Middle of the Road Financial Woes

We took a brief vacation from our exile this weekend. But it is as cold south of the Loire as it is north of the Channel.

And there was no warmth in the markets last week, either. They were tepid. Nothing much happened. Up a little, down a little…back and forth…it was hardly worth watching.

The only excitement came from Bear Stearns’ (NYSE:BSC) efforts to rescue its hedge funds. The funds had bought a few too many mortgage-backed securities and got into trouble.

Of course, we all know that the subprime problem is “contained.” Hank Paulson and Ben Bernanke have both said so.

But we are not convinced. Fires are “contained.” Uprisings are “contained.” Containers, we know, can hold liquids…and solids, too. But we’re still not sure if you can contain such a vast mortgage problem so easily.

To put it another way, you can contain something while it is still small, localized and manageable. You can’t contain it when it’s spread everywhere. It’s already too late. In a speech at the Mansion House last month, Mervyn King, governor of the Bank of England, was considerably less sanguine than his American counterparts: “Excessive leverage is the common theme of many financial crises in the past. Are we really so much cleverer than the financiers of the past?” he asked.

The short answer to that question is, of course – no. Subprime mortgages represent a substantial portion of the entire mortgage market. But it is not just the subprime part that poses a threat. The real problem is that American homeowners have too little money. Why do they have too little money? Because they’ve spent too much. And where did they get too much money to spend? From the equity in their houses.

In the last six years, America’s middle class has run down its balance sheet in a remarkable way. Never before have homeowners owned so little of their own homes. In the ’60s, homeowners barely mortgaged 30% of the value of their homes. Today, that figure is close to 50%. And it’s happened while house prices rose at the fastest pace in at least 80 years. Thanks to rising prices, owners’ equity increased $4.37 trillion since the beginning of this century. But, in a prodigious feat of borrowing, mortgage debt increased even more – $5 trillion.

But now, house prices are falling. A few days ago, Business Week reported that on June 25, according to the National Association of REALTORS, the rate of existing-home sales slipped 0.3% in May, to an annual pace of 5.99 million units, while supply climbed to 8.7 months, the highest reading since June, 1992. The median price of a new home dropped 11% in April from the previous month, to $229,100, the biggest decline since 1970.

Homeowners are taking a hit, and these are not just people who live in trailers and watch daytime television. No, dear reader, they are us! Well, not necessarily us, exactly…but they are most people.

“Nearly 70% of Americans either own or are in the process of paying off their homes. Everyone wants to believe the worst has come and gone, because that’s what’s best for them. But we don’t always get the market outcomes we want or expect,” The Survival Reports Mish Shedlock quipped.

The rich can lose money in the stock market and no one will particularly care – there are too few of them. The poor, and their problems, will always be with us, but they affect only a miniscule part of the financial system. The problems of the rich and poor can both be “contained.” But middle class troubles are troubles for the whole financial system…and the whole economy.

The rich save money in bonds, art and investment property. The poor save no money at all. But the middle class saves money in its own houses and uses the “savings” (equity) when they are needed – for education, health emergencies, unemployment, and retirement. After a long spree of borrowing and spending, many middle class families have little savings left. And if house prices continue falling, even that sliver of owner’s equity will disappear. In the next downturn, the middle class will be wrung out like a wet mop.

“The housing crisis is different than other crises of the past. In the 1989 crisis, fewer people owned real estate,” Mish continued. “In the 2000 tech bust, not everybody owned tech stocks. But in both cases, the impact was far reaching. What does that mean now, when most Americans own property AND a mortgage, alongside their stock portfolios? What does it mean when so many of the new jobs in America – as many as 43%, – came from the housing industry?

“Tighter spending. Lost jobs. Troubles for retail, restaurants, car dealers, advertising companies, jewelers, remodeling contractors, furniture manufacturers, banks, electronic retailers, and more. It’s like a virus – it can’t help but spread.”

Then Middle America will be on the same footing as the subprime market today. And the subprime problem will be everybody’s problem.

Bill Bonner
The Daily Reckoning
Ouzilly, France
Monday, July 2, 2007

More news:


Addison Wiggin, reporting from Baltimore…

“To the list of worries aiding both oil and gold, we should add an ailing dollar. Last week’s trading ended with the dollar at a one month low versus the euro, at $1.35. The yen, pound sterling, and Swiss franc all gained against the dollar last week. In this quarter alone, the greenback has fallen 1.4% against the euro, 7.5% versus the New Zealand dollar, 4.8% against the Australian dollar and 2% versus the British pound. The pound is sitting at a 26-year high against the dollar this morning.

“The Canuck buck hit 95 and a half cents on Friday – its highest level since Jimmy Carter was trying to ruin the US economy. Rumors of the Canadian central bank raising interest rates as early as this month pushed the loonie to a 30-year high.”

What does this mean for U.S. investors? Find out in today’s issue of The 5 Min. Forecast


And more thoughts:

*** “I was feeling a little down and gloomy when we left Paris,” Elizabeth reported. “But after two days in the country, I feel much better.”

Your editor journeyed to the South of France – well, south of the Loire – this past weekend, taking with him his mother, his wife and two children. Since he is a tax exile, he can only come for holidays.

Wherever you go, there you are. You tend to take your problems with you. But sometimes, they can be left behind – at least for a while.

This past school year was full of problems – all centered in Paris. And when we left the city this weekend, the problems stayed put.

“It is really a kind of paradise down here,” Elizabeth continued. “Flowers are blooming everywhere. And everything is so green…because of all that rain, I guess. And the smell of the tilleul (linden tree) is intoxicating. Coming here, has really given me a boost.”

We were celebrating our wedding anniversary – having dinner at a restaurant overlooking a river. Sunday night, the restaurant was deserted, except for one family – grandparents, parents and children – from Belgium. We watched the ducks, reminisced and wondered why things work out the way they do.

“We’ve been so lucky in so many ways,” said your editor, touching the wood paneling.

“Personally, professionally, financially. I don’t think we could ask for more. By the way, Madame Dupont came over after lunch. She just had one hip replacement operation. She said the other hip is hurting her now. We haven’t had any problem with our joints – and no serious health problems at all.”

He touched the paneling again.

“The children all seem to be doing reasonably well; of course it’s much too early to know how they’ll turn out…

“We live well…we don’t have a mortgage. Oh, I know it was hard for you this past year…trying to work with those Portuguese plumbers who never showed up…and your horse broke her leg; that was a Calvary for you, of sorts…and I’m not around very much. And I won’t be around much for the rest of the year. But all these problems are temporary; none are that serious.

“Even this tax problem will be resolved next year; we’ll all move back to England as soon as Henry finishes his school next year.”

“I was talking to Claudette,” Elizabeth replied. “Her husband took up a project in Normandy. So he’s rarely at home now. She said it was rather nice to have the house to herself. You know, Ségolène Royal broke up with her long-time partner right after the election…and you know Louise? Well, she and her husband separated too. She says they’re still friends. They go on vacations together. But they seem to enjoy being on their own too. She got a little studio apartment of her own over near the Eiffel Tower.”

“Hmmm… Well, don’t get any ideas.”

“Ha…ha…I wouldn’t think of it…it’s just that we’ve been so lucky. And didn’t you write that when you’re too lucky, you think you can get away with anything? I just don’t want to get in a situation where we’re tempting the gods.”


The Daily Reckoning PRESENTS: Printing money must be as fun as riding a roller coaster – because the Fed keeps getting in line to do it over again. Of course, it’s only a matter of time before someone loses his lunch, and as the Mogambo Guru explains, the U.S. dollar has already got a little bile in its throat. Read on…


TheStreet.com reports that “Paul (R., Texas) is so disgusted with the Fed and its role in failing to stem inflation that he wants to eliminate the entire institution, including its army of economics Ph.D.s and other money wizards”, which refers to a bill that he filed in Congress, HR2755, that would do just that.

As Junior Mogambo Ranger H.H.H. puts it, this shows that “Ron Paul will go to his grave with his honor and dignity intact, which is far more than I can say for most members of our government.”

Why does Rep. Paul want to eliminate the Fed? Well, according to me at my loudmouth, know-it-all, arrogant best, it is because the Federal Reserve has been a complete, dismal failure in every freaking respect, and especially in their duty to protect the value of the dollar.

Well, nobody ever wants to hear what I think, and so I am happy that the question is admirably answered by the epic truth revealed by Antony Mueller at Mises.org and handily posted at Agora Financial’s 5-Minute Forecast. “Central bankers,” he writes, “sometimes describe their activity as ‘more art than science’, which is implicit recognition of their ignorance. The ‘art of central banking’ is the art of pretending to know what one does not know. Not only is it not a science; it is not even an art. At best, it is alchemy; at worst, it is a gigantic cheat.”

Or as the Law of Logical Argument puts it, “Anything is possible if you don’t know what you are talking about”.

This leads to the Law of Lying and Statistical Manipulation, which I just made up, which is, “If you have a willing, co-conspirator like Congress, then the Federal Reserve can do and say anything it wants, whether it knows what it is talking about or not, and nobody will try to stop them, and the Fed will create so much money and credit that price inflation will destroy us all, which it will, and we are freaking doomed, doomed, doomed as a result.”

Vaclav Klaus is Professor of Finance at the Prague School of Economics and is a former Minister of Finance, and is quoted in the Financial Times as saying (although originally in reference to something else), “I am not ashamed of this ignorance of mine. On the contrary, I am ashamed of the confidence of those who claim to know the answer. I see a big difference between science and ‘national scientific establishments’. To believe in scientific establishment is impossible, this is just another powerful rent-seeking group.”

In short, being just as disrespectful as I can muster, the Fed and the Congress are two symbiotic parasites guaranteeing their own free ride by telling and believing lies, which is only possible under a fiat-money standard, as under the gold standard, “you have fixed exchange rates and free mobility of capital, but you give up domestic monetary policy,” says Robert Wright, who is a professor of economic history at New York University’s Stern School of Business.

Perhaps because he is at a university that receives huge amounts of government money, he forgets to mention that a gold standard also constrains fiscal policy of the government, too, as they don’t dare just spend and spend, because borrowed money has to be paid back by raising taxes! And the spending had better be good, too, because if it isn’t (like spending tax money for stupid crap like creating huge entitlement programs and, ummm, funding universities), then the gold will actually flow out of the country as foreigners get scared of our idiocy and take their money away, actually shrinking our money supply!

Therefore, under a gold standard, the government and the banks had to be smart and act smart. Now they don’t. And obviously aren’t.

If you want to see the real beauty of “gold as money” and the wonderful economic bliss that comes from it, then it is inferred when Mr. Wright brings up “the phenomenon of falling nominal wages.”

Note the use of the word “nominal” wages, which merely means wages expressed as a strict dollar amount (such as dollars per hour). “Real” wages, on the other hand, means nominal wages expressed in terms of inflation-adjusted buying power, which is experienced as rising prices.

I mean, if your income doubles, but all prices double, too, then you are not better off, are you? No.

But if your income stays the same and prices go down, then you ARE better off, right? Of course you are! Welcome to the gold standard!

The “problem” Mr. Wright refers to is that the gold standard was so successful that “Many of the conflicts between labor and factory owners in the 1800s had more to do with adjusting workers’ wages downward in line with the overall price level than they did with owner-inspired greed, as is popularly perceived.”

Aha! In short, thanks to our money being gold, the standard of living of the country was increasing! People’s lives were getting better! And they had more! And they bought more, although their nominal wages were exactly the same! And in fact, things were so good that the workers were becoming overpaid! Overpaid labor! What a Utopia!

And so who is so evil, so dastardly, so despicable as to screw with such a successful system?

Note the dark and gloomy soundtrack of wolves howling and the distant screams of people being eaten alive. The banks and the government! It’s always the damned banks and the damned government!

Until next week,

The Mogambo Guru
for The Daily Reckoning
July 2, 2007

Mogambo sez: I run down the checklist: Weapons? Check. Gold? Check. Silver? Check. Oil stocks? Check. Now ask yourself why I am doing this. Now ask yourself why you aren’t.

Richard Daughty is general partner and COO for Smith Consultant Group, serving the financial and medical communities, and the editor of The Mogambo Guru economic newsletter – an avocational exercise to heap disrespect on those who desperately deserve it.

The Daily Reckoning