The Market Ticker

Right around noon there was a huge high-volume sell off in Lehman.  In addition several other financials - including Fannie, Freddie and Wachovia - got shellacked.

Why?

Look at MTG.  Down 20%.  AGO in the tank, etc.

Mortgage insurers.  Shortly followed by bond insurers?

This is bad folks.  Really bad.  As in "you'll be fisted so hard that your tonsils will get grabbed from underneath" bad.

Unfortunately its also what I have been predicting for quite some time - a year or so - in this regard, going back to when the Radian deal was originally announced.

MBIA said it has enough assets it can sell to meet its collateral posting requirements:

"``MBIA is not in a `tenuous situation','' Chief Financial Officer C. Edward Chaplin said today in a statement."

This time.  The problem is that this is unlikely to be a one-time event, as I've pointed out.  Selling assets dilutes your capital ratios which means you are subject to getting hit with another downgrade, which requires more postings.  This spiral, once it starts, is very difficult to get under control.

Their claim is somewhat akin to the guy who falls out of an airplane minus a chute and on the way down he remarks that its really not bad at all - in fact, the breeze is refreshing and he needed to dry his hair anyway - it rained on him while he was getting in the plane.

Of course he's not talking about the last 1/8".... that sucks.

There is nothing that Bernanke can do about the situation at this point in time.  As I pointed out in the weekend Ticker, he made his bet that the housing market would turn within a year back last summer when he decided to throw half The Fed's balance sheet into the market in a futile attempt to prop up prices.

The ivory tower man thought he could "jawbone" the housing market.  But unfortunately for him, just like in the 1930s, the underlying problem is that the consumer - the buyer of all this crap, including houses, is overlevered and can't take on more debt to "reflate" the housing (or any other) bubble.  There is neither the income capacity to service the debt nor the asset base to pledge as good collateral behind it.

The wiser choice would have been to tell Bear Stearns and the rest of them to eat their own cooking back in August of 2007.  We would have gotten a huge selloff in the stock market, but we wouldn't have gotten the huge ramp in commodities and, I'd argue, we'd be better off net-on-net.

Instead, what we've managed to do is destroy the bond insurance companies and trash the municipal bond business.  Have you had a look at the higher-quality closed-end mutual funds lately?  IQI, for one?  Oh my God.  30% losses over the last year?!  Yow.  That will leave a mark.  I follow that fund because it happens to be one of my favorites for safe tax-free income, but as I noted last year I bailed on it precisely over these concerns, which now appear to be coming to fruition.

Never mind that OPEC is rather pissed off at the prospect of their dollar holdings being destroyed.  If you think $140 oil is about speculators you are wildly mistaken.  $140 oil is about the currency used to purchase that oil coming under attack as a direct consequence of the actions and inactions of our government, including Paulson, Bernanke and Congress.

Notice how neither of the Presidential candidates are talking about the economy in any sort of concrete fashion?  Neither is making a campaign issue out of the rampant fraud in our financial system?  Neither is threatening to investigate, prosecute and jail all those who engaged in it, from Wall Street down to the mortgage brokers who "jiggered" income and appraisals?  Does that have to do with the fact that back in 2001 a petition was circulated by Property Appraisers and Congress ignored it?  That Congress was explicitly warned after the S&L scandal that removing the Glass-Steagall protections would lead to this outcome in formal, under-oath testimony?  That both parties have so much Wall Street PAC money "given" to them that they have been effectively bought and paid for?  That both Democrats and Republicans literally have the financial blood of American households on their hands, and if they acknowledge this, they will sink themselves?  That telling Americans that they can't have that new IPOD, Plasma TV or Cruise Vacation has become equivalent to shoving Grandma down the stairs?  That they have become aware that its too late to fix it, having sat by and let petitions like the Appraisers, and the ones that Tickerforum ran last year go by unanswered? 

Hmmm.

Well guys and dolls, as Kirk said to Khan, "here it comes."

PS: Still expecting a bounce in here somewhere.  I'm just curious if it will happen before or after we have a few financial institutions implode!

Here we are at the end of June 2008, and its time for a mid-year update against my prognostications at the end of '07 to see how I'm doing.

But before we do the scorecard, let's look at what's up - and what I see lying dead ahead.

We have had no fewer than three major financial institutions (outside the US) call for an utter collapse of the equity markets in the last two weeks.  The latest to join the foray was Fortis, which (in this translated article) basically calls for a collapse of the United States financial markets and a large number of banks.

RBS, Barclays, and now Fortis - the credit crunch is not over, it is not contained, and that it can't be contained.

In short, they are saying that Bernanke was an idiot - he made a bad bet that housing and credit would turn in within a year from last August, and it is now evident that he has lost the bet.  The consequences will now rain down upon the capital markets and the economy, and due to the pumping of liquidity it will in fact be worse than it would have been were Ben to have stood back and let it happen last August.

Second, credit cards have been keeping the consumer afloat.  But for how much longer?  Not long.  Credit lines are being cut back; the consumer is currently drawing down credit card lines at a rate of more than 400 basis points ahead of his income growth, and the wall is dead ahead as contracting credit availability and rising default rates collide with consumer "requirements."  This is certain to produce spending declines at a mid to high single-digit rate, if not worse.  Count on it.

Bank lending is shrinking at a record rate.  Total bank credit outstanding is 9,339 billion; it peaked in March at 9,500 billion and has been on a downward trajectory ever since.  Why?  Credit demand by worthy borrowers is collapsing - oh sure there is demand, but its from people who couldn't qualify to borrow a piece of flypaper.  This is the hallmark of a deflationary credit collapse and the evidence is now on the table that what I and a few others have been talking about is starting to occur.

The document that was disclosed by National Review Online recently (the internal BAC document that served as the "template" for the $300 billion housing bill) showed that BAC was "valuing" second mortgages as worth just a few cents on the dollar.  Yet none of the banks are taking that as a mark - yet.  If that is their true value then any second written in the last three or four years is worth almost nothing; in effect, you can count them all as zeros.  There has been no recognition of this yet by the banks - but there will be, and when it happens it is likely to zero any bank that is holding this paper.  The secondary question is, of course, why these firms haven't taken those marks if that is how they're looking at valuation internally.

We are now seeing firm evidence of "dog eat dog" during the credit bubble years.  The latest to surface is a "smoking gun" email series from UBS related to Auction-Rate securities, but that is by no means the only one.  The lawyers are starting to have a field day with this - they key here is "starting."  This will gain traction and as it does, the better question will be "who survives", not "who is immune."  The answer is unlikely to be pretty for anyone who has been in the executive suite of these firms over the last few years.

Only in the world of government lies can you call an increase in debt "income."  Yet that's exactly what happened - the "stimulus" checks are being counted as an increase in consumer income, but they are no such thing.  If I go take out a line of credit from my credit card, my "income" doesn't grow, but golly gee, the government's statistics say it did in this instance.  Absolutely astounding stupidity on display here - or blatant, outright fraud.  Pick.

The Fed "jawbones" about price inflation but does nothing of substance.  Big shock - NOT.  They're stuck.  They're out of conventional liquidity and know what's coming - Bernanke has failed to prevent the deflationary credit contraction, and history is likely to compare him to The Fed in the days of The Depression when all is said and done. I believe he has made the eventual outcome worse.  We are now arguing over how much worse it will be elsewhere in the world, and my argument there stands - the Asian Tigers, in particular, are whistling past the graveyard and will soon be forced to face reality.  Have you had a look at the Shanghai stock market lately?  The prospect of capital flight is still here, and we still need $2 billion a day in foreign money to cover our government obligations.  As rates rise elsewhere in the world there is a point where that spigot will get turned off - and if it does, the bond market will collapse with disastrous consequences.  This is the 900lb gorilla in the china shop and yet nobody can determine if or exactly when it will happen.  My recommendation: Run like hell from anything with duration or credit risk and do it now! 

Oil is not coming down in price any time soon, and when it does, you won't like the "why."  What's becoming increasingly clear is that there is a major supply/demand imbalance that nobody has done a thing about, nor can they at this point.  Our opportunity to address this was thirty years ago and The Greens, along with the Democrats, have successfully blockaded any sort of in-our-nation energy exploitation.  This is not limited to oil drilling; these people have also blocked wind farms off Nantucket, they have blocked nuclear power plants for 30 years and now the latest is a block on large-scale solar deployment in the desert southwest on Federal land, where nobody lives - but we might have an impact on some sort of desert mouse or something.  This is the key item and yet it is totally unappreciated by the commentators and others who continue to insist that "its all ok" or "its all e-vile speculators."  Uh, no its not.  We have a major problem with oil prices and the simplest way to explain it is "there's a limited amount of supply, demand is available to meet or exceed that supply, and there are no ready alternatives because we have intentionally failed to develop them."  In addition a significant part of supply is controlled by a cartel and they can (and I bet they do) jack with supply to keep prices high. Until that changes, you won't see prices contract in a meaningful manner.  A good part of the dollar-priced oil problem is also due to Bernanke's intentional devaluation of our currency, and we may be about to get a hyperdrive-sort of kick in the nuts on that part, as should the ECB raise rates and drain the swamp this coming week....  The only short-run way out of this mess is for massive demand destruction to take place, which means a global recession - or worse.  Welcome to reality.

Remember a few days ago when I was talking about MBIA's downgrade and that they simply didn't have the money to post as required?  Guess what - I was right:

"MBIA's asset management unit was recently in the market selling at least $500 million worth of muni bonds, the newspaper said, citing an unidentified person familiar with the matter. Most of the bonds were sold at a profit, the Journal reported, citing the unnamed source."

Put a fork in them.  This is very likely to trigger yet more downgrades, which will force more asset sales, which will........

We sit here at the end of June severely oversold on the major indices, which means we're due for a bounce in the stock market.  However, there is one caveat on that - crashes happen from severely oversold conditions too.  Which way do we go in the short term?  That depends - does the system hold together for the time being, or not?  All it would take is one major financial institution to get in trouble - a big regional or money center bank, or similar - and the lid both can and will come off.

Ok, 'nuff said on today.

Here we go with the scorecard!

• The US will enter a recession, if it has not already done so. It will be consumer spending driven, with its genesis found in the Housing market. The slowdown will become evident once the “real” holiday sales data is posted, and accelerate into the first quarter.

Late, which is the same thing as "wrong".  Score 1 miss, although I believe if you use real data we're there.  But, since I didn't specify that you couldn't use the government's BS, I give myself a "miss" on this one.

• Unemployment will increase significantly, rising to north of 5% by the middle of next year. This will of course cascade back into consumer default rates (mortgages, credit cards, auto loans, etc) and cause yet more layoffs. The “virtuous cycle” will turn vicious.

Check.  5.5% on the last report; that's north of 5% and my time period was the middle of the year.  Cumulatively, 1 and 1.

• Housing will not turn in 2008. The total damage to prices will exceed a cumulative 15% from 2005-2008, and it will not be over. At least one, and probably several, national home builders will be cut to the single digits on their stock price or go bankrupt and be reorganized. Residential Real Estate will NOT be a buy in 2008; you’re still at least one and probably two years too early.

So far, cumulative damage has been achieved.  Home builder price prognostication has been realized on several (SPF, BZH, etc) and more are coming.  I will count this as a "CHECK" for now, although it could turn out to be wrong if housing turns later in the year, so I may have to take it back.  2 and 1.

• The story in the housing space in ’08 will be the defaults on “prime” mortgages – which in reality were nothing of the kind (e.g. “Option ARMs”), and on the piggyback seconds and HELOCs behind them. “Jingle Mail” will become common as homeowners that are deeply – 20% or more – underwater simply mail in the keys and say “screw the credit rating.” This will result in a near-total overhaul of the “FICO” system in the next couple of years, as these people will have defaulted on mortgages but nothing else, essentially forcing risk premiums higher for consumer credit and decoupling FICO from actual consumer credit (other than mortgage) behavior. I expect there will emerge a “shadow” FICO system which ignores mortgages but rates everything else.

The jury is out on the back half, but the front (jingle mail becoming common) is occurring.  Score that one as indeterminate (2-1-1 cumulatively.)

• The stupidity in the rest of the consumer lending space (rollovers in auto loans and 0% balance transfer hell for plastic, primarily) will come crashing down on these companies and bring a crushing wave of defaults there as well, along with yet more downgrades in the asset-backed paper market.

Check.  This market is a mess and everyone in the space is forecasting much higher default rates as we finish 2008.   Card issuer share prices are being pummeled and with good reason.  Card lines are being cut by virtually everyone.  3-1-1.

• Recreational sectors (e.g. boats, RVs, etc) will get smashed. If you’re in the market for high-dollar recreational assets and have cash, late ’08 and into ’09 will present some incredible buying opportunities.

Spot-on.  Brunswick (boats) and Winnebago (RVs) are in the toilet, with factories being closed and production cut back.  The opportunities are starting to show up in the used market, but you're still early.  4-1-1.

• Government will, as is usual, try to meddle in the market’s adjustment of risk and price. The depth of this meddling will be the determinant on whether this is a deep but sharp and reasonably-short recession or whether it morphs into something far more serious. With 08 being an election year the temptation to engage in SEVERE tampering will be significant, and if they do, the risks rise materially. There is a serious risk of an all-out deflationary depression, and if we get one, it will almost certainly be the government’s fault. Whoever wins the Presidency may wish they had lost come ’09 and ’10.

$450 billion thus far either proposed or passed and they're not done.  I'd say this is a gigantic "check".  5-1-1.

• Buffett just announced he is setting up a Municipal Bond insurance company. This will put a stake into the Monolines’ hearts, taking all their business away that is profitable, and leaving them with structured finance which has huge embedded – and unrecognized – losses. The announcement, which showed up on the 28th, didn’t send shockwaves through the market – but it should have. Effectively, Warren threw a grenade (minus pin) into the magazine of structured finance. This is the death knell for the few trillion in CDSs that are out there can’t be paid; there is no longer any reason to believe that the companies writing these things will be able to be recapitalized off “profitable” sides of their business! This is how fortunes are made (for Warren) and lost (for everyone who did imprudent things.) The “big story” in the financial markets for 2008, and the likely trigger for major turmoil, will be the implosion of the CDS marketplace and how Buffett profited from it. This will stabilize the municipal bond marketplace which has been positively hammered.

A swing and a big whiff.  Buffett didn't do a damn thing of value.  Munis are still getting pounded.  The monolines are in the process of collapse but I haven't seen the municipal market stabilize at all and cannot recommend hiding there at the present time.  5-2-1.

• Equity prices will be choppy in the first couple of months and will experience a peak to trough swing of at least 20% during the year in total. I expect the S&P 500 to at least touch 1220 in 2008 and my current downside target is 1070. Note that should we get a “parabolic” sort of move in the first quarter, which is possible, the potential for an even louder “boom” (collapse) goes up dramatically; in that case I would not be surprised to see a three-digit handle on the S&P 500 sometime during the 2008-2010 time period.

For the DOW, the 20% "bear market" swing has been achieved.  However, the accuracy of this call remains to be seen across the entire market, so I'll call this one "indeterminate."  5-2-2.

• Return OF capital will be far more important in 2008 than return ON capital.

Anyone need more examples of this than the last couple of weeks?  6-2-2.

• I do not expect the central banks to “hyperinflate” anything. Metals, in a protracted, serious deflationary selloff will get smashed. (If you're a "Gold Bug", read below for why I think you're nutty to hold metals - there's a better play if you believe in hyperinflation.)

Hyperinflation?  Where?  Metals haven't done so well this year, have they?  Still, the score on this is indeterminate, so call it 6-2-3 for now.

• Debt will be paid down when possible and when not, defaulted. This, of course, prevents deploying capital towards consumption and production. Expect this to show up in the first quarter in ways that cannot be refuted, and for the market to “get it” some time before the end of the second quarter.

Ding!  The last couple of weeks anyone?  7-2-3.

• Commercial Real Estate will collapse. The leverage in these deals has actually exceeded that in residential, if you can believe it. This will prove to have been totally insane and the losses taken there will be immense. It will also put a fork into the “this is contained” thesis, and validate the fact that generally, commercial R/E lags residential by 12-18 months. Guess what – time’s up!

How many examples do you need?  SRS may be the play of the back half of the year (yes, I own some and its doing well.)  So far, however, I can't score this one conclusively as my SRS was bought off the trough, so I'm not declaring victory here.  Yet.  7-2-4.

• Business CapEx will slow precipitously and may go negative. This will be “spun” for the first quarter or so, but by the middle of the second quarter it won’t be able to be spun any more, and the truth will have to be faced. That “truth time” will likely mark the start of the second big leg down in the equity markets.

Ding!  Oracle anyone?  RIMM?  Here it comes!  8-2-4.

• The Dollar will bounce all over before starting to take off when it becomes apparently that the rest of the world is going to get it worse than we will.

Indeterminate, but it sure looks pretty good so far.  8-2-5.

• The “market callers” who are (almost to a man!) calling for big moves northward in 2008 will be coming to the public “hat in hand” as we get into the latter part of the year. These people will be roundly discredited and yet another wave of so-called “analysts” will disappear from the scene, along with all the money the chumps who listened to them lost.

Cramer is still on the air.  Since I have until the end of the year, I won't call this one yet.  8-2-6.

Not bad, overall.  4:1 on those that can be considered settled, with 40% or so outstanding going into the back half of the year.