WEDNESDAY MARCH 21, 2007

MID WEEK ISSUE

THE INTERNATIONAL FORECASTER

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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International_forecaster@yahoo.com

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US MARKETS

We called for a correction in the mortgage finance bubble last year, but we were early. In June of 2005, we called the top of the real estate market and felt the finance aspect couldn’t be far behind. It took a little more than a year but it has happened. The delay was due to the extraordinary liquidity in the world markets and the absence of large numbers of failures. Yes, there were plenty of foreclosures and defaults but they didn’t occur for the most part until later in the year. The CDO issues were the rage as the insatiable demand for higher-yielding securities and like in all markets a lot of garbage was included. As defaults manifested themselves the investors began to bailout. The bubble had burst and the blowout had begun. That whole problem was accompanied by unprecedented speculation in credit derivatives. The world was and still is awash in money. Yes, we have heard the arguments that individual exposure is small and that the risks are hedged. We do not totally believe that. There are a number of large CDO positions and not everyone is hedged. It is more important to look at the bigger picture and that is the credit and risk markets are under severe pressure. In addition, the ending of the Japanese yen and Swiss franc carry trades are going to deny markets much needed capital flow. Appetite for risk could shrink considerably as well. Once that capital flow begins to shrink it will be the central banks that will have to augment the loss by increasing money and credit beyond the 10% to 11% they are already providing. Private sources of credit will have to continue to contribute as much as they have and probably more.

The actions by Fannie Mae and Freddie Mac and mortgage lenders to impose dramatically tighter credit standards and availability for subprime borrowers means many homeowner, mortgage holders won’t be allowed to reset a new loan. Half of those that can won’t be able to make the new higher payments anyway. These are loans that should have never been made in the first place because the borrowers simply do not have the income to make the payments. The result is the Ponzi scheme is over, and we are in a state of collapse in the mortgage market. This will be accompanied by a lessening of risk aversion and a move up the credit chain to better quality mortgages. It should also erode the junk bond market, which is way overpriced. We are in the early stages of mortgage problems and the real key is Southern California. In 2005 and 2006 over 60% of loans were ARMS and other exotic loans, so when California breaks the resounding financial earthquake will effect every credit market in the country. That will be accompanied by the exposure of massive fraud. Fannie Mae and Freddie Mac packaged some 45% to 52% of CDOs and this financial disaster should bankrupt them. That means a consortium of banks backed by the government will have to come in and pick up the pieces. Most mortgage lenders and many banks will fail in the process. It is called contagion and it is inevitable.

We find it amusing that our government and Wall Street would have us believe that CDO risk is widely dispersed and derivative insured. If that is so how was it that GMAC has lost $1 billion and is still counting? How about the billions lost by 26 mortgage lenders, soon to become 100 plus. We haven’t even begun to deal with predatory lending practices, never mind suitability. We have been discussing the problems of those with loans. Those who want loans now have to score 680-700 on the FOIC and put 5% down. Would be homebuyers with blemished credit histories are going to be shut out of the housing market now that risky loans are no longer being made. That means there is no new canon fodder for the housing market. Buyers will no longer be able to buy homes they cannot afford. Already 50% of applications are being rejected. Some have good income and credit, but they have no down payment. They spend every cent they make.

In 2006 lenders threw caution to the wind and as a result on those loans alone the 2005 default rates jumped to 14.3% for 2006. When all is said and done it will take five years to work off the excesses. That means by 2011 we should be back to normal, unless we get lucky and it only takes three years. It is not just the loans – it is the real estate prices falling and the disruption in the credit markets. That means shortly the CDO market will greatly diminish in size. Mortgage lenders you have never heard of are quietly closing up shop and fading away. That makes the borrower that wanted to reset have to seek out another loan broker who is still in business. Many of these mom and pop operations were sitting on a pile of loans that were set to close the day they shut the door and took down the sign.

Fannie Mae and Freddie Mac have guaranteed $3.8 trillion of $10.7 trillion of mortgage debt. US housing is supposedly worth $22 trillion. If on average over the next few years prices fall 30% that will incur a wealth loss of $6.6 trillion. That will wipe out the equity of some 40% of homes, in as much as there were those cash out loans and equity loans that were so popular over the past few years. That will be exacerbated by higher unemployment in the years to come. A loss of 1.2 million jobs from construction, suppliers and real estate alone, plus we are already in a recession, plus offshoring and outsourcing are the fashion and continue to rip the heart out of our country and we still have 30 million illegal aliens – about 14 million – of which are vying for your jobs. This is not a very positive picture is it? You can lay all the fault at the feet of the elitists and their minion Sir Alan Greenspan. They wanted us financially on our knees so we would accept world government, and we are headed there. Keep in mind subprime mortgages represent 13% of outstandings and mortgages with negative or no amortization representing another 27% of the $6 trillion of mortgages originated in 2005-06. That is 40% of $6 trillion at risk. Now add that together and you have a possibility of $3 trillion in mortgages failing. We do not believe that will happen, but as of now we figure $700 billion to $1.3 trillion could be lost. For now we will stick with the $700 billion, which is $200 billion more than the 1980’s S&L disaster. We said three years ago there would be a collapse and it is here. The former hot areas will be decimated. That is particularly the east and west coasts and particularly California, which we see falling 40% to 60%. In addition, Fannie and Freddie could take losses of $350 billion to $1 trillion. The problem is they only have combined capital of $79 billion. As we have said for five years Fannie and Freddie are already bankrupt.

Again we see a loss of some $700 billion to $1.3 trillion in the subprime and above areas. A loss of $6.6 trillion in home values and a 50% loss in the stock market of $9 trillion. That is $16.8 trillion down the rat hole. This is going to be a cataclysmic collapse. We know you do not want to hear that, but that is the way it will be and that is why we recommended selling homes in early 2005. That is why we have said stay out of the stock market and as an antidote we said invest in gold and silver assets for the past six years. We have been right 98% of the time. That means you should listen. We are facing 20% inflation that government will admit too. Stagflation-stagnation and inflation and then deflation.

Subscribers ask how could this have happened. We will tell you how. The vast majority of home loans made since 2002 were subprime or otherwise, loans that should never have been made in the first place. Borrowers had low credit scores, no down payment and were borrowing more money then they were realistically capable of paying. Most subprime loans involved low teaser rates that lasted only two years. Teaser rates for most prime ARMS typically last for five years. That means following the two years of financial agony ahead, we will have a new crop of better quality ARMS coming due, and they will have problems as well. Not on the scale of the subprimes, but they will have problems, the extent of which will be dictated by the state of the economy and employment. If things are bad they could be quite problematic. The call for stricter rules, such as 20% down and a 900 FOIC is where we are headed and that means a return to traditional house prices. Due to their income limitations, only 60% of Americans should own homes in the first place. Forty percent simply cannot afford to own a home. This late stage crackdown is going to make the situation worse. Where was government, and why weren’t politicians speaking out when Sir Alan Greenspan was telling Americans that everyone should have an adjustable rate mortgage? Politicians and Greenspan wanted a booming economy where home valuations could be cashed out to spend because their wages were stagnant, their employers were screwing them over and inflation was over 10%. The equity withdrawal is coming to an end and unemployment is rising as we just experienced our first year of recession. Without access to cheap credit the spending stops and the economy swoons. If you are unemployed even those with low fixed mortgage rates and high credit scores will not make their payments. You ask, what will the Fed do? They won’t do what they did in 1928 and cut back on money and credit. They will increase money and credit until there are no more borrowers. That is hyperinflation Weimer style, and then the deflationary collapse.

Most of, if not all, of the independent subprime originators will go bankrupt. Many conservative lenders will go under as well. It is called implosion and you can blame it on Sir Alan Greenspan. Many banks will stop lending and CDOs will disappear. CDO losses could run over $1 trillion, not the $100 billion being thrown around presently. Remember the derivatives market is unregulated and if one or two major writers go down it could take the whole financial system down with it. Hedge funds are private and mostly unregulated pools of capital. They can invest or short or use derivatives anyway they please. If a couple of major hedge funds bite the dust it could cause real trouble within the financial system. They are similar in some ways to the trusts of the 1920s and 30s that were eventually outlawed. The subprime problems and the phasing out of the yen and Swiss franc carry trades amid a falling, overpriced market, does not bode well for the future.

Our nation’s drive to increase home ownership, pushed by both the Fed, politically, via public policy and misguided financial innovations, will prove to be a disastrous experiment. Some people simply do not qualify to own homes. It is bad financial management for subprime borrowers to spend 37% of their after-tax income on mortgage payments, insurance and property taxes this year. This is 10% more than they spent in 2000. We have 450,000 subprime loans in foreclosure and the party has just begun.

All forms of debt are a problem in America today. Just like those who should never had sub prime loans, many Americans should not have been deluged with credit cards by banks. It is no wonder we have people in way over their heads. As we have said previously the housing bubble has now become a credit bubble.

What has happened in the past six years is extraordinary. The debt that has been accumulated will be with most of the borrowers for the rest of their lives. They have become debt slaves to the banks and tax slaves to our government. There are those in our society that will remain in perpetual debt. A debt that is almost impossible to pay off. Their debt game is how our society is being controlled and destroyed. Our children are bombarded on TV with ads or situations where the credit card is the preferred mode of payment. Upon entering college students are deluged with credit card offers. By the time they graduate they have $20,000 in card debt and $30,000 in studying loan debt. This debt in many cases stays with these graduates for life. The banks want you in debt from cradle to grave. They do not want consumers who regularly pay off their debt. They can’t make any money off them.

These conditions make the bank the boss. This perpetual debt makes the consumer subservient, not just because his credit rating may be used against him, but it shades his political perspective as well. The debt is a privilege meted out by the all powerful bank whether it is your home or your credit card or your vehicles. You should bow down to MasterCard, Visa and America Express, because they are doing you a priceless favor.

Americans owe over $10 trillion or over $30,000 per household. The banks are legal shylocks just like the Mafia. The credit industry’s policies are not only egregious, but illegal. It lends to people they know cannot repay their debt. It is known as fraudulent inducement and is punishable with fines and imprisonment. This is borne out by millions of pre-approved credit cards sent to those who cannot possibly pay off the balances. Eighty percent of the blame for unpayable credit card debt lies at the feet of the banks not the borrowers. There are many Americans who should never own homes. They do not make the money to afford them. Besides sometimes you are much better off renting. One of those times is right now, whether you know it or not. Over the next few years in the demise of the housing bubble we will also see the end of the credit bubble. Incidentally, some researchers call a home a debtor’s prison. They could be right.

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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. international_forecaster@yahoo.com