Subprime Shoes Continue to Drop
The meltdown in the subprime mortgage market is inexorably spreading throughout the U.S. economy. The first shoe dropped in February, when scores of mortgage originators went bust amid rising defaults and tightening lending standards. Last week, the second shoe dropped as two CDO-focused Bear Stearns hedge funds blew up. Overshadowed by the Bear Stearns drama which unfolded at the same time, California-based brokerage firm Brookstreet Securities shut its doors when unsecured customer losses from margined investments in collateralized mortgage obligations were "unrepentantly" marked down. However, as the subprime monster likely resembles a giant centipede, this will not be the last show to drop.
Bear Stearns' reluctance to
mark down the value of their overpriced CDOs is mirrored by an
equal desire among homeowners to hold tight to their fantasies
of real estate riches. Despite the obvious weakness in the current
market, deluded sellers continue to behave as if the boom of
1998-2005 never ended. A recent survey by Boston Consulting Group
showed that 55% of home owners believe they could sell their
house for more now than a year ago, and nearly three-quarters
think they could sell their homes within the next six months
at a price they set. Is it any wonder that there is a record
8.9 months supply of new homes on the market?
If they do not do it themselves,
appraisers, just like Brookstreet Securities' clearing firm will
do it for them. Imagine the effect on the economy when America
consumer's biggest assets turn into their greatest liabilities!
However, amidst the hysteria and oblivious to their own roles in perpetuating the bubble, lenders also believed that real estate prices could only go up. With such assumptions, defaults seemed unlikely and ultimately riskless (a foreclosed property worth more than the underlying mortgage is a boon). Also, in many cases, as hedge fund managers made huge profits by risking their client's money, both the borrowers and the lenders had no skin in the game. All the risks were transferred to those who purchased the re-packaged loans, and who are now left holding the bag.
All of the pundits and so called "experts" who did not see this coming still do not appreciate the magnitude of the mortgage disaster and how it will impact the housing market in general, the economy, the stock market, the dollar, interest rates, inflation, and the price of gold. They are content to believe government hype about the resilience of the American economy. On Tuesday, just as home building giant Lennar reported huge losses due to a weak pricing environment, the government told us that new home prices basically held firm to last years gains. Later in the week, similar losses blamed on falling home prices were reported by KB Homes. Just like with the CPI, this is yet another example of government numbers being in sharp contrast with reality and why they should always be taken with a grain of salt.
The curtain has yet to close, but if you listen closely you can hear the fat lady warming up in the wings. It has been one hell of a show, but there will be no encore. For those holding toxic mortgage paper there is nothing left to do but sue. However, even those who do not own this stuff are not in the clear. A much larger disaster looms for holders of U.S. dollar denominated assets in general. It will not be long before our foreign creditors realize that Uncle Sam is the biggest subprime borrower of them all and will similarly mark down the value of its debts as well.
For a more in depth analysis of the tenuous position of the housing and mortgage markets, the Americana economy and U.S. dollar denominated investments, read my new book "Crash Proof: How to Profit from the Coming Economic Collapse." Click here to order a copy today.
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Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
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Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange