Lenders Learning to 'Just Say No'

The Daily Reckoning – Weekend Edition

Jim Rogers, who predicted the global commodities rally in 1999, told reporters on Friday that U.S. housing is one of the biggest bubbles in history – and one that will leave the biggest mess.

"This is the only time in world history when people were able to buy houses with no money down and in fact, in some cases, the builders gave them money for a down payment," Rogers said. "So this bubble is the worst we’ve had in housing, and it’s going to be the worst we’ve had cleaning it out."

And it looks like lenders have started to catch on, as far as the zero-down mortgages go. The Washington Post reports this morning that "home buyers again need their own money to close a deal."

What?! Absolutely unheard of. You mean if I want to buy a house – I need to actually use my own money? I thought they were just giving them away!

"It used to be that we would finance a loan up to $1 million with no down payment for a first time home buyer," Daniel H. Aminoff, a senior loan consultant with Washington Mutual Loans in Alexandria to the Post.

Sure, that sounds reasonable. Why not just finance a million-dollar home to a first-time buyer…someone just out of college, on their first job – they are definitely good for the money. The Post points out that now the trend is to not only put more emphasis on job stability and low debt when writing this kind of loan – but lenders are even checking to verify the borrowers income and employment, something that was not happening during the height of the bubble. Wow.

While we are relieved that lenders are learning to ‘just say no’, the damage is done – well, not actually done. Many experts agree that the housing market, specifically the subprime sector, still has quite a ways to fall.

Among the other gloomy housing data released this week, TIME magazine reports that foreclosures are up – WAY up – in the market that was once seen as untouchable: southern California.

"Led by an astonishing 799% rise in Los Angeles County, foreclosures in southern California jumped 725% in the second quarter, to a record 9,504, from 1,152 a year ago."

Even more surprising was the news from Countrywide Financial that subprime homeowners aren’t the only ones falling behind on their mortgage payments – homeowners with good credit are beginning to falter as well.

With all of this data under their belt, many wonder what will come of Tuesday’s Fed meeting – will Helicopter Ben let the credit crunch work itself out…or will he step in and lower rates? We shall see.

Short Fuse
The Daily Reckoning
August 4, 2007

P.S. Mike "Mish" Shedlock recently wrote to his Survival Report readers:

"It was just a few months ago that Toll Brothers was ‘dancing above the bottom’ and the Fed was saying housing would pick up in the second half of the year. Alan Greenspan said the bottom was in. Almost out of the blue, the Fed has started chirping a different tune. The newly revised song from the May 9 FOMC minutes is, ‘The correction of the housing sector was likely to continue to weigh heavily on economic activity through most of this year.’ That assessment is, ‘somewhat longer than previously expected.’ Hmmm. Is it somewhat longer than expected, or orders of magnitude longer than expected?

"Perhaps we can find a clue in the words ‘weigh heavily.’ Has the Fed finally spotted what our readers have long known, that the second wave of the housing tsunami is about ready to hit the shore right as real wages are shrinking and high-paying jobs are getting harder to find?"

— The Daily Reckoning Book of the Week —

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THIS WEEK in THE DAILY RECKONING: Don’t worry if you were basking in the summer sun this week and missed an issue of The DR – we never get outside, and have dedicated our lives to cataloguing the issues for you, dear reader. See below…

Debt Becomes Her                                                 08/03/07
by Bill Bonner

"While the foreigners have gotten richer and more competitive…America’s middle and lower-middle classes have merely gone deeper into debt…and added to their monthly expenses."

Strong ARMing the Market                                      08/02/07
by Bill Bonner

"’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."

Rotten Apples: $900 Million a Bushel                       08/01/07
by Bill Bonner

"CDO investors are having a rough time of it because the people who are supposed to be paying their subprime mortgages don’t have enough money. That was always been the rotten apple in the low-end mortgage business."

The Market’s Biggest Idiots                                     07/31/07
by Bill Bonner

"Surely, the fellow who buys a trashy barrack in a bad part of town using a subprime ARM is an idiot… But so is the fellow who buys a whole inventory of these packaged mortgages – collateralized debt obligations – asking for trouble."

Complimentary Cash in a Fantasy Casino                07/30/07
by Bill Bonner

"Real wealth is neither having more money, nor having higher priced stocks. Real wealth is accumulated capital – buildings, tools, factories…and the skills to know how to use them."


FLOTSAM AND JETSAM: Just as the U.S. government was slow to come to grips with the disaster in New Orleans so that people were left to fend for themselves, so too will investment bankers and investors have to fend for themselves. They may find themselves clutching their worthless paper and wishing someone would bail them out from the rooftops of their now-worthless homes. Susan Walker explores, below…

Subprime Katrina
by Susan C. Walker

Wall Street may have reason to worry about a financial hurricane poised to do the same kind of damage Hurricane Katrina did – in terms of money and assets lost – in New Orleans in 2005. Given the latest storm warnings about subprime mortgages and the Dow’s dive last week, it looks like "Subprime Katrina" might become the financial storm of the decade.

Wall Street investment bankers who remember the devastation in New Orleans might want to start battening down the hatches. In fact, some of them seem to understand their pending doom as they try to cajole the rest of the world into thinking that the subprime (otherwise known as low-quality) mortgage contagion is contained. "Sure, sure, Bear Stearns got hit when its subprime hedge funds lost their value, but everyone else is O.K.," they say. "Let’s all heave one collective sigh of relief that we dodged that bullet."

Does that attitude sound familiar? It’s exactly how the people of New Orleans felt for the 8-10 hours after Hurricane Katrina whipped up the Gulf Coast and dumped its rain. It was over; they had dodged the bullet. Their beautiful city that is built below sea level and surrounded by sea walls and levees was safe. That’s where Wall Street is right now – hoping the levees will hold as investment bankers try to sandbag the rest of us with lots of placating talk. Well, it turns out that New Orleans was about as safe as the subprime bonds that are now below their own "C" level.

Although Wall Street bankers have been doing one heckuva job, I think it’s too soon to breathe easy, just as it was too soon for those in the Big Easy to breathe easy. Because right now, we’re in that eerie quiet period when everyone thinks that the subprime storm has blown over and headed east. We’re all oblivious to the larger problems coming behind it. Just like when New Orleanians breathed their collective sigh of relief, oblivious to what a few city engineers worried about and watched for: Would the levees hold, or would they be breached?

We shouldn’t give into that false sense of relief, and here’s why: Wall Street was warned about the coming hurricane-force fall-out from subprime mortgages, and it ignored the warnings, buying up all the securities backed by subprime mortgages that it could. Subprime Katrina actually did hit hard and wiped out one of Bear Stearns’ hedge funds invested in subprimes valued at $6 billion. It left the other hedge fund at only 10% of its original value. But now that this episode is behind us, Wall Street is having trouble selling more debt. News came last week that the group of Wall Street banks that is raising funds for GM had to postpone a $12 billion debt offering, because investors wanted better terms. It sounds like it may be too late for many Wall Street denizens to get out of town – and their positions – before the floodwaters start rising.

Nor is everyone buying the argument that now we’re safe. The Economist magazine (June 21, 2007, issue) suggests that "perhaps the most worrying thing for financial institutions holding mortgage-backed paper is not the subprime market itself, but the unnerving parallels with an even bigger one to which they are also exposed: leveraged loans to companies." The story also quotes Daniel Arbess of Xerion Capital Partners as saying that subprime might well be "a dress rehearsal for something bigger and scarier."

Doug Casey, who writes The International Speculator newsletter, agrees in his July 2007 issue. Referring to the $6 billion hedge fund wipeout, he writes, "There could be hundreds of billions more in losses. And it’s impossible to say which firms that are bankrupted by the default may in turn default on debts to others, like a string of dominoes."

Remember, too, the finger-pointing and blaming that started as soon as the rest of the nation realized that the U.S. government was not doing enough to help New Orleans? The editors of The Elliott Wave Financial Forecast recognize a similar change in attitudes toward Wall Street:

"The unwinding process will be sped along by a flood of revelations about illicit hedge fund and investment banking activities. Just as Enron, Tyco and a host of other primary beneficiaries of the late 1990s bull market run became the focus of scandals, hedge funds and the banks that enabled them are starting to become a focal point for scrutiny." (The Elliott Wave Financial Forecast, July 2007)

Then will come the final installment. Just as the U.S. government was slow to come to grips with the disaster in New Orleans so that people were left to fend for themselves, so too will investment bankers and investors have to fend for themselves. They may find themselves clutching their worthless paper and wishing someone would bail them out from the rooftops of their now-worthless homes.

And if this analogy holds true, Heckuva Job Brownie – now known as Helicopter Ben Bernanke and his Federal Reserve team – won’t have any more luck picking up the pieces on Wall Street than FEMA did in New Orleans. Neither the federal government nor the Federal Reserve did the heavy lifting up front to avert these natural and financial disasters. So telling us now that the subprime problem is contained sounds too much like wishful thinking, the kind that the federal government indulged in as the floodwaters started rising in New Orleans two summers ago.

Editor’s Note: Susan C. Walker writes for Elliott Wave International, a market forecasting and technical analysis company. A graduate of Stanford University, she has been an associate editor with Inc. magazine, a newspaper writer and editor, an investor relations executive and a speechwriter at the Federal Reserve Bank of Atlanta.

The Daily Reckoning