Walk Away From Your Home?

Jim Cramer finally wakes up to reality. He's gone from mocking housing bears to full out bearish mode himself. It's nice to know that he sold all his real estate while he was advising others that there was no bear market in housing!

Stock Market Report

The Dow's Wild Day

Quote of the Day

"We are experiencing home price depreciation almost like never before, with the exception of the Great Depression"

-Angelo Mozilo, Countrywide Mortgage CEO, July
2007

$100 Oil on the Way? How about $200?

Anybody else want to buy a house in the suburbs? The commute will kill you...or at least your wallet if oil prices skyrocket!

The $100-a-barrel oil that Goldman Sachs Group Inc. said would prevail by 2009 may be only a few months away.

Jeffrey Currie, a London-based commodity analyst at the world's biggest securities firm, says $95 crude is likely this year unless OPEC unexpectedly increases production, and declining inventories are raising the chances for $100 oil. Jeff Rubin at CIBC World Markets predicts $100 a barrel as soon as next year.

Higher prices will increase revenue for energy producers from Exxon Mobil Corp. to PetroChina Co., while eroding profit at airlines including EasyJet Plc and railroads such as Union Pacific Corp. The U.S. and other oil-importing nations risk accelerating inflation, while higher energy costs threaten to restrain growth.

Benchmark crude oil futures ended last week at $75.57 a barrel on the New York Mercantile Exchange, up 51 percent since mid- January and twice the level of early 2003. A record number of options have been sold that give the buyer the right to buy crude oil at $100. The contracts, covering 50 million barrels, only pay off should oil go above the target price.

A National Petroleum Council study led by former Exxon Mobil chairman Lee Raymond, released last week, predicted a growing gap between production and demand for oil and gas during the next two decades. As recently as 2005, Raymond said oil prices had probably peaked and dismissed the possibility that supply and demand could not be brought back into balance.

"There are questions about whether the oil industry can keep up with demand," U.S. Energy Secretary Samuel Bodman said last week, commenting on the Petroleum Council report.

Oil prices could triple in three months to more than $200 a barrel, given the right circumstances, according to Matthew Simmons, chairman of Simmons & Co., a Houston investment bank.

Gasoline pump prices averaging more than $3 a gallon across the U.S., the consumer of 25 percent of the world's oil, haven't dented sales. Deliveries of gasoline were a record 9.23 million barrels a day in the first half of this year, according to a July 18 report from the American Petroleum Institute in Washington.

"It appears that high prices are acceptable to the American consumer," said Robert Ebel, chairman of the energy program at the Center for Strategic and International Studies in Washington. "People want the house with a yard and white-picket fence so they are moving further and further out of the cities. They have to just get up earlier and drive further."

A pullout from Iraq may be the event that pushes oil to $100 a barrel, according to Boone Pickens, the Dallas hedge fund manager who has joined Forbes Magazine's list of billionaires because of his bullish bets on energy prices. Pickens predicted a year ago that $100 oil would probably occur by now. Today he is looking for $80 within six months, and he says growing chaos in Iraq would be a bad sign. "That could run prices pretty high," he said.

Goldman Sachs's Currie also notes similarities to a year ago, with global inventories at about the same level and U.S. government data showing an increasing bet on higher prices.

"At face value this market is strikingly similar to a year ago," Currie said. "What is different? Supply is down a million barrels a day, demand is up a million barrels a day. The market is in a deficit."

Ben Bernanke Agrees with Ron Paul

Unfortunately, you won't see this on the evening news folks. It is the most important topic that the mainstream media never discusses. It's easier to say that Ron Paul is radical and dismiss him outright. He's the only one telling it like it is.

Who's to Blame for Subprime Mess?

Bond funds may have a reputation for being boring, but anybody who attended Morningstar's annual mutual fund conference in Chicago last week might have the impression that the fixed-income market is the most dangerous part of the U.S. financial system right now.

Both the opening and closing sessions featured tough-talking bond fund managers who pulled no punches about the state of the subprime mortgage market and about who was to blame for the mess.

"It's an unmitigated disaster," Jeffrey Gundlach, chief investment officer at TCW Group, said during the conference's opening address. "And it's only going to get worse."

Gundlach said that he expects to see more delinquencies in loans made to borrowers with poor credit histories and that the subprime mortgage market's woes would lead the Federal Reserve to cut interest rates.

Robert Rodriquez, chief executive officer of First Pacific Advisors, was even more blunt. "We haven't seen much of a problem in the subprime area [but only] because the pricing is a fraud; the ratings are bullshit," said the two-time recipient of Morningstar's Fund Manager of the Year.

"I don't buy these prices, but as long as someone can provide capital to keep the finger in the dike, the charade will go on."

Rodriguez concurs with Gundlach that rising subprime mortgage delinquencies are a problem not just for hedge funds but also for major banks and other financial institutions.

"It is estimated that U.S. banks have invested 10% of their assets in collateralized debt obligations," he said. "And 40% of the CDOs are in subprime mortgages. I'm trying to get details on the components and I can't get any. This is setting up the next catastrophe."?

Rodriguez co-manages the FPA New Income fund (FPNIZ), which gained 4.8% last year and is up 2.13% year to date. It also carries a two-star rating from Morningstar.

Rodriguez anticipates a huge drop in the prices of both long-term and high-yield debt and avoids both in his portfolio; as a result, it currently has about 41% of assets in cash. This cautious approach may temper gains, but it also reduces volatility: The fund hasn't suffered a calendar-year loss since Rodriquez took charge in 1984, according to Morningstar.

Stephen Walsh, the deputy chief investment officer for Western Asset Management, voiced similar concerns. "There's been a complacency among investors," he said. "I read that 50% of the (subprime mortgage) loans were low- or no-documentation loans, just state your income without any proof."

Walsh said he didn't understand how anyone could analyze the risk in holding loans when borrowers have little or no equity in the property and there is no way to verify their ability to make payments. However, he said he stayed away from these securities not because of a "doomsday scenario" but rather because of a lack of faith in the analysis.

"How do you make an assumption on a loan that is undocumented?," Walsh said, referring to the lack of documentation of a borrower's employment or income for many subprime loans.

Burning Down The House

CNBC provides an excellent analysis of the Subprime Meltdown and the effects it is having on portfolios. This debunks the consensus analyst view that subprime mortgages are isolated and won't affect the broader economy.

Credit crunch will 'shred investment portfolios to ribbons'

The near collapse of two Bear Stearns hedge funds has lifted the rock on our 21st century mutant capitalism, exposing the bugs beneath to a rare shock of naked light.

When creditors led by Merrill Lynch forced a fire-sale of assets, they inadvertently revealed that up to $2 trillion of debt linked to the crumbling US sub-prime and "Alt A" property market was falsely priced on books.

Even A-rated securities fetched just 85pc of face value. B-grades fell off a cliff. The banks halted the sale before "price discovery" set off a wider chain-reaction.

"It was a cover-up," says Charles Dumas, global strategist at Lombard Street Research. He believes the banks alone have $750bn in exposure. They may have to call in loans.

Not even the Bank for International Settlements (BIS) has a handle on the "opaque" instruments taking over world finance.

"Who now holds these risks, and can they manage them adequately? The honest answer is that we do not know," it said.

Markets have been wobbly since the surge in yields on 10-year US Treasuries, the world's benchmark price of money. Yields have jumped 55 basis points since early May on inflation scares, the steepest rise since 1994. It infects everything; hence that ugly "double top" on Wall Street and Morgan Stanley's "triple sell signal" on equities.

Wobbles are turning to fear. Just $3bn of the $20bn junk bonds planned for issue last week were actually sold. Lenders are refusing "covenant-lite" deals for leveraged buy-outs, especially those with "toggles" that allow debtors to pay bills with fresh bonds. Carlyle, Arcelor, MISC, and US Food Services are all shelving plans to raise money. This is how a credit crunch starts.

"This is the big one: all investment portfolios will be shredded to ribbons," said Albert Edwards, from Dresdner Kleinwort.

The BIS had warned days earlier that markets were febrile: "more risk-taking, more leverage, more funding, higher prices, more collateral, and in turn, more risk-taking. The danger with such endogenous market processes is that they can, indeed must, eventually go into reverse if the fundamentals have been over-priced. Such cycles have been seen many times in the past," it said.

The last few months look like the final blow-off peak of an enormous credit balloon. Global M&A deals reached $2,278bn in the first half, up 50pc on a year. Corporate debt jumped $1,450bn, up 32pc. Private equity buy-outs reached $568.7bn, up 23pc. Collateralised debt obligations (CDOs) rose $251bn in the first quarter, double last year's record rate.

Leveraged deals are running at 5.4 debt/cash flow ratio, an all-time high. As the BIS warns, this debt will prove a killer when the cycle turns. "The strategy depends on the availability of cheap funding," it said.

Why has such excess happened? Because global liquidity flooded the bond markets in 2005, 2006, and early 2007, compressing yields to wafer-thin levels. It created an irresistible incentive to use debt.

What is the source of this liquidity? Take your pick. Goldman Sachs says oil exporters armed with $1,250bn in annual revenues have been the silent force, sinking wealth into bonds; China is recycling $1.3 trillion of reserves into global credit, a by-product of its policy to cap the yuan; Japan's near-zero rates have spawned a "carry trade", injecting $500bn of Japanese money into Anglo-Saxon bonds, and such; the Swiss franc carry trade has juiced Europe, financing property booms in the ex-Communist bloc. And, all the while, cheap Asian manufactures have doused inflation, masking the monetary bubble.

The deeper reason is the ultra-loose policy of the world's central banks over a decade. They "fixed" the price of money too low in the 1990s, prevented a liquidation purge to clear the dotcom excesses, then kept rates too low again from 2003 to 2006. Belated tightening has yet to catch up.

Don't blame capitalism. This is a 100pc-proof government-created monster. Bureaucrats (yes, Alan Greenspan) have distorted market signals, leading to the warped behaviour we see all around us.

As the BIS notes tartly in its warning on the nexus of excess, this blunder has official fingerprints all over it. "Behind each set of concerns lurks the common factor of highly accommodating financial conditions" it said.

Rebuking the Fed, it said Japan and Europe have turned sceptical of the orthodoxy that central banks can safely let asset booms run wild, merely stepping in afterwards to "clean-up".

The strategy leads to serial bubbles, creates an addiction to easy money, and transfers wealth from savers to debtors, "sowing the seeds for more serious problems further ahead".

If you think we are too clever now to let a full-blown slump occur, read the BIS report.

"Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and south-east Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived," it said.

The subtext is that you bake slumps into the pie when you let credit booms run wild. You can put off the day of reckoning, as the Fed did in 2003, but not forever, and not without other costs.

So the oldest and most venerable global watchdog is worried enough to evoke the dangers of depression. It will not happen. Fed chief Ben Bernanke made his name studying depressions. He will slash rates to zero if necessary, and then - in his own words - drop cash from helicopters. But his solution is somebody else's dollar crisis.

On it goes. Perhaps governments should simply stop trying to rig the price of money in the first place.

BIS warns of Great Depression dangers from credit spree

Construction in Shanghai: BIS warns of Great Depression dangers from credit spree
The BIS said China may have repeated the disastrous errors made by Japan in the 1980s

The Bank for International Settlements, the world's most prestigious financial body, has warned that years of loose monetary policy has fuelled a dangerous credit bubble, leaving the global economy more vulnerable to another 1930s-style slump than generally understood.

"Virtually nobody foresaw the Great Depression of the 1930s, or the crises which affected Japan and southeast Asia in the early and late 1990s. In fact, each downturn was preceded by a period of non-inflationary growth exuberant enough to lead many commentators to suggest that a 'new era' had arrived", said the bank.

The BIS, the ultimate bank of central bankers, pointed to a confluence a worrying signs, citing mass issuance of new-fangled credit instruments, soaring levels of household debt, extreme appetite for risk shown by investors, and entrenched imbalances in the world currency system.

"Behind each set of concerns lurks the common factor of highly accommodating financial conditions. Tail events affecting the global economy might at some point have much higher costs than is commonly supposed," it said.

The BIS said China may have repeated the disastrous errors made by Japan in the 1980s when Tokyo let rip with excess liquidity.

"The Chinese economy seems to be demonstrating very similar, disquieting symptoms," it said, citing ballooning credit, an asset boom, and "massive investments" in heavy industry.

Some 40pc of China's state-owned enterprises are loss-making, exposing the banking system to likely stress in a downturn.

It said China's growth was "unstable, unbalanced, uncoordinated and unsustainable", borrowing a line from Chinese premier Wen Jiabao

In a thinly-veiled rebuke to the US Federal Reserve, the BIS said central banks were starting to doubt the wisdom of letting asset bubbles build up on the assumption that they could safely be "cleaned up" afterwards - which was more or less the strategy pursued by former Fed chief Alan Greenspan after the dotcom bust.

It said this approach had failed in the US in 1930 and in Japan in 1991 because excess debt and investment built up in the boom years had suffocating effects.

While cutting interest rates in such a crisis may help, it has the effect of transferring wealth from creditors to debtors and "sowing the seeds for more serious problems further ahead."

The bank said it was far from clear whether the US would be able to shrug off the consequences of its latest imbalances, citing a current account deficit running at 6.5pc of GDP, a rise in US external liabilities by over $4 trillion from 2001 to 2005, and an unpredented drop in the savings rate. "The dollar clearly remains vulnerable to a sudden loss of private sector confidence," it said.

The BIS said last year's record issuance of $470bn in collateralized debt obligations (CDO), and a further $524bn in "synthetic" CDOs had effectively opened the lending taps even further. "Mortgage credit has become more available and on easier terms to borrowers almost everywhere. Only in recent months has the downside become more apparent," it said.

CDO's are bond-like packages of mortgages and other forms of debt. The BIS said banks transfer the exposure to buyers of the securities, giving them little incentive to assess risk or carry out due diligence.

Mergers and takeovers reached $4.1 trillion worldwide last year.

Leveraged buy-outs touched $753bn, with an average debt/cash flow ratio hitting a record 5:4.

"Sooner or later the credit cycle will turn and default rates will begin to rise," said the bank.

"The levels of leverage employed in private equity transactions have raised questions about their longer-term sustainability. The strategy depends on the availability of cheap funding," it said.

That may not last much longer.

U.S. tells lenders to crack down

As usual, a day late and a dollar short. The abuses that the blogosphere has been reporting about for years, finally get the attention of banking regulators.

U.S. banking regulators told mortgage lenders Friday to toughen standards for subprime home loans in a belated effort to end abuses that led to a surge in defaults and the highest foreclosure rate in five years.

Lenders, in most cases, should verify income levels instead of relying on borrowers' statements, the Federal Reserve, the Federal Deposit Insurance Corp. and other regulators said in guidelines issued in Washington. They also said banks should consider potential interest-rate increases when judging whether homebuyers can pay off loans.

"We clearly have a profound problem," FDIC Chairman Sheila Bair said Friday. "It is going to get worse before it gets better, and decisive action was required," she added. "Everybody was asleep at the switch."

The guidelines come too late to repair the growing crisis in subprime mortgages. Nor did the effort satisfy lawmakers, who want regulators to complement the guidelines with enforceable rules. While bank examiners can strong-arm banks with the recommendations, consumers can't file lawsuits based on them because they aren't laws.

The focus now turns to the Fed, which is reviewing whether there is a need to codify the standards. While central bank policymakers have preferred to rely on guidance and disclosures, Fed Governor Randall Kroszner said they will "seriously consider" using its rule-making authority to prevent abuses.

"The Federal Reserve must take the guidance, strengthen its protections" and turn it into rules that apply to all lenders, Senate Banking Committee Chairman Christopher Dodd, a Connecticut Democrat, said Friday. "Subprime borrowers, who are disproportionately black and Hispanic, deserve strong protections."

Bair also put pressure on the Fed to act quickly in adopting regulations that "apply across the board." Friday's guidance applies to lenders overseen by federal regulators, not to mortgage brokers that write most subprime loans, she said. Those lenders are overseen by state regulators.

The Conference of State Bank Supervisors and the American Association of Residential Mortgage Regulators said in a statement that they will issue similar guidelines for state regulators "in the next two weeks."

Lenders and consumer advocates said Friday's guidelines went further than they expected and signal that regulators have determined that such loans are high-risk products for consumers that require standards and protections.

"The regulators stuck to their guns," said Allen Fishbein, director of credit and housing policy at the Consumer Federation of America in Washington. "The key point is that it requires a sound analysis of the borrower's capacity to repay."

Subprime loans are those made at higher interest rates to borrowers with weak credit histories or high debt burdens. Fraud increased and lending standards fell as Americans borrowed $2.8 trillion for home loans from 2004 to 2006, the largest mortgage boom of any three-year period on record.

Lenders should be able to "readily document" a borrower's salary by checking annual income statements, pay stubs and tax returns, according to the guidelines, which were released by the Fed, the FDIC, the Office of the Comptroller of the Currency, the Office of Thrift Supervision and the National Credit Union Administration.

"Stated-income and reduced-documentation loans should be accepted only if there are mitigating factors that clearly minimize the need for direct verification" of the borrower's ability to repay, the regulators said. That phrase is, in effect, a warning to lenders to avoid low-documentation loans, consumer advocates said.

Mortgage Bankers Association Chairman John Robbins said the new guidelines will "constrain consumer credit choices." The Washington-based group, which represents the mortgage industry, also discouraged Congress from passing legislation that would subject lenders to "rigid underwriting standards and litigation risk," Robbins said in a statement.

The value of subprime loans fell 10.3 percent to $722 billion in 2006 from a record $805 billion in 2005, according to JPMorgan Chase & Co. Credit Suisse Group predicts that loans will fall as much as 60 percent this year.

When CDOs Trump Paris Hilton, There's a Problem

Repeat after me: CDO's could be the next "bad thing" in the history of bad investments. People have heard of "Pyramid Schemes", "Junk Bonds", "S&L Crisis" and more recently, "Sub-prime mortgages" but it's time for the general public to get ready for CDO's.

June 27 (Bloomberg) -- If you're like me and can't seem to get your arms around the concept of home loans pooled into mortgage-backed bonds packaged into collateralized debt obligations carved up into tranches combined to form other CDOs (CDOs-squared), you may wonder what all the hullabaloo has been about these past few weeks.

Unless you're a Bear Stearns Cos. stockholder or an investor in a hedge fund that owns the riskiest piece of a CDO (the equity tranche), the owners of which line up behind everyone else when it comes time to get paid, why should you care about complex Wall Street structured-finance products designed to turn a hefty profit without landing the issuer in jail?

Answer: Because losses in one area have a way of rippling through to others; because risk is a four-letter word, especially if priced improperly; because uncertainty about the value of illiquid, opaque securities backed by home loans breeds risk aversion on the part of mortgage lender and CDO investor alike; because the lightly regulated derivatives market has become so big and so diffuse that some out-of-nowhere event may bring the domino theory back for a retest; and because each of us, directly or indirectly, owns a small piece of the rock.

When he was Federal Reserve chairman, Alan Greenspan extolled derivatives as a way to unbundle and transfer risk to those willing to assume and manage it.

But first the risk has to be identified and priced as such. Many CDOs were considered practically risk-free, with their ability to deliver a steady, reliable return month after month.

Safety in Numbers

It's true there's safety in numbers. Put enough junk bonds or subprime mortgages into a composite entity, and a default here or there isn't going to matter.

It may be easy, with the benefit of hindsight, to say ``there was insufficient capital at the very beginning, but it was not impossible to determine it at the closing date based on the underwriting characteristics of the loans,'' says Sylvain Raynes, a principle at R&R Consulting, a structured valuation boutique in New York, and author, with Ann Rutledge, of ``The Analysis of Structured Securities.''

The delinquency rate for subprime loans rose to 13.8 percent in the first quarter, according to the Mortgage Bankers Association. It was 11.5 percent a year earlier.

When the collateral in residential mortgage bonds is impaired, ``nothing will undo the losses,'' says Joseph R. Mason, associate professor of finance at Drexel University in Philadelphia. ``It's a static pool of investments, a brain-dead trust.''

Buying Time

With the residential real estate market continuing to deteriorate, mortgage-related derivatives aren't only a concern for sophisticated investors, rating companies and regulators. Subprime delinquencies may cause problems for everyone from potential homebuyers to small investors to the Federal Reserve to the man on the street. It's something everyone should care about.

If you are a Bear Stearns shareholder, you should care. The securities firm will inject about $1.6 billion into one of its failing hedge funds to prevent a fire sale of illiquid assets, including CDOs, by creditors. The stock has lost $6.46, or 4.4 percent, since the announcement.

In becoming its own lender of last resort, Bear Stearns bought itself some time. If neither housing nor market conditions improve, time may not be on its side.

Hedge funds should care. The over-the-counter CDO market is opaque. The value of any CDO is primarily model-determined. There is no active market and no fair market value. It's a kind of don't-ask-don't-tell-'til-you-gotta-sell system.

Making a Mark

Once a CDO is sold, it forces other investors to revalue, or mark to market, that security. Last week, creditors of Bear Stearns's hedge funds seized collateral to cover the funds' losses and ended up selling only a small portion of the assets. It's not far-fetched to think other lenders to other hedge funds will come a knockin', forcing liquidations into a poor market.

The small investor, who may have no idea what a CDO is, should care.

``We should care because our money market account, pension account, insurance company all may be invested in these securities, which have not been tested in a down cycle,'' says Joshua Rosner, managing director at Graham Fisher & Co., an independent financial-services research firm in New York. ``We should care because as we saw last week, an asset carried at a value determined subjectively maybe be worth a lot less when it's traded.''

S&L Crisis

The Federal Reserve should care. While Bear Stearns's bailout of its hedge funds is being compared to Wall Street's rescue of Long-Term Capital Management in 1998, a better paradigm might be the savings and loan crisis in the early 1990s. Insolvent thrifts saddled with -- guess what? -- bad real estate loans depleted the now-defunct Federal Savings and Loan Insurance Corp., which provided deposit insurance to S&Ls. The U.S. government created the Resolution Trust Corp. to dispose of bad loans, auction off the underlying properties, shut insolvent thrifts and arrange for solvent institutions to assume the performing loans of insolvent ones.

The result was a true credit crunch, with banks unable to make new loans until they repaired their balance sheets. The economy hobbled along until the process was complete.

Nowadays banks are only a small part of the home-loan market. Outside the banking system, the situation is worse. Rising defaults on subprime mortgages have forced some 60 mortgage companies to close or sell their operations since the start of 2006, according to Bloomberg data.