The Mega Storm
The mega-storm develops slowly. Small regional home builder Kara Homes of New Jersey has filed for bankruptcy. Depositors have reason to worry. Other builders like Hovnanian, which serves the same northeastern area, has begun to ax executive and field jobs. Construction jobs had primed the labor pump for four years, and now will provide drag. No evidence yet, so it lies just over the horizon. Chain reaction linkage in home sales grows as a problem. Sellers must dispose of their current homes in order to free funds, but are having trouble doing so. New home builders do not return deposits in such cases, ouch!
A war has been triggered between Wall Street and lending institutions over damaged loan portfolios, the new "hot potato" in the game. Technical violations, any legitimate angle, are being cited for sending loans and packaged portfolios "back to sender" by Wall Street, which has open eyes. Mortgages are acidic on balance sheets, soon to be felt but fully anticipated from such squabbles. Bear Stearns has entered lawsuits in an ugly public display. New home unsold inventory has grown in volume by 29% year over year, but is under-reported since cancellations are resold but do not re-enter the inventory ledger column. Existing home unsold inventory has grown by a whopping 82% yr/yr.
Let this piece be a synopsis of the October Hat Trick Letter planned to be posted this coming weekend. Housing is the main focus, as in the September report, with huge impact on both the economy and bank sector. My best analysis and most important information is laid out fully.
A quick editor personal note. This US national election might be the most controversial in our history, as concerning the role of electronic voting machines. The entire democratic voting process is at risk. Eligible voter lists can be deleted in midnight raids on databases (see Maryland, Sept 2006). Votes can be altered with random number generator software (see Broward County Florida, Nov 2004). Votes can be simply switched to "full party line vote" with software (see Tallahassee Florida, Nov 2004). Convenient laws installed by the majority party have prevented paper trails, as no accounting is possible for votes. Ohio requires a $1.5 million bond to be posted for any voting machine integrity challenge, an obstacle. Stalin cleverly claimed he cared more about who counted votes, than ensuring that all votes be counted. Have we as a society advanced at all? Cast a suspicious eye on electronic voting machines !!!
USFED STUCK IN MUD
The next change in any position for the USFed will result in a USDollar selloff. A rate hike would deliver a death blow to a flailing, ailing, failing housing market, to drag the economy down, and harm the US$. A rate cut would unleash FOREX traders to unwind their bond spreads, whose object is the USTBond. That would also harm the US$. A change in their bias would lead to similar effects. The money supply, what we can monitor, has lost its growth in the last two years, and must be pumped again. Fed Funds futures contracts indicate a near 100% perceived likelihood of an official Fed rate cut by next summer. Last week the certainty was perceived one month sooner next summer. Meanwhile, Chairman Bernanke suffers the shame of the short end of the Treasury Yield Curve being 40 to 50 basis points under his official Fed Funds rate. Hacks are as hacks do.
Hey, take comfort! The goombas at the Fed have declared that the housing risk has been contained. These are the same geniuses who cannot recognize bubbles. They must have some fine whisky at the Fed cafeteria, methinks! The housing decline will turn out to be the worst bear market in 50 years. New home cancellations, abandoned land leases, growing inventories, and yet clownish so-called experts proclaim a Soft Landing. In literature, they say "torrid love between a man and woman never turns to indifference." To which one might make the parallel, "a feverish housing bull market built atop lax lending never turns to a soft landing." If it took five years to build up the housing bubble, it will take a similar length of time to dissipate that same bubble. USFed policy will be forced, kicking and screaming, to react to the housing downturn, sure to worsen with each passing month for the next two years. Any other perception and forecast is highly compromised and motivated to serve vested self-interest.
The linkage from housing to the USEconomy is unmistakable. Yet somehow both economists and market mavens dismiss the possibility of either a significant housing decline or a recession triggered by housing. My outline contains six major factor dynamics to argue a recession. They pertain to bubble creation willingness, effects of rate cuts, decline in foreign investment, reliance upon consumption in the economy, reset option adjustable mortgages acted upon supply, and the neutered effect of lower mortgage rates acting upon demand. Is the lower crude oil price a result of booming supply flowing into inventory, or reduced demand signaling recession? Probably both, much more of the latter than the market or leaders or pundits wish to admit. Only three economists on my radar correctly perceive the housing-led economic recession. Nouriel Roubini of New York Univ is one, whose factors are very much in synch with my own.
Actually the recession has already begun. The US GDP is over-stated by 5% routinely, just like the CPI is under-stated by a similar amount. Why this simple fact is overlooked about 99% of the time is beyond me. The GDP runs about minus 2% to 3% now. Cash flow will be the financial blunt instrument within household budgets to hinder large sales, then a broader sales pattern. Credit has become too much the primary well for cash flow, and that credit is to be obstructed or refused willingly.
HOUSING DRAG & THREAT TO BANKS
The housing market is $20 to $22 trillion in size. Even Bernanke admits a 1% GDP shave to growth, but his estimate is grossly understated. The falloff will be more rapid and surprising, since the six factors cited above can be potentially sudden in their effect. Almost a 3% decline has already been seen in the Gross Domestic Product from Q1 to Q2 of this year. The impact to bank assets will be significant from the lost housing collateral to mortgage bonds. Nobody but nobody is talking about the threat to bank balance sheets. That is precisely why Wall Street is jettisoning their crappy mortgage bonds back to lenders. The bank sector has 40% exposure to mortgages in one form or another.
Home builders face a nightmare of falling profit margins and lower volume, a deadly combo. The land option abandonment has nowhere near ended, a trend certain to affect detrimentally the wider property market. We have yet to hear about writeoffs of joint ventures. Home builders have also abused leverage, the US national pastime (next to eating to excess and achieving an inebriated state). Their HGX stock index will take additional serious lumps in harsh declines, round after round, perhaps resulting in the complete wipeout of all gains since 2001. The HGX index bounces are mere short covering episodes, setting up ripe new shorting opportunities.
Foreclosures jumped 24% from July to August, now 53% higher than a year ago. Delinquencies are running at an astonishing 17% on subprimes, the worst quality riskiest loans, according to MGIC. The Mortgage Bankers Assn anticipates a $500 billion cutback in mortgage originations this year, to $2400 billion. The Fanny Mae centrifuge of funds and cesspool of assets remains a key unresolved entity. Its assets are worth $46 billion, strangely above its assets of $40 billion. Iit deserves no bonus on book value. Some experts forecast between $25 and $29 billion in losses from declining house collateral valuation. My forecast is for a loss in excess of its asset base by a few multiples, like above $100 billion. Hint, Fanny Mae abused leverage routinely. Hint, banks recycled only their worst quality mortgages to Fanny Mae.
The widespread problem of hundreds of thousands of Americans in the tight box (prison) of living in a home with underwater mortgages will ensure the recession. This is the new social group: bankrupt homeowners. The IRS has a solution for them. If the bank forecloses, takes a big loss, that loss becomes a gift for the abandoning homeowner, subject to income tax. And that tax is not forgiven on passage through bankruptcy. You gotta love the new bankruptcy law which the bank sector essentially wrote without citizen participation.
Look for widely expanded debt industries, which might involve household insurance against bankruptcy, tradable assets of collateralized debt, maybe even labor agreements tied in. A grand wave of bankruptcy this way comes, and with it new industries. The obvious niches are collection agencies, debt consolidation, bankruptcy counsel. Default brokers and odd contracts are next in a mushroom of service industries, which might parallel the fire/hazard, property, car, and life insurance system in place.
CONTROL OF ENERGY & INDUSTRY RESPONSE
The "dynamic duo" JPMorgan and Goldman Sachs are running rampant, making money like bandits, coming and going, in market sectors which rise or fall. Or are they "evil twins" instead? They have a partner in the USGovt and immunity from investigation, audit, and prosecution. What has this country come to? A laundry list of questionable market practices and government activities can be cited. Start with the GSax commodity index (GSCI) whose unleaded gasoline weight was reduced from 8.45% to 2.3% without warning or justification. Fully $100 billion is invested in indexed commodity funds tied to the GSCI, managed by fund managers, brokers, and individuals. They were forced to sell a lot of gasoline contracts to abide by enforced weightings.
Let's be real clear. It would be great if I could put my personal $30 thousand short position in place on a trade, then change an index weightings, then wink to the Dept of Defense on selling a scad of crude oil from inventory, then pull a string at EIA on a weekly story on reduced national energy demand, then sell the heck out of positions which my client hedge funds hold (knowing their important support lines), then to sit back and count my $100k profit a month later. Wow! Isn't it great that the USGovt has JPMorgan and Goldman Sachs as partners to protect our freedom and to ensure market vitality? This media debate on the realistic belief of one third of the public harboring suspicions of election engineering in the energy market is interesting. THEY OPENLY DISCUSS EVERY IMPORTANT FACTOR EXCEPT JPM AND GSAX!!!
The USGovt Dept of Energy spokesman has actually admitted that oil drawn from the Strategic Petro Reserve during the Hurricane Katrina is not to be replaced yet. Check section 161, item g2B of the law, with stipulates that a drawdown cannot persist "for more than 60 days with respect to each shortage." Since when does law interfere with the current Administration when on a mission?
Heck, it is election season just one month away! That is motive enough, isn't it? Gasoline is more domestically controlled for price, so criticism of any manipulation with election expedience as motive would be domestic, if at all. The energy complex is inter-related, with contracts for crude oil, heating oil, diesel, gasoline, and natural gas intertwined. GSax set off a chain reaction. Oh yes, the US Military is rumored to have sold a staggering amount of diesel fuel. Did they accumulate over 18 months only to discharge surplus prior to the election? Coordination between the USGovt and US Military is easy, with the dynamic duo in partnership. This is not idle speculation, but engrained collusion. The largest energy consumer in the world, as a single corporate or institutional entity, is the US Military. Their data is held secret, but when they enter a market, their activity can be detected, and is often the subject of rumor mills. Research has traditionally maintained the grapevine as 75% reliable. Toss in some reduced EIA energy demand forecasts, lower OPEC demand forecasts, and some games on firm OPEC output, and presto, the energy market declines further. Bear in mind that OPEC grossly exaggerates its oil reserves, struggles to maintain output levels, while the Alaskan slope has interrupted supply lines. Saudi oil production is down from 9.5 million bbl/day last year to 9.1 or 9.2 million bbl/day now, not publicly trumpeted by any means. They are under strain. As one paints the ultimate reality, the market action points to the current reality.
JPMorgan and Goldman Sachs are having a field day (rather, two months) forcing hedge funds into liquidation on their heavily stressed energy positions. Amaranth is not the only fund in the middle of a death experience. Expert professionals inside the two adept firms are in competition with young hedge fund managers, some young and inexperienced. The Amaranth story is not isolated. The wealthy do not relish public displays of their investment failures anymore than their fund managers do. Motherrock of ABN Amro was the previous story. Of 9000 hedge funds managing $1300 billion, are we to witness only a handful of failures? Methinks not. Many typical spread trades are anchored with USTreasury Bonds, which must see buyback upon liquidation (the short cover). Thus we saw a strong USTBond rally until last week, the implied beneficiary. So the USGovt applauds the efforts by their twin knights of the Oval Office, JPM and GSax as they force exposed over-leveraged hedge fund managers. This pressure aids the bond rally, which aids the stock rally. Perhaps the current phase of the liquidation has ended. See the minor bond selloff this week.
Does anyone pay attention to the other Plunge Protection Team? The Working Group for Financial Markets has another protection squad, their sidekick. The Counterparty Risk Mgmt Policy Group was designed to preserve the stability of the hedge fund community, whose principal credit and equity partners are Wall Street firms. Yes, taxpayers are doubly exploited to protect the wealthy Ruling Elite players, the Manhattan Made Men.
We are in the midst of a Global Energy War to secure oil & natural gas supplies. It is inconceivable to me that energy prices would suffer prolonged decline when the world's most powerful military is obviously pursuing it at great cost. Oil supply and reliable sources are in severe shortage, Saudi supplies are largely depleted, and major elephant oil fields worldwide are in decline. These are not signals of an energy market price decline. Look for a snapback rally in crude oil and natural gas in the next few months. The natgas bottom has begun formation, as we "climb the contango curve" to higher price during contract expiration rollover. Boone Pickens has been quoted again, with "we will see $70 oil before $50." He points out the importance of Canada to the United States.
Meanwhile, back in the field, natural gas producers have begun to shut down uneconomical natgas fields. Major production firms with no hedged price on delivered output are at risk of loss. The best run of producer firms can shut down isolated higher cost fields temporarily. The impact on supply pulled from the market will be very quick, toute de suite, pronto. Chesapeake has cut back on certain gas field production, and remains effectively hedged on forward sales. On the other hand, EnCana is exposed to the spot price and will be more likely to cut back on output.
With a hefty 31% rise in exploration and upstream production investment, marginal growth in industry output rose minimally, while oil reserves rose minimally also. The entire industry is under strain. The BP Thunder Horse oil & gas rig in the Gulf of Mexico will not open under mid-2008, way behind schedule. Russia is playing more legal contract treachery games again also. The Nigerian bandits are active again, kidnapping local oil company workers, even at their own homes! Supply is not so reliable globally. And winter weather is on its way, whether moderate or not. Snow has already fallen in Alberta, and Minnesota is next. The provincial govts such as Alberta have exposure to revenue reductions tied to natgas price. These factors are detailed.
RANGEBOUND DOLLAR & GOLD
With a big drop in crude oil over 20%, one would have expected a bigger rise in the USDollar from its tight Petro-Dollar linkage. Not so. The beneficiary was largely the USTreasury Bond, which is the anchor in many hedge fund spread trades. As crude oil positions are sold when under pressure of liquidation, oddly the USTBond benefits oftentimes, since it must be bought back as the anchor. Harken back to the GM and Ford distress in summer 2005. When their debt spread trades were unwound, the USTBond rallied to register 52-week lows on the 10-yr yield.
The Euro Central Bank is predictable. When the euro was flirting with the 129 level over a month ago, the ECB stood firm with no rate hike. With the USDollar buttressed by a strong floor built upon a falling crude oil price, the European perspective has changed. With the euro currency running with a 125 handle, the ECB hiked by 25 basis points to 3.25% last week.
The USDollar has also been assisted by tremendous gold bullion dumping by mindless Western central bankers, who are dead set on unloaded that dead weight gold which earns no dividend yield and flimsy leasing interest income. They have not learned how profiting from forward contangos can produce written option call income. They have not learned that holding a tangible stable asset backing a currency is a wise practice. The Germans stand apart as the main country whose central bankers realize that holding gold to fortify currency is an intelligent policy. Barclays points to the Banque of France as a chief culprit in gold bullion dumping before the Sept 26th Washington Accord deadline, from transactional data.
Gold output struggles to respond to higher prices. Against a backdrop of 10% higher mining costs from extraction, a mere 2% has been the output gain in gold ounces. The silver price has held up much better, still over $11 per oz. Gold used to wander in the mid-600's almost all summer long. Gold continues to fight the political battles, while silver simply marches higher, unimpeded by mere mortal actions. One should note that some of the most wealthy old Europeans favor silver as their top asset. Silver remains in technical default, as deliveries are grossly delayed, and games are being played to meet individual sales from national mints.
Gold continues to be treated like a commodity. As the weak USEconomy turns weaker, metal speculative demand will likely decline. However, thinking on gold is badly flawed. With enough economic weakness and housing erosion, THE USFed WILL BE THE LAST ONES TO NOTICE. The USFed will cut interest rates when they finally detect enough economic damage from housing. The result will be a weaker USDollar and a strong gold price, BUILT UPON ECONOMIC WEAKNESS. Why is there so much incorrect gold thinking? Because they do not regard gold as a currency. The weaker crude oil price is in part due to the weaker economy. That lifts the USDollar, even minimally, so as to provide it support. That weakens gold for the time being. The gargantuan trade gap of $69.9 billion again testifies to upcoming USDollar devaluation. We have massive cross currents which will resolve after the elections in November. Then, we will see the dogs of war let loose, south of Turkey, north of Israel.
Jim Willie CB is a statistical analyst in marketing research and retail forecasting. He holds a PhD in Statistics. His career has stretched over 24 years. He aspires to thrive in the financial editor world, unencumbered by the limitations of economic credentials. Visit his free website to find articles from topflight authors at www.GoldenJackass.com.
Also read Ben Stein's