The Housing Market's Stray Puppy

The “Greatest Economic Boom Ever” looks a little less great morning.

You’ll recall how experts rushed to assure us that the little problem in subprime lending was “contained.” Of course, no one knew how much of a problem it would be. Subprime was like a stray puppy; you couldn’t know how big it would get when it grew up…or how much damage it would do to the furniture.

Well, over the last 10 days, the little mutt has been more trouble than a Japanese earthquake…hitting containers of CDO waste and knocking the lids off.

What began as a problem for borrowers has turned into a problem for lenders, too.

The slump in the housing market has made it tough for borrowers to sell or refinance. Or, from another perspective, it has made it hard for people to buy houses; yesterday’s news tells us that homebuilders are so depressed that their wives are hiding their hunting rifles. They have not been in such a funk for 16 years, say the reports. And the people who finance the homebuilders are not feeling so good either. Countrywide Financial Corporation, one of the nation’s biggest mortgage lenders, says conditions “became increasingly challenging” in the second quarter.

Meanwhile, the homeowners are often stuck – with a nice house, but no way to pay for it. Finally, the long arm of the law stretches out and takes their house away from them. But that is hardly the end of the story. It is only the beginning. Because then the mortgage goes unpaid…and the whole bunch of dodgy sausages that were packaged up as Collateralized Debt Obligations begins to stink.

“Up until now, hedge funds have been creating a great deal of the miraculous ‘liquidity’ sloshing around the globe,” offers Dan Amoss. “By buying the highly leveraged equity and mezzanine tranches CDOs, they’ve greatly strengthened the buying power that’s been bidding up the prices – and lowering the yields – of risky debt instruments. George Soros’ theory of reflexivity was at work during the financing stage of the housing bubble; now it’s working in reverse to ‘de’-finance the housing bubble.”

“Indigestion tends to lower an appetite, and institutional investors’ appetite for junk bonds is spoiling just as Wall Street tries to serve them heaps of acidic securities,” continues Dan.

“While CDOs have shifted risk away from the banking system by linking borrowers with lenders from around the world, they have not lessened default risk; they’ve merely transferred it to unsuspecting lenders that are just beginning to push back.”

You can read more from Dan on CDOs in this month’s issue of Strategic Investment

Last week, all three rating agencies – Moody’s, Standard and Poor’s, and Fitch – announced downgrades of subprime linked debt. And this week, Bear Stearns said investors in one of its hedge funds that bought CDOs on a leveraged basis would get none of their money back. They were wiped out, said the letter reported by Bloomberg, buying Triple-A bonds. Just how subprime CDOs, suspicious byproducts of a disreputable industry, came to be rated AAA is a story worth telling, but today we will stick to the news. Bear went on to say that while investors in one of its two endangered funds had been wiped out, investors in the other fund could breathe a sigh of relief – they had only lost 91% of their money.

As this news made it up and down the street, the indexes that measure confidence in collateralized debt dropped. “All but one of the 15 ABX indexes fell to a record low,” says the Bloomberg news. In the words of one trader, offers for CDOs are going “no bid.”

These losses, declines, and reverses were “unprecedented,” as Bear put it. But then, they always are.

Bill Bonner
The Daily Reckoning
London, England
Wednesday, July 18, 2007

More news:


Addison Wiggin, reporting from Baltimore…

“Wal-Mart, Target, Home Depot and other big box stores use those containers to import gee-gaws and widgets for next to nothing with little ‘Made in China’ stickers on them. What, if anything, gets shipped back to China?


“Scrap is the second largest U.S. export to China in dollar value, behind electronics. Go figure. The U.S. makes tens of billions of dollars sending scrap – broken gee gaws and widgets – to China so that they can process them and sell more widget and gee-gaws right back. What a wonderful symbiotic relationship, don’t you think? They build, we consume. Yummy.”

For the rest of this story, and to find out how you can see a sneak peek of our documentary, see today’s issue of The 5 Min. Forecast


And more views:

*** Gunner, with a report on the next homeland security star:

“Earlier this year, Northrop Grumman tested a laser missile defense system on a FedEx plane flying out of LAX. The Department of Homeland Security has funded a lot of the development in this technology that will ultimately trickle down to commercial jets. Initial costs guesses are $1 million per plane for a defense system, with more than $350 per flight in maintenance costs.

“And that expense has to be spread over the nearly 7,000 planes in the current U.S. fleet.

“Known as the Airborne Laser Project, it’s one example where lasers and photonics are finding increasing defense applications. Direct Energy weapons are likely to become relatively big business for lasers companies with DARPA providing a significant amount of funding.

“Our favored way of investing in this trend at the moment is a $29 million market cap bulletin board stock…you can find out more, here:

Hidden Gems in the “Secret” Stock Market

*** What we are witnessing in the CDO market we believe, are the first real cracks in the Crack-Up Boom. In the first half of 1995, total issuance of securities backed by subprime residential mortgages did not exceed $25 billion. Ten years later, between January and July of 2005, the number was more than half a trillion. What this increase did is now visible to the human eye. Just look at Las Vegas or Central Florida…or around any major city. There are split foyers, Spanish colonials, neo-classical…you can get wood, you can get brick, you can get stucco – boy can you get stucco.

Less obvious to the human eye is the extraordinary effect of so much easy, innovative credit on the whole world economy. Borrowers could lie about their incomes; nobody cared to check because the lender had no intention of holding onto the loan until it was paid off. No…he was going to sell it on…and on…and on…until it came to rest in a hedge fund, such as Bear Stearns’ Enhanced Leverage Credit fund. But now, we are seeing – for the first time – what some of these CDO packages might really be worth. And the answer is – “not much.”

*** China…China…China – soon the planet’s third biggest economy – is now, mostly minding its own business, like America until 1917. But how long will it be before China begins to throw its weight around?

The Crack-Up Boom is a two-faced beast. To the United States of America it is 80% crack-up…and 20% boom. To China, it is 20% crack up…and 80% boom. The Chinese work hard. They save money. They invest in new factories and new infrastructure. They make things. They sell them. They earn a profit…save it…and re-invest it. Chinese wages are rising. Living standards are shooting up. The Chinese people are getting richer; the Chinese economy is becoming more powerful. That is what a real boom does.

That is not to say that China doesn’t have its problems; it has plenty. And no boom happens without a correction. Given the size and speed of the boom in China, and given the Chinese government’s tendency to err, the correction ought to be a doozy – perhaps as bad as the Great Depression in the United States. But the savings, skills, infrastructure and industrial capacity in the Middle Kingdom will not disappear.

The problem for China will come when Americans finally realize that their Crack-Up Boom is not all it’s cracked up to be. That may be happening now (though this is not the first time we’ve thought so) with the deepening slump in housing and housing-credit. When it begins, we don’t know…but that Americans will begin to buy less from China sooner or later we have no doubt. And when that happens, the Chinese will find that they have overdone it; that they have built capacity for buyers with no money.

Still, there is a huge, rising domestic market in Asia. After a difficult transition, China, as low-cost producer of practically everything tangible, will probably be able to shift production to this new, emerging consumer market. Then, it can continue to grow…and eventually do to the New World what the United States of America once did to the Old World – upstage it.

*** We are bearing our exile as best we can. Last night, at a dinner party organized by our daughter, Maria, a group of young women asked us for insight.

“What are the attributes that you would want to see in a daughter-in-law?” they asked.

We had never thought about it. But we have four sons…we’re bound to end up with a few daughters-in-law. In fact, we already have one with whom we are perfectly happy.

“Let’s see, I guess there are three key qualities,” we ventured, not knowing exactly what they were, but figuring that we’d think of them as we went along. “If we were thinking of sons-in-law…we’d want a young man who was on the level as the most important thing. Someone who was honest. Someone with integrity.

“When we think of women, though, those same words don’t come to mind…instead, we think of a woman who is loyal…faithful…and true. Yes, that is probably the first and most important quality that we would look for. Whether you are man or woman, you have to be able to trust your spouse as you would a business partner…not just trust that they are not trying to put a knife in your back…but just their judgment…and their values.

“The second requirement is that they must be engaging, stimulating, and alive. Marriages can last a long time. And if you’re married to someone who does not engage your emotions and your intellect, it can seem even longer. What’s worse, you’re quite likely to run into someone who does, sooner or later, and then you either stuck with the marriage, and feel like a martyr…or you abandon it and feel like a heel. Better to get someone who really engages you from the get-go.

“And the third requirement is that she must be capable. Remember, it’s a partnership. No one wants a weak sister as a partner. The wife has to be able to hold up her end of the stick – running the household, figuring out the finances, managing the children. They actually used to teach women how to do these things. But during the ’60s and ’70s, the job of running a household got downgraded in the public mind so much that women didn’t want to do it anymore. And yet, depending on how ambitious you are for your family life, it can be extremely challenging…a lot more challenging that putting in 9-to-5 at an office job. And if it is done badly, family life can be misery for everyone.”

“But you didn’t mention pretty,” said one of the young women. “Shouldn’t a daughter-in-law be pretty?”

“Oh…well…yes, that goes without saying.”

Then, he couldn’t help but want to pass along more of his fuddy-duddy advice.

“Prettiness is not an immutable quality. No woman is unquestionably beautiful or irredeemably ugly all her life. Prettiness is marginal…and best viewed as a life-long habit. I remember when housewives used to do their hair…and put on a fresh skirt and heels… so they would look good for their husbands when they came home from work. In other words, they took a lot of effort to look good – for their own husbands – even as they got older. That’s the kind of prettiness a man really needs.”


The Daily Reckoning PRESENTS: As we have moved further and further away from the gold standard of yesteryear, the United States has become increasingly irresponsible for their spending standards. Howard Ruff takes us through a brief history of money, as we now know it. Read on…


History tells us that the first paper currencies were notes payable (redeemable) in gold or silver, or, mere warehouse receipts for stored gold. Over the years, it became obvious that it was easier to simply exchange the receipts after a transaction than go to the warehouse with the receipts to get the gold and silver. The receipts became currency in common usage, and the people began to think of the receipts (currency) as money all by itself, completely detached from any stored gold.

Then, as governments began to buy votes or finance wars, they yielded to the temptation to simply print more “receipts” than there was gold and silver to back them up (who would know?), each time triggering more and more inflation. The foundation for inflationary tactics was laid in America when Roosevelt created the New Deal, then Lyndon Johnson financed the War on Poverty and the Vietnam War at the same time (guns and butter), and the printing presses have had to step up the pace ever since. (Poverty won and so did North Vietnam, but that’s another story.)

The process of currency destruction has been accelerating, with advances punctuated by retreats, since the ’30s. Throughout history, this has been the case over and over again ever since the birth of paper money. The critical moment in this era came when Nixon “closed the gold window” (no longer allowing dollars to be exchanged for gold or silver) at the Federal Reserve. This move finally admitted America’s irresponsible reality and permanently detached the paper dollars from gold or silver, and the money printers were off to the races. Then Uncle Sam hammered the last nail into the coffin in 1965 by no longer making 90 percent silver coins.

In the last ten years, the Fed has manufactured trillions of dollars out of nothing at the fastest pace in history by far, and it’s now accelerating. The Fed has then loaned the dollars into circulation, or given them to politicians to spend. Since then, Congress has been spending like a drunken sailor. (The difference between Congress and a drunken sailor? A drunken sailor spends his own money!) This money expansion now dwarfs the monetary explosion which led to that historic metals bull market in the ’70s. Gold and silver have been rising recently in response, driving gold from $252 to $560, and silver from $4 to more than $15.50.

It’s hard for me to exaggerate or overstate what is happening. Economists call this monetary-expansion process “inflation.” It really should be called “dilution,” that is, dilution of the money supply, and consequently its value. Inevitably, this sooner or later causes rising consumer prices, which laymen, and the media, and even Wall Street, will still mistakenly call “inflation.” Calling rising prices “inflation” is like calling falling trees “hurricanes!” Or as Jim Dines says, “it’s like calling wet sidewalks rain.

When will the masses catch on to this steadily progressing fact of life? Gold and silver prices are the true measure of public awareness. Sooner or later, awareness reaches critical mass, and the metals go through the stratosphere.

One early-warning harbinger of inflation is the dollar losing exchange value against foreign currencies, which began in earnest in 2002 and 2003. The dollar, with fits and starts, has been in a long-term bear market against other currencies for a few years. A falling dollar is inflationary, as it takes more and more dollars to buy the increasing amounts of foreign-produced goods we are now buying. Wal-Mart’s soaring sales are a telling indicator, as they are Asia’s biggest customer. Gold and oil are quoted in dollars, so up they go. And now the metals are rising, not just against the dollar, but against nearly all currencies as the metals grow in strength, and virtually every country on Earth is inflating its currency. It’s actually more accurate to say the dollar is falling in relation to gold, than to say gold is rising in relation to the dollar

The falling dollar-exchange value explains the early strength of the metals, and there is a lot more to come, as we continue to flood the international money markets with dollars. We now don’t even have to print them. This is the age of cyber-money, when less than five percent of the dollars are minted or printed, and most are only computer entries at banks. We don’t even know how many dollars there are!

There is a serious supply problem. 22 years of low or falling gold and silver prices gave us a drop in production and exploration of epic proportions, as miners pulled in their horns to preserve their capital. This set the scene for a great supply/demand problem. Now that prices are high enough to make gold and silver mining profitable, it will take as long as seven to ten years to develop new mining and production, and falling supply and rising demand have made higher prices inevitable for the imminent future.

Also, remember that most of the easy shallow silver has been mined over the centuries, even with primitive methods, and the silver deposits are still being depleted. For example, during the Roman millennium, silver coins were used for currency, so the Romans, after they conquered Spain, expropriated the large Spanish silver mines so they could use the silver for their own coins. They soon depleted the shallow mines, so they began to counterfeit their own currency, mixing silver with base metals, making the coins thinner, or clipping the corners.

As the mines were further depleted, it got worse and worse until the citizens began to distrust the currency, demanding more and more of it in exchange for their goods and services, causing a great inflation. Soon, the far-flung Roman Legions refused to accept the less-and-less valuable coins at face value for their pay, and began deserting in droves. This inflation was one of the root causes of the fall of the Roman Empire-all because they counterfeited the currency.

Now, silver industrial applications have soared into the thousands, and there are few satisfactory substitutes in sight. New silver mines are getting harder and more expensive to find, and supply is falling farther and farther short of demand. One expert claims that the deeper you go into the ground, the less silver there is.

Both metals are far rarer than most people know. All the gold ever mined since the dawn of history, including that in central banks, gold fillings and sunken shipwrecks in the Caribbean, would cover a football field about four feet deep. And, demand is now leaping past new supplies.

China and India are enjoying a historic burst of capitalist prosperity, and their booming new middle class is enthusiastically buying gold and silver jewelry, creating soaring new demand! Silver use is incredible and rising! The thousands of irreplaceable silver industrial uses, partially accounts for the shrinking inventory. Government silver warehouses are now all empty, and COMEX futures positions, much of which must be covered eventually by deliveries or purchases, are estimated to be equal to or greater than all new production!

Silver is the poor man’s gold. Think of gold as large denomination money, and silver as small change. A one-ounce gold coin now costs only about $650, and you can buy a roll of pre-1965, 90 percent-silver dimes for close to $50 a roll. Partly because it is so much cheaper that the potential buying pool is much larger, and industrial use is so much greater, silver will be more profitable than gold by at least 100 percent!

And, there’s more to come.


Howard Ruff
for The Daily Reckoning
July 18, 2007

Editor’s Note: Howard Ruff has been the Editor and Publisher of the award-winning financial newsletter, The Ruff Times, for 32 years, and wrote the biggest selling financial book in history in the ’70s (2.6 million copies) which was a major factor in helping to create the great gold and silver bull market of the ’70s. You can get a copy of his latest book, Ruff’s Little Book of Big Fortunes in Gold and Silver on his website at

The Daily Reckoning