THE INTERNATIONAL FORECASTER
MID WEEK - NOVEMBER 22, 2006
P. O. Box 510518, Punta Gorda, FL 33951-0518
An international financial, economic, political and social commentary.
Published and Edited by: Bob Chapman
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US MARKETS
What are the elitists afraid of? They are afraid of a housing collapse that they deliberately created. They have managed to create the largest financial bubble in history. Unsold new homes are colliding with an even larger number of existing homes. They know the collapse in equity values is inevitable, and they are terrified the affect it will have on the financial system. They know what the public doesn’t as yet know, and that is the financial system is hopelessly bankrupt. As mortgages go bad and homes are liquidated in foreclosure, the whole system will head down the tubes.
These elitists are the global stewards of our world financial system and again they have turned it into a dog’s breakfast. Shortly the real estate numbers will worsen and it will become evident that the life’s gone out of the bubble. That the trillions coming due in adjustable rate mortgages are going to begin a tidal wave of foreclosure sales that will send the mortgage market and derivatives into chaos. Bankers and other lenders know full well risky mortgages were designed for those with very strong financial records, not people who were allowed to double their incomes on the mortgage questionnaire without verification or those who couldn’t even sign their name because they were illiterate.
Part of the consequences will involve Fannie Mae and Freddie Mac. These publicly held corporations originally created by government will be bankrupt. They may well be already bankrupt. We haven’t seen financials for two years. Eventually the government will have to take these bankrupts over and all their guarantees will be worth nothing. These two vehicles were the vehicles used by Sir Alan Greenspan to finance this housing bubble. Half of what is left of Fannie and Freddie’s capital will be lost in the housing slide. In 2004, they bought some 70% of sub-prime loans, 55% in 2005 and 45% in 2006. Talk about exposure. Even if the Treasury and the Fed cooked up a scheme to come up with a government bailout of short-term and ARM debt off the books of lenders and reissue it as longer-term debt, such as the NYC 1968 Big Mac debt recycling, it would still leave Fannie and Freddie bankrupt. The affects would thunder through the system pushing up interest rates and driving down the stock market.
In 2005, interest-only and payment option loans comprised 36.6% of mortgages. Eighty percent of borrowers are making the minimum payment on their payment option loans, eroding their home equity with every payment. Borrowers may soon have no options. Sub-prime ARMs have a 40% higher default rate than fixed-rate loans. Delinquencies are up about 60% from 2005.
During our call few have joined us in warning America of the coming real estate price collapse. Just a handful of professionals have sounded the call. One of those is economist Gary Shilling. In his recent letter he sites the fact that house prices have gone up 50% faster than official inflation. That even with the increasing size of houses, the McMansion effect – being excluded, inflation-adjusted house prices have jumped as never before in over a century. This is the first time since the 1920s that the bubble is nationwide, and it has been driven by four national forces. First the decline to accommodate those who have been priced out of the market under conventional mortgage terms. Those are the vehicles we have talked about so frequently, interest-only Adjustable Rate Mortgages, as well as option ARMs. Then Gary cites unrealistically high property appraisals to justify oversized loans and the lack of full documentation that allows borrowers to overstate their ability to make mortgage payments. Lenders have also accommodated financial-weak borrowers with high loan-to-value ratio, and piggyback loans, which in effect finance more than 100% of the houses’ prices.
Those loose lending practices, promulgated by former Fed Chairman Sir Alan Greenspan, are a manifestation of the massive speculation that infected stocks in the late 1990s and was never eliminated, despite their 2002-2002 collapse. Substantial easing by the Fed and other central banks aided and abetted by big tax rebates, the carry trade and US government spending on homeland security and military needs, kept the 2001 recession short and speculation in tact. It shifted from the dotcom stocks to private equity, commodities, emerging market stocks and bonds, hedge funds and, especially, real estate as investors remained convinced that they deserved 20% returns each and every year.
Thus, gigantic levels of speculation remain and they won’t disappear unless forced by significant events, such as housing crashes in the US, Canada, Australia, England, Ireland and Spain. When one goes they will go, and the US is leading the pack.
The game is still on because the world is awash with liquidity, which amply feeds speculation. It comes from the leap in house values, which have been liquefied by refinancings and home equity loans. Speculation is feeding on itself as specs take bigger and bigger risks. These risks are now at a high. Loose mortgage lending has been encouraged by the development of mortgage-backed securities that allow lenders to package mortgage loans and sell the securities to yield-hungry investors.
Gary Shilling is forecasting a 25% drop in median single-family home prices nationwide. We differ – we see 35% to 70% in the 30 former hot areas and 5% to 20% in areas that had little or no appreciation. We all have to remember that those who see a 5% to 10% correction do not dare tell the truth or they will lose their jobs. One element that could help housing to a small degree is that online realtors and the Justice Department are putting tremendous pressure on the previous cartel-set commissions of real estate brokers. This could stoke speculation, but we do not think so. The smart speculators have real estate licenses or have set up brokerages.
Forty percent of purchases are for second homes (12%) and speculation (28%). Builders really got bagged. The specs told them they were going to occupy the new homes they bought. Now builders are shocked as 50% of buyers walk away from deposits. They were really building spec homes and didn’t know it. They were also misled by lies from the Bureau of Labor Statistics (BLS). For the next year they will be building out their commitments. After that its stop building and layoff time. Layoffs are already about 25%. Housing starts begin thin, usually 50% or greater decline before the peak of business at which time unemployment starts to rise.
Existing home prices in September fell 2.2% from a year earlier, the biggest drop in 38 years.
Gary says two scenarios can force house prices to step off their recent plateaus and catch up to the already severe declines in sales. Specs have to give up hope for appreciation, which to many is crucial since the rental income on their properties falls short of their mortgage, taxes, maintenance and other costs. As they dump their housing on the market, prices will nosedive, which will encourage other worried sellers to do the same and generates a nationwide rout.
Over half of existing homes for sale are vacant and many are now reaching the market. After that wave comes the spec occupied. They will be the next sellers followed by the 40% of owner occupied existing houses for sale. During all this those who bought new homes will have to back out because they cannot sell their existing homes. History of past patterns suggest a two-year gap between the decline in house sales and the collapse in prices. Due to hyper-speculation that gap may be 1-1/2 years. We called the top of the real estate market in June 2005. That is when sales peaked. That means the big 2-year to 3-year slide should accelerate in January.
The second phase will trigger, mortgage rate-reset shock, which is underway. That is why we are looking for a 10-15% correction in the 30 former hot markets this year. That will be expedited by the 35% of mortgage holders who spend 30% plus of household income on housing outlays. In California, that figure is 48%. Gone are the days when 25% of income for housing was the standard. Other states are Nevada 42.4%, New Jersey 40.7%, Florida 40.6%, New York 38.9% and nationwide 34.5%.
If investor, speculators capitulation doesn’t initiate a big house price decline soon, reset shock will do it by late in 2007, or the nosedive in new home prices and continuing aggressive selling by homebuilders may speed up the collapse in existing house prices by scaring potential worried sellers into action as buyers turn to new homes rather than old homes.
Those who believe lower gasoline prices will give consumers the ability to pay their increased mortgages are mistaken. Gas only makes up 3.7% of consumer spending and only increases consumer purchasing power by 1%.
This is peanuts compared with the money that homeowners have been extracting from their abodes. The Fed says they took $719 billion out of their homes last year. That’s 4.1% of consumer outlays, or four times the effect of lower gasoline prices. Overall lower gas prices are not a big factor, but they are a strong psychological factor. Americans are in for a big surprise. The days of their homes being piggybanks or ATM cards are drawing to a close. They have home equity loans, large credit card debits and no savings. They believe their homes were going to increase in value forever. The money you thought would be there for the children’s university education and your retirement may not be there. The wealth effect will soon disappear. Wages have only grown at 3.1%, although they are picking up at a strong pace.
Mr. Shilling believes that if the Fed lowers rates there would be a small recovery in housing or at least a flattening. He says such dramatic action by the Fed is unlikely soon enough to save the day. The Fed doesn’t change its policy on the basis of forecasts, but in response to current developments. They know if they lower rates inflation moves higher and the dollar lower, and then there is the matter of drawing funds to cover the $3.5 billion daily current account deficit. Shilling says the Fed won’t ease until housing is collapsing. We disagree because of the above.
Needless to say, many builders, mortgage companies, real estate brokerages and sales people, other lenders and construction workers will be bankrupt or out of work. Gary is calling for delinquencies on sub-prime mortgages 16%. We are calling for 35%. Even if Washington works out a scheme to cover lenders to reduce the damage of foreclosures the price of houses will fall.
Today’s problem is not unlike the S&L fiasco of the 1980s, when the government should have been acting in 1982-1984, but it didn’t. The same will happen again.
People will be forced to live within their incomes and that will compound the downside and will guarantee a major recession at best. As Mr. Shilling says there is a close link between the Homebuilder’s Sentiment Index, which rose from 30 to 31, but is down from 60, and consumer spending. There will be a bloodbath in housing related employment and the wages at all levels of the industry are way above average. In addition, as we said before, you will have massive unemployment among illegal aliens and that will be socially explosive. If there is not illegal alien legislation of any kind before the 2008 election those will be major social problems.
In addition, one of the reasons the stock market is at a high on the Dow is that investors firmly believe rates will be lower early next year, it will never happen. How can professional thinking be so shallow? How can professionals believe that housing will revive? They just do not get it or things have been good so long via government manipulation that they are in denial.
Third quarter GDP growth was 1.6%. We see zero growth in 2007 and -1.5% in 2008 barring 1% interest rates again. Those with sub-prime adjustable rate loans will be in negative equity plus most are at the bottom of the employment pole and they will tend to be laid off first along with illegal aliens.
At best the Dow will test 7,268 and if it’s as bad as we believe it could be we could go to 4,000 to 6,000. That as well will turn pensions upside down. Once the fed stops increasing money and credit, deflation will set in – a depression. That is when all your liquid assets go into gold bullion coins and be sure you are very well armed and have provisioned yourself adequately. Once that deflation begins commodities will fall. If you have to diversify try Swiss franc Treasuries. In 1981, the 30-year Treasury traded at a yield of 14.7%. For those with lots of money capturing high yields in the world’s strongest currency would be a masterstroke. If you capture a high yield and events eventually bring lower yields, you will capture capital gains. Read this again it will save your financial life.
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GOLD, SILVER, PLATINUM, PALLADIUM AND DIAMONDS
The data, which we received on the Commitment of Traders Report last week, was incorrect; the COT saw the commercials increase their shorts by 18,069. In our report we had them decreasing their shorts by 18,069. Based on these findings, from a technical viewpoint and in addition to the fact that gold lease rates are almost zero it leads us to believe it’s possible $600 will be tested on the downside. We believe it will hold but if it does not hold you can expect a test of $560. One mitigating factor is that during the week the commercials were short about 25,000 contracts so they did cover about 7,000 of them. The CRB, but particularly copper and oil, have already made large corrections that are probably fully discounted in gold’s price. You must remember though that their prices are only a minor factor in the performance of gold. The Democrats are going to move toward forcing other countries to revalue their currencies, particularly China and Japan. That means the dollar is definitely headed lower and that is a far more powerful mechanism in the upward movement in the gold price. That 35% devaluation is on the way. Thus, any short term moves to the downside should be used to accumulate more gold and silver related assets. Don’t forget M3 plus the other credit creating devices have money and credit expansion at about 14% and those figures are even higher in Europe. That means gold is still on an upward trajectory until those excesses cease.
The action in gold and silver on Monday and Tuesday tells us the commercials may be covering or there is unbelievable physical buying. It could be either or both. We’ll know better after the close on Friday when we have the new COT report.
In the last issue we brought to your attention the comments of Robert Rubin and Paul Volcker, regarding the undermining of the dollar over the next 2-1/2 years. These are elitists, not gold bugs, or alternative journalists. They tell us the systemic problems of the US dollar show no signs of going away, and that structural weakness is being reflected in the gold price and will probably end in a spectacular gold price blow-off during an inflation and dollar crisis.
There is no question the stage is being set for a US dollar crisis of major proportions. The US consumer boom of recent years has been supported domestically by a housing boom, which we are now seeing is unsustainable and internationally by the willingness of foreign countries to hold US Treasury bonds.
Now that the US housing market is crashing, and China has signaled its intention to diversify away from its $1 trillion foreign currency holdings, the risk is that at some point there is a disorderly devaluation of the US dollar. Without devaluation America simply cannot compete. If exporters to the US do not allow their currencies to revalue then there will be import tariffs. This is the only part of the dollar problem. The real problem is not only over valuation of the dollar, but its underlying systemic problems.
These factors make gold and silver related assets a surefire winner. Gold and silver will assume the role of currencies until the dollar is priced properly. This is why Paul Volcker has set a timeframe of 2-1/2 years, it’s inevitable.
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SUBSCRIPTION and RENEWAL INFORMATION: 1-YEAR $129.95 U.S. Funds.
Make check payable to Robert Chapman (NOT International Forecaster), and mail to P.O. Box 510518, Punta Gorda, FL 33951-0518. Please include name, address, telephone number and e-mail address. We accept Visa and MasterCard charges. Provide us with your card number and expiration date. We will charge your card US$129.95 for a one-year subscription.
Foreigners please use foreign U.S. dollar denominated checks or Money Orders.
Note: We publish twice a month by surface mail or twice a week by E-mail.
