Credit Where Credit is Due

“It’s a bloodbath out there,” says an official with Market Street Mortgage in Houston.

She was exaggerating. There is very little blood in the streets – so far. A few hedge funds have failed. A few thousand householders have lost their homes. A few mortgage lenders have gone under. And nearly a trillion dollars have been taken out of the U.S. stock market.

True, Jim Cramer seems to have lost his mind, but he had nothing much to start with. And the lending industry is clearly growing more cautious.

“Alt-A lender Aegis halts home loans,” says the news from Houston.

“No more ‘liar loans’ for Impac Mortgage,” says another report.

German bank, IKB, has gotten an $11 billion bailout.

And a Bible school in California is suing its investment bankers, saying it was stuck with inappropriate swaps by its commission-greedy advisors.

But we suspect that the real bloodletting is still ahead…when hundreds of billions in adjustable rate mortgages are reset…when speculators find out what is in their derivative positions…when investors turn fearful…and when consumers finally begin to live within their means.

Richard Russell thinks all this is merely driving down expectations…so the stock market can be fully sold-out in anticipation of the third phase of this big bull market. We’re not so sure. Consumers, investors, and speculators have been positive and bullish for a very long time. Except for a couple brief setbacks, prices and confidence have been rising since 1982. It seems to us that this bubble has gotten big enough. Of course…that is not for us to say. Anything could happen.

What we find amusing now is that the press is finally beginning to give credit where it is due. Two articles – one in Forbes and the other in the Wall Street Journal – single out our own dearly beloved former Fed chairman, Alan Greenspan.

“Our present misery dates back to Alan Greenspan’s easy money policy of a few years ago,” writes Martin T. Sosnoff in Forbes. “When the risk-free rate was pegged at 1%, financial market players, starved for higher yields, moved out on the quality spectrum for long maturity goods. Insurance underwriters, brokers, banks and some hedge funds that play the carry trade game have taken hits to their net asset value, but not enough to cripple them permanently.”

“The housing debacle already has cut 1% out of GDP,” he continues. “Fortunately, we are heading to the first anniversary of the decline in new construction, but there’s more coming and no likely recovery before 2009. Existing home prices have peaked until the country absorbs new home inventory and coming defaults on mortgages outstanding.”

The Wall Street Journal adds this:

“When the Fed cut interest rates to the lowest level in a generation to avoid a severe downturn, then-Chairman Alan Greenspan anticipated that making short-term credit so cheap would have unintended consequences. ‘I don’t know what it is, but we’re doing some damage because this is not the way credit markets should operate,’ he and a colleague recall him saying at the time.

“Now the consequences of moves the Fed and others made are becoming clearer.

“Low interest rates engineered by central banks and reinforced by a tidal wave of overseas savings fueled home prices and leveraged buyouts. Pension funds and endowments, unhappy with skimpy returns, shoved cash at hedge funds and private-equity firms, which borrowed heavily to make big bets. The investments of choice were opaque financial instruments that shifted default risk from lenders to global investors. The question now: When the dust settles, will the world be better off?”

We have already answered that question: yes and no. There are two parts to this boom – which is what makes it so damnably difficult to understand. There is the part where people are building real businesses, paying real wages and making real profits. Where that is happening – mostly in Asia – the world is a better place already…and getting better all the time.

The other part of this boom is a fraud. People who are not really earning more money have been lured by EZ credit to borrow and spend more than they could afford. Their spending has helped build a real economy in Asia…but it has destroyed their own economy at home. These poor saps are now in a jam. They cannot expect to earn more money; worldwide labor competition is fierce. They have huge debts to pay. And their cost of living is going up sharply – thanks to the growing purchasing power of their new competitors in Asia and elsewhere.

Prior to this big boom, they practically had the world’s oil and resources all to themselves. Now, there are two billion more people bidding for everything – including the food they eat. When they figure out what has happened to them – if they ever do – that is when the real bloodbath will come.

*** Australia put up its key lending rate to its highest level in 11 years – at 6.5%. The U.S. central bank left its key lending rate unchanged yesterday. It still talks about fighting inflation, but it is more likely to want to fight deflation in the months ahead. We would not be surprised to see a rate cut this autumn.

*** Should you be worried about any of this, dear reader? Does it matter if the stock market goes down… or if it enters a new third phase of delirium?

Well, of course, there are bound to be financial and economic effects. But in our humble opinion, it is almost always best to stick to your own knitting. And it is especially important to stick to the knitting when everything seems to be unraveling.

When a society is stable and prosperous, you can cast your lot along with everyone else and prosper along with your neighbors. That was the situation in the United States and Europe after WWII. Almost everyone became richer.

But since the mid-70s…it has been harder. In America, for example, hourly wages of working men have gone nowhere. And since the money in which wages are paid has been cut loose from gold, it is hard to know what anything is really worth…hard to keep track of what you have…and hard to hold onto it. The dollar, for example, lost half its purchasing power during the short time when Alan Greenspan was chairman of the Federal Reserve.

More recently, the bubble economy of the 21st century has been rewarding certain groups of elite traders and financial mavens, while punishing the average person with higher debt – personal, mortgage, and governmental. Soon, average investors will be hit hard too…and average homeowners…and average consumers.

More on this tomorrow…

Bill Bonner
The Daily Reckoning
August 8, 2007

P.S. The secret to success will be to avoid being average – that is, to be a contrarian. And the secret to that is to pay attention to your own, unique, individual opportunities and challenges – while ignoring the lures and traps of the masses.

…and now…

some views from Short Fuse in Los Angeles…


Views from the Fuse:

*** Bernanke’s decision to keep rates steady caused the dollar to rally yesterday…but before you get too excited, our friends in the Far East have an interesting message for us:

Beijing has decided to use its foreign reserves as a “bargaining chip”, saying that they could sell their $900 billion in U.S. Treasuries if the United States imposes trade sanctions to force a yuan revaluation.

As Dan Denning put it: “China says: you smear our export quality, we smear your dollar.”

Dumping their U.S. bonds would cause some pretty major waves in the global economy – and would be the end of the dollar’s run as reserve currency of the world. But of course, that’s not what China wants, according to Xia Bin, finance chief at the Development Research Center.

“China doesn’t want any undesirable phenomenon in the global financial order,” he said.

“The threat comes on the heels of heightened protectionist legislation from the dingbats in the U.S. Congress, senators taking the Donald Trump approach to finance: ‘Look, we owe you sooo much money that if you don’t do what we say, we’ll just forfeit and take you down with us,'” writes Addison in today’s issue of The 5 Min. Forecast.

“Fact is, it would be just as foolish for the Chinese to cause the dollar to crash as it would be for the Senate to try to restrict trade between the two countries.”

For more on this story, see today’s issue of The 5 Min. Forecast.

*** “If we were sitting at a bar enjoying a beer – a good beer – and I had to tell you only one reason why you should have money invested in the agricultural boom in some way, I think I would say this: Grain inventories are near all-time lows, Chris Mayer writes in today’s guest essay.

And they are about to get lower…wheat prices hit a new 11-year high today on tight global supplies and panic buying.

The Financial Times reports:

“Mehdi Chaouky, agriculture analyst at Diapason in London, explained that Middle East and North African countries were trying to build up their wheat stocks ahead of the start of the Islamic holy month of Ramadan in early September, a period when business activities slow down.”

With a drought in southern Europe, and flooding in other wheat producing parts of the world, the supply of wheat is even tighter than it had been…and the U.S. market is going to feel the pressure.

“US farmers last week sold 1.74m tonnes of wheat in the international market, the second straight week of large export volumes from the country. The previous week saw 2.1m tonnes of US wheat sold to foreign buyers, the largest weekly transaction since 1996.”

If you are positioned properly, this could be pretty good news for you.

“It’s basic economics,” continues Mayer in today’s essay. “Higher demand. Lagging supply. Inventories down. Prices going higher. And that’s why more production of agricultural goods will follow.”

Until tomorrow,

Short Fuse
The Daily Reckoning

The Daily Reckoning