Signs of the Economic Apocalypse, 7-9-07

From Signs of the Times:

Gold closed at 654.80 dollars an ounce Friday, up 0.6% from $650.90 at the close of the previous Friday. The dollar closed at 0.7338 euros Friday, down 0.6% from 0.7384 at the previous week’s close. That put the euro at 1.3628 dollars compared to 1.3542 the Friday before. Gold in euros would be 480.48 euros an ounce, virtually unchanged from 480.65 for the week. Oil closed at 72.81 dollars a barrel Friday, up 3.0% from $70.68 at the close of the week before. Oil in euros would be 53.43 euros a barrel, up 2.4% from 52.19 for the week. The gold/oil ratio closed at 8.99 Friday, down 2.4% from 9.21 the Friday before. In U.S. stocks, the Dow closed at 13,611.68 Friday, up 1.5% from 13,408.62 at the close of the week before. The NASDAQ closed at 2,666.51 Friday, up 2.4% from 2,603.23 for the week. In U.S. interest rates the yield on the ten-year U.S. Treasury note closed at 5.18%, up five basis points from 5.13 at the end of the previous week.

Oil prices rose last week and the dollar fell against the euro, ending close to historic lows. Hedge funds keep falling prey to the subprime mortgage mess. Yet the U.S. stock market rose and mainstream commentators were looking at halfway decent jobs numbers for June as a sign that all is well with the economy. The only way that could possibly be true would be if the housing drop has bottomed out. As we will see, the chances of that are slim. I think at this point we can ignore the stock market if we are trying to figure out what is coming next. The dollar may be the more important indicator. This week, for example, the Dow, while going up 1.5% in dollars, went down 1.5% compared to oil.

Garbage Bonds & Bonfires

Jim Willie CB

Jul 6, 2007

Holiday

In keeping with the Independence Day holiday, a preface is offered. The irony is stiff as a board, as thick as a fog, as ugly as a pig. Citizens in the Untied States have never seen such a broad, deep, palpable threat to their liberty, this time from within, in terms of the system and its leadership. Dependence, the opposite of the celebrated theme, is running strong. The corporate agenda takes a one-day holiday. Refer to waging war, deceiving the masses, selling out the Middle Class, undermining the institutions, and rendering any threat to systemic reform as anti-business or unpatriotic. Any opportunity for a day off is a good thing, to be honest. If you ask me, somehow this year the nation should skip the holiday. It is one thing to commemorate the fallen soldiers on Memorial Day. However, as national financial catastrophe approaches, sure to shred liberty and compromise sovereignty, it makes sense to skip any festival for independence. How about calling it the Second Labor Day, since some workers toil twice as hard or long for the same wage, and others earn half as much as they used to for the same work. My preference would be to work toward independence from the US Federal Reserve and the US Military, whose monetary inflation and warmongering have enslaved 300 million Americans by destroying the currency and decimating manufacturing base respectively. (Decimate technically means kill every tenth person, but here let's call it sparing every tenth company.) The bipolar alternatives are inconceivable to a sleepy, distracted, materialistic, hedonistic, betrayed, unhealthy, heavily medicated, poorly educated, misinformed public: a fully free bond market backed by gold currency, and an industrial dedication to research & development of products outside of weaponry. Like my top10 ideas for a economic, financial, political solution, not a single item of which stands a chance of enactment, the bipolar path is an exercise in futility and a waste of breath.

So let's celebrate a Dependence Day and hope for a bolt of lightning to save the day from our leaders, who regard the Constitution as a mere piece of paper, who work in a hideous manner to conceal their path toward a totalitarian state, the first stop being the North American Alliance, with a new amero currency sure to set off massive unprecedented controversy and retaliation on an international scale. The teetering dependence is acute, the US needing oil from the Persian Gulf, Nigeria, and Venezuela, offset by Europe needing Russian oil & natural gas. The teetering dependence is acute, the US requiring $3 billion per day in foreign capital, a continuing stream from China, constant flows from the Persian Gulf. The bona fide trouble makers reside in WashingtonDC and a suburban Virginia enclave, causing a rumpus domestically and internationally. They have inflicted terror for a long time…

Double Edged Sword

The title of this article shows full respect for junk bonds. The derogatory label of 'Garbage Bubble Bonds' befits the mortgage bonds, which pale in value by comparison to the respectable tainted paper sold as junk bonds in high yielding securities by companies with a speckled past. Junk bonds do not deserve any insult, since they almost always offer true value behind the bond, just some laden risk and a higher rewarding bond yield for investment return. Mortgage bonds do not, having been born of a bubble intentionally and recklessly created by Greenspan for the unexpressed purpose of covering up his stock bubble bust in 2000. Why is this man revered?

For the last few years, a constant reminder has banged around inside my head, that the housing crisis & mortgage debacle represent a double edged sword, as the households lose valuable home equity while the mortgage bonds lose basic principal value. Kurt Richebächer stresses numerous times in our conversations, that for every homeowner suffering a loss is a bond holder suffering an equal loss. The $22 trillion housing sector is matched by a comparable but lower number of trillion$ in mortgages, perhaps half of which are secured in mortgage bonds. The $750 billion in subprime mortgage bonds is only the tip of the iceberg. Layer upon layer of other asset-backed bonds are in trouble, each with larger size, each with probably less loss, versus the previous layer of higher risk. The point of the double edged sword is that for every loser on the home equity property owner side, one can point to a loser on the mortgage bond investor side. The argument extends to distress, market troubles, and more.

Just as the mortgages have begun to reset to higher adjusted rates (an average of 1.8% to 2.2% higher), the mortgage bonds must next be reset to lower ratings than 'AAA' which stands as an insult to the intelligence of a warm bodied investor with a pulse. Value is not based upon assumptions in a flimsy model. The significantly higher monthly mortgage payments coincide with the massive mortgage bond valuation declines. Just as foreclosure auctions essentially go 'No Bid' with 90% of the home inventory to move, the mortgage bonds have gone 'No Bid' with those auctions in the public view. Bankers and lenders face a tough decision. Soon the cost of portfolio insurance will exceed the loss from their liquidation. Then mortgage bonds will be sold in droves. Correspondingly, soon it might dawn on millions of homeowners that their home equity might go negative. Then marginal property owners will sell their homes in droves. My forecast stands. This housing bear market will be the worst, without any semblance of doubt or dispute when it ends, since World War II and probably since the Great Depression. It will be denied every step of the way, as losses mount for homeowners and bond investors alike. The denial is intended to prevent a housing stampede and bond meltdown.

For years the homestead, the house property has been considered the ultimate inflation hedge asset. Sure, price inflation wrecked havoc in the USEconomy, but the nation of citizens had a home which was rising in value to offset the undermine from inflation. Now the leaders point to still substantial gains in home equity from the last six years when the housing bubble was erected. In two to three years, they will sing a different tune, since most of the gains from the entire six years, nearly $10 trillion in additional home equity, will evaporate. A strong claim. Just watch as it happens. Call me crazy, send me nasty emails, but not a single forecast of mine has been outlandish in hindsight. This devastation will unleash the extraordinary economic recession, the unending bond crisis, the USDollar global upheaval, and the political response. In a matter of several months to a couple years, a growing sense of chaos will take over the landscape. After chaos intensifies, a totalitarian state is a certainty. The cry will be for order, not growth or job preservation. The next painful phase will involve inflationary recession, not stagflation. The powers mismanaging matters of state and banks will hope for stagflation, and not see it except in this falsified statistics.

The USEconomy has already handed its manufacturing base to Asia. Banking officials and economic counselors have leaned upon the residential real estate as foundation for the entire consumption driven economy, against all sacrosanct wisdom in full heretical style. The price to pay will be economic decline, lost wages, a lower standard of living, and rising chaos. People will lose their homes and lose their jobs. People unfortunately will volunteer to forfeit their freedoms in order to maintain order. They will eventually beg for order when the suburbs are invaded. When? Something like by year 2010. What lies around the corner is the end of the United States of America as we know it. The objective of each citizen is to preserve wealth, even to profit from the predictable decline, decay, degeneration, which will affect every aspect of life. The homestead is officially under siege, as are banks. Remember that 40% of all bank assets are tied to mortgage portfolios or mortgage bonds. Japan went underwater for a decade, due to heavy real estate commitment and losses. Expect something similar with the United States…

With lower mortgage bond principal comes higher bond yield. With higher bond yield comes higher mortgage rates. With higher mortgage rates come lower home purchase demand. With lower demand comes lower home prices. The dominoes are falling in ultra-slow motion. With lower home values, less spending results. With lower home values come more decisions to sell properties. With more homes up for sale come an aggravation to inventory strain. With colossal bond damage, related bond and asset sales will ensue. The meltdown is underway. Bear Stearns lit the fire. Wall Street in its infinite stupidity, recklessness, and cliquish behavior endorsed the torching of their colleague's bond basements…

Coercion Next

…Without a doubt the USDollar is the weakest link, as numerous holes must be plugged to in the leaking dike. Gold and silver must be prevented from a zoom rise in price, since they serve as warning signals. Crude oil and natural gas must be prevented from a zoom rise in price, since they directly strain the USDollar. The long-term interest rates must be prevented from jumping higher. The stock market indexes must be prevented from falling sharply, since the public sees stocks as a visible signal of wealth. The USDollar must be prevented from a sudden freefall. The entire Wall Street and US Federal Reserve leadership is in the process of soiling their skivvies. The best investment might be in Depends Adult Diapers. These guys, leverage mechanics in financial engineering, destroyers of economies, snake oil salesmen of cancer ridden asset bonds, they are sweating bullets, pooping their pants, staring into space, stunned by failed auctions and uncertain valuation, wondering about leverage implications and debts called by creditors. These are no longer exaggerations written in tabloids, but rather front page news items.

…The weakest link in the above list of assets to protect is the USDollar. The untold story is that the strain on credit derivatives has put tremendous pressure on the USDollar, which cannot hold. The sale and liquidation of countless billion$ in credit derivatives will deliver a series of unending blows to the USDollar, sure to crack before long. With $120 trillion in notional value for credit derivatives, figure with 30:1 leverage that $4 trillion in original equity tied to margin investment is involved. The FOREX markets (foreign exchange for currency trades) involves between $1 trillion and $1.5 trillion in daily volume, less on holidays and more during crises. We have a crisis building. The USDollar in my view cannot be defended in the face of a credit derivative crisis. Look for coercion next, in the form of threats to those wishing to liquidate vast tranches of bonds. To expect no interweaving of military activity with the coercion would be naïve. It is a certainty. It has past precedent…

Crude Oil As Canary

In the face of a weak link USDollar, a fast eroding Petro-Dollar defacto standard enforced by Persian Gulf principal players, one should expect the crude oil price to hurtle higher. It is doing precisely that. Blame had been put on the Nigerian situation, but that is but a false facade and distorted assessment intentionally given. The links have always been firm between the USDollar and crude oil. The alchemists cannot control them, while at the same time keep their controls in place on the vast price capping required throughout the Western bond world on long-term interest rates…

Gold Awaits

In time, the push upward in crude oil price will be matched by a push upward in the gold price. The two are strongly correlated. A systemic bonfire has been lit, the effects of which will undermine the confidence in the US banking system, the US bond arena, and the USDollar itself. To date, the authorities have succeeded in tossing a wet blanket over the gold market. See the monumental official gold bullion sales out of Europe. But they cannot break gold, which has been successfully defended at the $650 mark. In time, analyses will surface that the entire US banking system is at risk, possibly to repeat the Japanese 1990 decade outcome.

According to Gary Dorsch, policy makers engineered the rise in stock prices in order to cushion the effect of the housing collapse. The problem is, that stocks will most likely not emerge unharmed from a real housing crash.

Global Exodus from the US Dollar in Motion

By Gary Dorsch, Editor, Global Money Trends newsletter

Trading in the arcane world of foreign exchange is often akin to judging a reverse beauty contest. The trick to profitable trading is to pick the least ugly currency. Nearly all fiat or paper currencies are ugly, because the 18 of the world’s top-20 central banks are inflating the money supply at double digit rates. At the moment, the world’s two ugliest currencies are the Japanese yen and the US dollar.

The Bank of Japan pegs its overnight loan rate at just 0.50%, in a brazen effort to devalue the yen, to boost exports abroad, and prevent an abrupt unwinding of the mushrooming “yen carry” trade. Meanwhile the Federal Reserve is inflating its M3 money supply at a 13.7% annualized clip, according to private economists, which if correct, would be the fastest rate of expansion in more than 30-years.

US Treasury chief Henry Paulson, and former chairman of Goldman Sachs, “monitors the financial markets closely,” and has reinvigorated the infamous “Plunge Protection Team,” which comes to the rescue of the US stock market whenever nasty revelations come to the surface. At the moment, Paulson’s grand strategy is to offset losses in the US housing sector with big gains in the stock market, to prevent the US economy from sliding into recession.

A key player in the “Plunge Protection Team” (PPT) is none other than Federal Reserve chief Ben “helicopter” Bernanke. Since the Bernanke Fed discontinued the decades-old reporting of the broad M3 money supply in March of 2006, the growth rate of M3 has accelerated from an 8% rate to a sizzling 13.7% clip, its fastest in more than three decades. The Bernanke Fed is preventing borrowing rates from rising at a time of explosive loan demand for US corporate mergers and takeovers, by rapidly increasing the US money supply.

The Bank of America, Citigroup, and JP Morgan led US loan underwriting in the first half of 2007, which totaled $943 billion, up 5.4% from a year earlier. Global mergers and takeovers soared to an astronomical $2.78 trillion during the first six months of the year, up 51% from a year ago, led by $1.05 trillion in the US alone. Buy-outs by private takeover artists soared 23% to a record high of $568 billion in H’1 2007, with 35% of US takeovers, and 13% of European takeovers financed with debt.

But one sector of the US stock market which has not responded positively to the Fed’s heavy injections of monetary steroids has been the home builders, once regarded as a top bull-market leader from 2003 thru August 2005. The Dow Jones Home Construction Index, a yardstick that measures home builder performance, is off 25% this year, and is flirting with key support at the 525 level, which if penetrated, would be especially bearish.

On July 2nd, Paulson sent a discreet signal to Wall Street power-brokers to avoid dumping the home builders. “In terms of housing, it’s had a significant impact on the economy. No one is forecasting when, with any degree of clarity, that the upturn in housing is going to come, other than it’s at or near the bottom.

The Fed has obscured its money printing operations by discontinuing the reporting of M3, in order to limit the damage to the fixed income markets. But word of the explosive growth of the M3 money supply is slowly leaking out, and taking its toll on the US Treasury Note market, which briefly tumbled to its lowest level in five years in June, lifting 10-year yields as high as 5.30%, before receding back to 5.00%, on a “flight to safety” from the riskiest of the sub-prime home loan market.

Because the US credit markets are swimming in a tidal wave of rising liquidity, there will always be bargain hunters who are happy to park excess cash into the bond market whenever yields surge higher. Asian central banks and Arab Oil kingdoms in particular, have been big buyers of US T-bonds over the past four years, and hold roughly $1.3 trillion of the IOU’s, but even this massive intervention couldn’t turn the tide of the four-year bear market.

But now there are indications that China’s insatiable appetite for US T-bonds is waning. Beijing was a net seller of $5.8 billion of US T-bonds in April, the first drop in Chinese holdings since October 2005, and sparking the recent slide that lifted 10-year yields by 70 basis points, at its high mark. Since Beijing unhinged the dollar from a fixed peg of 8.27 yuan in July 2005, the value of the US 10-year T-note, when converted into yuan, has declined by 15 percent. Earlier today, the dollar slipped to 7.59 yuan, or 8.9% lower since the yuan was freed from the dollar peg…

Bank of England – Pioneer of “Asset Targeting”

Just about every major central bank has a big credibility problem, when it comes to maintaining the purchasing power of its currency. The Bank of England, for instance, has tolerated double-digit growth of its M4 money supply for the past two years. The BoE is the “Group of Seven’s” original pioneer in “asset targeting,” or guiding the stock and real estate markets to higher levels, by injecting excess liquidity into the markets, until asset prices reach the bank’s targeted levels.

The BoE has guided the Footsie-100 from a low of 3,500 in Q’1 of 2003, to a 7-year high above 6,600 this month. But the BoE’s monetary abuse that has taken place over the past few years, is taking its toll on the British debt markets, where the benchmark 10-year gilt fell to a 7-year low in June, lifting its yield to as high as 5.55%, before bargain hunters came out of the woodwork.

“Investors are likely to take advantage of this ample liquidity and the associated easy credit to purchase other assets, driving risk premia down and asset prices up," the BoE said in a February 20th, report for parliament’s Treasury Committee. “In due course, those higher asset prices may be expected to feed through into higher demand for goods and prices, putting upward pressure on the general price level.”

In a speech to mark the tenth anniversary of the central bank’s independence, BoE chief Mervyn King said on May 2nd, “It is unfortunate, if monetary developments are given insufficient attention in the analysis of the inflation outlook. The growth of money and credit may signal in advance of other indicators that the Bank rate is set at a level inconsistent with bringing inflation back to the target in the medium term.

The BoE is well aware of the inflationary consequences of double-digit money supply growth, and London futures markets are pricing in two BoE rate hikes to 6% in the days and months ahead. But the BoE must still overcome stiff political opposition to higher borrowing costs, namely from newly installed prime-minister Gordon Brown. “Rigid monetary rules that assume a fixed relationship between money and inflation do not produce reliable targets or policy,” Brown argued on June 14th.

Such reckless comments by Mr Brown, are reminiscent of his decision to sell off more than half of the UK’s centuries-old gold reserves in May 1999. The decision to sell 400 tons of gold is seen in City circles as a financial bungle on the scale of the Tories’ “Black Wednesday” that cost the taxpayer 3.3 billion pounds. Brown offloaded the gold at a 20-year low in 17-auctions between $256 and $296 /oz, with an average of $275 /oz. Since then gold has risen sharply and stands around $650 /oz.

…Mitigating some of the pressure for sharply higher BoE rates however, is the strength of the British pound, which climbed above the psychological $2 mark last week, for only the second time since 1980. The British pound is being driven higher by widening interest rate differentials moving in its favor, with the Federal Reserve handcuffed by a weakening housing market and a sub-prime loan debacle.

Both the British pound and US dollar are heavily inflated currencies. Both offer large external trade deficits and big budget deficits. While the Fed is inflating its M3 money supply at a 13.7% clip, the Bank of England is inflating its M4 at a 13.9% annualized clip. But the US economy is roughly six times the size of England’s, so in absolute terms, the increase in supply of US dollars is much larger. And with the BoE expected to lift its lending rates to 75 basis points above the US$ rate, the pound is winning this “reverse beauty” contest…

One piece of good news about the lower dollar and lower wages for U.S. workers is that the U.S. is starting to look like a lower cost manufacturing alternative:

VW mulls N. America plant due to dollar weakness

July 7, 2007

FRANKFURT (Reuters) - Volkswagen, the world's fourth-largest carmaker, is considering building a new North American factory if the dollar stays weak, Chief Executive Martin Winterkorn said in an interview with German magazine Focus.

"If the dollar stays at its current level, one has to consider a factory in North America very seriously," Winterkorn said, according to a preview of the interview released on Saturday.

The euro is near an all-time high against the U.S. dollar and Japanese yen, making it harder for European-made cars to compete with those produced in the United States and Japan and causing concern among some euro-zone politicians.

Volkswagen has only one factory in North America currently, in Puebla, Mexico, which manufactures its Jetta and New Beetle cars as well as buses and trucks.

Winterkorn said Volkswagen had not done very well in the United States up to now, and hoped planned new offices away from Detroit, the centre of U.S. auto manufacturing, would bring it closer to U.S. consumers.

Winterkorn also forecast that Volkswagen would produce more than 6 million cars this year, up from 5.7 million in 2006. A goal of 10 percent higher productivity was attainable this year, he added.

The bad news is, with all currencies falling against energy prices, the price of food is rising. Energy is a large input in each step of the food production and distribution process. To make matters worse, more and more food growing acerage is devoted to ethanol production to run cars.

Nestlé chief fears food price inflation

Geoff Dyer

July 5 2007

Food prices are set for a period of “significant and long-lasting” inflation because of demand from China and India and the use of crops for biofuels, according to the head of Nestlé .

Peter Brabeck, chairman of the world’s largest food company, said rises in food prices reflected not only temporary factors but also long-term and structural changes in supply and demand.

“They will have a long-lasting impact on food prices,” he told the Financial Times during a visit to China.

Several food companies have warned about the short-term outlook for prices, but Mr Brabeck’s comments are among the starkest warnings that a long period of rising food prices could stoke broader inflationary pressures.

Mr Brabeck said Nestlé had first forecast higher food prices two years ago and price pressure had become apparent last year.

Corn prices have risen about 60 per cent and wheat about 50 per cent over the last 12 months. Sugar, milk and cocoa prices have also surged, prompting the biggest increase in retail food prices in three decades in some countries.

The Nestlé chairman cited population growth, rising demand from “the phenomena of India and China” and the use of food products by biofuel producers as causes of pressure in international food markets.

Reports from two international organisations this week forecast food price rises of between 20 and 50 per cent over the next decade.

But some analysts believe the long-term risk of higher food prices is exaggerated. Julian Jessop, chief international economist at Capital Economics in London, said biofuels producers would develop technologies that required less raw material or used non-edible parts of food.

“There are good medium-term reasons to think that the biofuels price shock will pass,” he said.

In the United States, the past sixty years has seen low food prices, rising real estate prices, and low import costs (due to a strong dollar). All that seems to be on the verge of a sharp reversal. There are still people alive in the United States who remember the Great Depression, but they are getting fewer with each passing year. The result is that the United States has reached a peak of what Andrew Lobaczewski calls the “hysteroidal cycle.”

During good times, people progressively lose sight of the need for profound reflection, introspection, knowledge of others, and an understanding of life’s complicated laws. Is it worth pondering the properties of human nature and man’s flawed personality, whether one’s own or someone else’s? Can we understand the creative meaning of suffering we have not undergone ourselves, instead of taking the easy way out and blaming the victim? Any excess mental effort seems like pointless labor if life’s joys appear to be available for the taking. A clever, liberal, and merry individual is a good sport; a more farsighted person predicting dire results becomes a wet-blanket killjoy.

…During “good” times, the search for truth becomes uncomfortable because it reveals inconvenient facts. It is better to think about easier and more pleasant things. Unconscious elimination of data which are, or appear to be, inexpedient gradually turns into a habit, and then becomes a custom accepted by society at large.

…Such contented periods for one group of people—often rooted in some injustice to other people or nations—start to strangle the capacity for individual and social consciousness; subconscious factors take over a decisive role in life… Catastrophe waits in the wings. In such times, the capacity for logical and disciplined thought, born of necessity during difficult times, begins to fade. When communities lose the capacity for psychological reason and moral criticism, the processes of the generation of evil are intensified at every social scale, whether individual or macrosocial, until everything reverts to “bad” times. (Andrew Lobaczewski, Political Ponerology, 1st ed., p. 85-6)

That explains a lot about recent history in the United States, not least how a small group of plotters could have assassinated and blackmailed their way into power in the United States with surprisingly little resistance. (It also explains why the U.S. infuriates so many like a privileged child acting foolishly.) As Dr. Lobaczewski said, this takes place at all levels. With this in mind, the following description of mortgage lending in recent years takes on deeper significance:

Why A Changing Lending and Borrowing Ethos Led to the Housing Bubble

Thomas Au

July 6, 2007

Why did house prices go berserk in the past decade? Did American homeowners develop a greater taste for housing, relative to other consumption goods? Was it because of globalization or other macroeconomic factors? Was it a rising ownership culture? Each of these factors played a part, but the main answer appears to be changing behavior of lenders. That’s because it seems that borrowers will borrow as much (for the reasons discussed earlier) as lenders will lend them. This took the form of low (or no) down, low (or no) “doc” loans. In essence, lenders said to subprime borrowers, “Just sign on the dotted line, your credit’s good. If there’s a problem, we’ll just repossess your house and come out whole.”

Why would borrowers do this? Most of them aren’t that financially sophisticated, and therefore mainly rely on the lender for guidance. They don’t typically say, I can afford a house worth X, will you give me a loan for X (or X minus my down payment of Y). More often, they go to lenders and say, here is my income, this is what I can pay a monthly basis, can I afford to buy such and such a house? And they will take the lender’s word for it without making an independent judgment. This seems to extend to all segments of society (present company aside): I’ve spoken with high-paid (non-financial) professionals who weren’t sure what compound interest is.

As a beginning homeowner two decades ago, I tried to avoid this trap, refusing to buy a condo that would have cost almost three times my income (then considered the limit of prudence) in favor of one that cost only half as much, or just over one and a half times income. (Condos and coops have maintenance charges tied to underlying mortgages that effectively raise their true cost.) The cheaper unit was also better sized to my down payment, which thus represented 20%, rather than 10% of the cost. But I (and other thestreet.com subscribers and contributors) am vastly atypical of the general population.

The truth of the matter is that many investors are fairly sophisticated about stocks, but not about bonds. The reason is that stocks can be analyzed as a combination of a bond and a call option. Investors are sensitive to the “optionality” properties of stocks, but not to the fixed income characteristics. Their mentality is “you pay your money and you take your chances” (Punch, 1846). At some level, many investors believe that mortgage writers are “paying their money and taking their chances.” But that’s not how mortgages (or other forms of debt) are supposed to work. Yet lenders recently seemed (by their actions) to ignore this fact, and also encourage borrowers in this regard.

Time was, when a banker’s first responsibility was to protect against loss, because the returns offered by interest would not be enough to compensate for principal loss. If there was any real doubt about the borrower’s creditworthiness, the loan was not made. Over the past few decades, however, the emphasis has shifted to “selling” loans (even though the process is more like bond-buying.) Under this ethos, if there was any doubt about the matter, the loan was made. Only the certifiably insolvent were denied credit. In fact, lenders bent over backwards to “qualify” borrowers who were otherwise unqualified: “To make it possible for you to take out this loan, we’ll give you a two year ‘teaser’ rate that’s much lower than the market rate, thereby putting your monthly payments just within acceptable limits.” The problem was that the loan was affordable only during the “teaser” period, and not over its whole life.

Such adjustable rate mortgages (ARMs) were particularly prevalent in the past five years, and many of them are “re-setting” as we speak. Using index numbers, the rate of ARM resets came into 2007 at about 20, rose to 40 or so in the first half, will climb to around 60 in the second half of this year, and will peak at 100 in the first quarter of 2008. So we won’t know until the middle of next year (one year hence) what the default rate of the peak number of ARM loans will be.

The reason these lending practices occurred was that “slicing and dicing” of mortgages separated the origination (selling), underwriting (credit analysis) and insurance (investment) functions. Mortgage brokers are not bankers, they are loan sales outlets. The “bankers” that fund these loans are in many cases not really performing this function; they are then merely assemblers and packagers of loans for resale to large investors such as hedge funds, which are now essentially writing insurance. This last function used to be performed by private mortgage insurers who actually performed underwriting functions; hedge funds usually don’t. In essence, no one is now taking responsibility for the whole process, so problems can be blamed on someone else in the food chain…

According to Lobaczewski, once the process has gone too far, the only way out is the hard-won wisdom of truly difficult times. Europe experienced the hysteroidal peak a hundred years ago. Much suffering ocurred on that continent for fifty years to burn away the folly. Given what Lobaczewski says about the unconscious elimination and substitution of data, it is not surprising that the United States has refused to learn from the wisdom of the Europeans. Laissez-faire capitalism and preemtive wars: who cares about consequences, about realistic cause and effect? Things will be as we want them to be because we are special and we are powerful!

Then,

When bad times arrive and people are overwhelmed by an excess of evil, they must gather all their physical and mental strength to fight for existence and protect human reason. The search for some way out of the difficulties and dangers rekindles long-buried powers of discretion…

Slowly and laboriously, however, they discover the advantages conferred by mental effort; improved understanding of the psychological situation in particular, better differentiation of human characters and personalities, and, finally, comprehension of one’s adversaries. During such times, virtues which former generations relegated to literary motifs regain their real and useful substance and become prized for their value. A wise person capable of furnishing sound advice is highly respected. (Political Ponerology, p. 88)