Subprimed to Lose Lots of Money
Peering through his perpetually bloodshot eyes, the "angriest guy in economics" sees a giant wave of problems threatening to wash most of us away…and take the rest of us out with the tide. So why is he telling us to let our guard down? Read on to see the Existential Side Of The Mogambo (ESOTM)…
The Washington Post reports that "The widening credit crunch is making it harder for cities and school systems to get money for buildings, ballparks and other vital projects from the $2.5 trillion market for municipal bonds, a sector of Wall Street that rarely sees trouble. That is leaving them with a tough choice: either put off the projects, or pay higher interest rates on their bonds."
It is already happening, as the article notes that, for example, "Faced with the prospect of paying higher interest rates this month, Chicago canceled a $960 million bond. Miami-Date pulled a $540 million offering for its airport."
And let’s not forget that Florida is seeing a run on a money-market fund used by municipalities, packed as it is with worthless subprime-related "higher yield" crap, and losses are in the billions.
Is this a "Black Swan" event? Well, a true "Black Swan" event would be both unexpected and profound in its effects, so it would seem so, as Bloomberg.com quotes Hal Wilson, the chief financial officer of the Jefferson County school district who has watched the money in the fund go bye-bye, as saying, "The unthinkable and the unimaginable have just happened here in Florida."
And it is not going to get better, according to a report by the U.S. Conference of Mayors, namely that, "The worst U.S. housing recession in 16 years will drive down property values by $1.2 trillion next year and slash tax revenue by more than $6.6 billion."
And for those familiar with multipliers, every dime of that $6.6 billion of "lost tax revenue" is not going to be spent, meaning that vendors who cater to governments and their programs are not going to have $6.6 billion in income next year, and they won’t pay a little tax and spend/invest the rest, thus providing the money for someone else’s income, who will pay a little tax and spend/invest the rest, thus providing the money for somebody else’s income and yadda yadda yadda. So, after the last of the money is finally spent on taxes, that $6.6 billion reduction in tax revenue actually means somewhere between five and eight times as much will be "lost income" and lost taxes!
Unless they borrow the money, of course, which is another whole subject about which you do NOT want to get me started, because I just never shut up and I end up crying.
So if you are, like me, one of those people who is terrified at the sheer scale of this whole subprime mess and you wake up in the middle of the night bathed in cold sweat and screaming in terror, often shooting off whole clips of expensive ammunition at the horror of it all, and all just because estimates of the direct financial losses are climbing towards a trillion dollars, or trillions of dollars, then let me tell you to relax. Be calm. Put the gun down. Or at least put some of them down. Keep the big one.
Instead, be comforted in an existential way, serene in the knowledge that these are relatively good times yet, and things will continue to get worse and worse and worse in the future, as the ultimate horror of the penalty for supreme economic stupidity of allowing the Federal Reserve and the banks to (again) act like greedy, half-witted, corrupt children is going to be several times worse than anyone suspects, and for a Long, Long, Long Time To Come (LLLTTC).
And I say this with all the Profound Mogambo Sincerity (PMS) that I can muster on so short a notice, so that when you gaze deep, deep, deep into the fiery blue pools of my Bloodshot Mogambo Eyes (BME), you cannot help but think to yourself, "Hey! This guy is sincere! You guys ought to come over here and look at this awesome sincerity!"
And the reason for my awesome sincerity? I thought you’d never ask! It’s from looking at all of the rest of human history, peopled as it was by the same sort of lying, corrupt, stupid, ignorant, thieving scum that we have today, and we look at all the governments thus composed that wanted to spend, spend, spend money (all of them), and we look at all the schemes they cooked up to get the money to spend, spend, spend, and we look especially carefully at those times when the government decided, "Hey! This ‘gold and silver as money’ crap, holding our money supply constant, is for the birds! Let’s use paper money, and we’ll call it ‘fiat money’ which is a French word that nobody knows what it means, but it sounds like it is something good in the way of food or sex, and we can spend, spend, spend as much as we want, and cause as much inflation in prices which we will pay for by printing more money, all because we have a banking system that can create as much money and credit as we want! Whee! Free sex and food for everyone! This is going to be fun, and everyone will love us!"
Unfortunately, the record of success with such a scheme is (in a word) dismal, or in two words is "extremely dismal", or in 50 words or less is "Extremely dismal, as inflation in prices foments civil unrest, and there will be food shortages, riots in the streets, and the papers will be full of stories of hungry, angry mobs of suicidal people encountering withering gunfire trying to storm the Impregnable Mogambo Bunker Of Doom (IMBOD)." News and video at eleven!
Until next time,
The Mogambo Guru
for The Daily Reckoning
December 10, 2007
Mogambo sez: There are many reasons why gold, silver and oil had a little downdraft in prices recently. I particularly like the one about how Someone Up There Likes You, and this mysterious someone is arranging things so that you can buy on a dip.
If you bought some, then you know it was you that is so adored, as is proved when their prices resume their inexorable climb to where you can say "I’m freaking rich! Let me pack a bag and I’m outta this dump for good!"
What did we say last year? We remember our visit to India. And we remember commenting on the Indian stock market – when the Sensex Index was under 15,000. We hope we said it was going up…because that’s what it did. The Sensex Index touched 20,000 last week – a new record high.
We met with a group of a dozen analysts. All but two or three thought next year would be another growth year for Indian stocks.
Looking in the paper or out the window, we find the growth story everywhere:
New apartment buildings are going up all over the place. Automobiles fill up the roads. Salaries are rising. And GDP growth is over 9% per year; only China is growing faster.
"India is a great story," said a colleague yesterday. "The economy is growing very rapidly. Of course, if you spend a few more days here you will begin to wonder how it grows at all. Nothing works quite as it is supposed to, so we spend a lot of time trying to cope with everyday inconveniences. But the basic story is very solid. The economy is growing in spite of the government. And it’s growing fast. And now we have the ingredients for growth – we have money, skills, people…this growth story should continue, unless the government finds a way to stop it.
"You know, those terrorists who were responsible for 9/11 did their basic training here. They broke into our congress many years ago. They were going to kill as many of our politicians as they could. Instead, they botched the job. But the funny thing was the most ordinary people were disappointed that they didn’t succeed!
"But since they abandoned the worst of the Stalin-era regulations…and the Soviet-style central planning…Indians have been allowed to make money again. And that’s what they are doing…"
We visited the analysts on Saturday morning. In the United States or Europe, it would have been hard to get together a group of financial professionals on Saturday. But the Indians are still hungry…
On TV, a man was breaking up watermelons with his head. The show was in a local language, but he seemed to be aiming at a record. He head-butted one big watermelon after another, taking barely two seconds on each one. Then, when he had smashed a couple of dozen of them, he ran out of steam. His head went down…and bounced back up. He tried a second time…and a third time…and finally gave up; he was out of steam.
The streets of Mumbai are crowded – unbelievably crowded. Crowded with locals…and crowded with Chinese and Japanese businessmen, doing deals.
"When I was growing up – in the ’70s – Bombay was a paradise. Or, at least it seemed like it to me. There were only 2 million people. Now, there are 11 million – in exactly the same space. Bombay is a narrow peninsula…so there’s no room to expand. They’ve built up the open areas…giving away the land to people with political connections. And now, the price of space in Bombay is as high as Manhattan. It takes a little while for the builders to catch up…but they’re building millions of square feet of new living space, so prices are sure to collapse. They do every 10 years or so.
"If there is one thing you can count on it is that developers, bankers and farmers will over-do it. They all go bust every 10 years or so."
What is hurting the banking industry now is subprime lending – that is, passing out money to subprime mortgage borrowers, subprime corporate borrowers and subprime speculators.
But don’t worry. We live in an age of Zoo Capitalism…and the keepers are supposed to make sure the animals don’t get hurt.
*** So it was that Henry Paulson came up with an idea…the ‘teaser freezer’ plan. It is being sold to the public as a way to protect homeowners. But it has another purpose, says a reporter from the San Francisco Gate, to help save the banks from their own bad judgment.
"The ticking time bomb in the U.S. banking system is not resetting subprime mortgage rates," says an article at SF Gate. "The real problem is the contractual ability of investors in mortgage bonds to require banks to buy back the loans at face value if there was fraud in the origination process.
"And, to be sure, fraud is everywhere. It’s in the loan application documents, and it’s in the appraisals. There are e-mails and memos floating around showing that many people in banks, investment banks and appraisal companies – all the way up to senior management – knew about it.
"The catastrophic consequences of bond investors forcing originators to buy back loans at face value are beyond the current media discussion. The loans at issue dwarf the capital available at the largest U.S. banks combined, and investor lawsuits would raise stunning liability sufficient to cause even the largest U.S. banks to fail, resulting in massive taxpayer-funded bailouts of Fannie and Freddie, and even FDIC.
"The problem isn’t just subprime loans. It is the entire mortgage market. As home prices fall, defaults will rise sharply – period. And so will the patience of mortgage bondholders. Different classes of mortgage bonds from various risk pools are owned by different central banks, funds, pensions and investors all over the world. Even your pension or 401(k) might have some of these bonds in it.
"Ultimately, the people in these secret Paulson meetings were probably less worried about saving the mortgage market than with saving themselves. Some might be looking at prison time. As chief of Goldman Sachs, Paulson was involved, to degrees as yet unrevealed, in the mortgage securitization process during the halcyon days of mortgage fraud from 2004 to 2006.
"Paulson became the U.S. Treasury Secretary on July 10, 2006, after the extent of the debacle was coming into focus for those in the know. Goldman Sachs achieved recent accolades in the markets for having bet heavily against the housing market, while Citigroup, Morgan Stanley, Bear Sterns, Merrill Lynch and others got hammered for failing to time the end of the credit bubble.
"Goldman Sachs is the only major investment bank in the United States that has emerged as yet unscathed from this debacle. The success of its strategy must have resulted from fairly substantial bets against housing, mortgage banking and related industries, which also means that Goldman Sachs saw this coming at the same time they were bundling and selling these loans.
"It is truly amazing that right now everyone in the country is deferring to Paulson and the heads of Countrywide, JPMorgan, Bank of America and others as the best group to work out a solution to this problem. No one is talking about the fact that these people created the problem and profited to the tune of hundreds of billions of dollars from it."
Hmmm…does this sound like another government official that we know? If our dear readers will recall, Dave, over at the Desidooru Saloon reported a similar story – about the Vice President of the United States.
Apparently, Kiplinger’s magazine had done some digging around in the financial disclosure forms that Cheney and his wife filled out in 2006 and found some pretty interesting stuff.
Kiplinger’s reports: "Vice President Dick Cheney’s financial advisers are apparently betting on a rise in inflation and interest rates and on a decline in the value of the dollar against foreign currencies."
"Let’s examine just that first sentence in light of recent events," says Dave at the DR blog. "The Vice President’s own investment portfolio is structured in a way to benefit from the rampant inflation and precipitous drop in the dollar brought about in part by his own stated economic philosophy that ‘deficits don’t matter.’"
Looks like there’s a new "Tricky Dick" in town…
Despite the noise in the markets right now…with Countrywide (NYSE:CFC) taking it on the nose…the crumbling big banks like Citigroup (NYSE:C)…Fannie Mae (NYSE:FNM) and Freddie Mac (NYSE:FRE) tanking…and the billion-dollar losses of housing-related funds at Bear Stearns (NYSE:BSC) – a little Santa Monica hedge fund spat out 1,000% returns in less than a year.
Not too shabby, eh?
This is now being called the ‘Santa Monica Technique’: betting against companies or assets that ought to go down…and then profiting handsomely when they do, eventually, plummet.
Early next year, Agora Financial will launch its own research service that uses the ‘Santa Monica Technique’: the Strategic Short Report.
*** We’ve been thinking more about this New Era capitalism. In the old capitalism, owners were stingy. The idea was to exploit labor…not to be exploited by it. But that has changed too. The capitalists seem to have lost their heads; they think their new Zoo-Capitalism is all upside. And since it is all upside, there is no reason to worry about the downside. Control costs? Heck, they’re all going to get rich; why bother to be a skinflint? They also have an outsize faith in money and financial incentives. So, they figure if they pay managers…or money managers…excessively, somehow they will get outsize returns. Give the corporate managers big stock options, they believe, and these hacks will make big profits. Likewise, give the hedge fund managers a big percentage of the gains…and they will make big gains.
As a logical matter, it seems absurd. If a manager can’t deliver profits at a salary of $1 million a year, how can he do so if you pay him $2 million? Why would he be holding back? And why would competent managers need to be paid so much more than they were before the New Era arrived? Every generation must have a number of successful managers; if salaries were only $1 million a year, rather than $10 million per year, what would they do…become crane operators?
And what about the hedge fund managers…and other financial professionals? Even if their salaries were only half as high, they wouldn’t likely give it up to become short order cooks.
The whole idea of the New Capitalism is a humbug. You can’t set aside common sense and standards of prudence just because some yahoo tells you the new free market will make you rich. The old free market can make you rich, but not if you ignore the old rules that go with it.
*** And finally, a note from a reader:
"I truly enjoy your commentary, and look forward to it every day. I’d like to provide you with a little history on King Canute.
"Canute, far from being foolish, was actually considered a wise and benevolent king. His empire traversed much of Scandanavia, northern France, and England. Through a common (metal-based, of course) currency, and relatively free trade, he increased the
English economy significantly. By signing an agreement with Edmund Ironside, the current king of England, in 1016 that they should rule jointly until one die (Edmund being severely wounded from battle at the time), he avoided a great deal of unnecessary bloodshed. But, there’s always the myth…
"The Canute story is always told as if he, in some foppish display of arrogance, strode out into the waves, and told the tide to recede. In fact, the real story is the exact opposite. Canute, tired of flattery and unreal expectations from his court, planted his throne in the sands, and told the tides to recede.
"When the tide inevitably came in, he turned to his courtiers and told them there were limits on everything, including the powers of a king. I think this was an excellent object lesson, and well delivered.
"Again, I really enjoy reading your thoughts; I hope you might correct this mis-reading of Canute, especially as the true story seems particularly ‘a propos’ in view of the current subprime mess. All the courtiers – the banks, the media, the bond guarantors, the mortgage holders in over their heads – expect the ‘king’ (Bernanke? Paulson? Bush? eek.. Hillary?) to turn the tide back. You and I both know that can’t happen."
The Daily Reckoning