’ summertime. But lately, things are looking up.

Here at Ouzilly, the clan is still gathering. Your editor, your editor’s mother, Sophia, and Edward have already been here for several days. Then, Maria arrived on Tuesday. Henry came on Wednesday. Today, Jules and Elizabeth are scheduled to be here and the family will begin its traditional August-at-home.

“Oh Daddy, it’s so nice to be back here,” said Maria at lunch. “I’ve been so busy. It will be nice to take a break. Besides, I haven’t seen Mom for a long time.”

“There’s something so special about Ouzilly. It’s so pretty. I didn’t remember how nice it was…it’s been so long since I was here. And did you see the plum trees? There’s so much fruit, the branches are breaking off.”

“It’s the Year of the Plum,” said our neighbor from across the road. “We’ve never seen anything like it. It rained so much this spring. And it has been so cool. All the plum trees have too much fruit on them. First, the Damson plums were great. Now, the Mirabelles are delicious. And soon the Reine Claudes will be ripe.

“Of course, it has been a terrible year for the cereals. Our harvest this year was much lower than we expected. A lot of the crop got beaten down by the rain. It lay on the ground and rotted. Nothing we could do about it. But that’s what happens in farming. Some years are good for some things…others for other things. This was a good year for plums and a bad year for wheat and barley. Too bad we don’t grow plums.”

“Well, at least we have plums in the garden…I’m going to make some plum jam,” Maria replied. “I’ll get Edward to help me pick them.”


“I don’t see what’s so great about being out here,” Edward volunteered. “All we do is work. I had to help Maria all afternoon, picking plums. We got two buckets of them. And yesterday, I helped you paint the gypsy wagon. And we’re going to have to spend the whole summer painting the windows of the house. Why don’t we do like other people…and take a vacation at the beach?”

Until tomorrow,

Short Fuse
The Daily Reckoning

P.S. If you liked what you heard from Chris Mayer, be sure and check out his latest report. In it, he details a water-industry infrastructure company that will crush the competition on total shareholder performance over the coming months. This company dominates the water pump industry – the beating heart of the water-delivery network – and makes a juicy opportunity for investors.