And They Said it Wouldn't Spread...

Five articles of subprime spread.

The first: Subprime May Be Hitting Credit Cards, Too:

"Fallout from the mortgage mess and lower home prices may have started to creep into the credit card arena, judging from July payments and some initial moves by issuers to tighten the screws on cardholders."

The second: Mortgage Woes to Hurt Auto Sales:

"The ongoing slump in new-home sales and turmoil in the subprime mortgage industry will continue to hurt U.S. sales of light vehicles for the rest of the year and into 2008, according to an automotive market forecasting firm."

The third: Asian currencies led by rupiah dip as subprime losses spread:

"Asian currencies dropped yesterday on speculation global funds are exiting emerging-market assets as losses linked to US subprime mortgages spread."

The fourth: Layoffs Grow in Mortgage Industry:

"Brian Jurvis of Hazel Park wasn't surprised when he was laid off late last week from Countrywide Financial Corp.'s subprime lending division."

"Jurvis joined more than 25,000 workers nationwide who have lost jobs in the financial services industry since the beginning of the month -- more than half of them eliminated since Friday."

The fifth: Subprime pain spreads into office market:

"As business volume plunges for real estate firms hurt by the housing slump, they and companies that service them are abandoning office space and leaving landlords and surrounding communities suffering".

So far subprime problems have affected five other sectors or markets: consumer credit, auto industry, Asian markets, labor market, and commercial real estate.

Where else will this colossal problem rear its ugly head? Time will tell, but one thing is certain: the bubble is yet to burst. From Finance Markets.co.uk:

"In a recent CNN interview, Nouriel Roubini pointed out that current Federal Reserve estimates of the problem may be extraordinarily undervalued at $100 billion."

"Instead, he points out that minority equity is bundled with debt, which is then leveraged against further higher debts, which can in themselves then be set up as collateral against even yet higher debts."

"Any loss of value on the original equity value - ie, sub prime mortgages - leaves only debt sustaining debt - a house of cards that we are only beginning to see unravel."

Holy Deadly Debt, Batman! Does that mean we're in trouble??

The Bears are Breaking the Banks

Forbes.com has a great article on the bears ruling banking stocks. Tom Van Riper makes some very sound arguments for that reasoning:

"Investors in major U.S. brokerage stocks haven't seen the last of the sell-off. Not with bank funding for merger deals slowing as credit gets more expensive. Wider spreads in the junk bond market, where so many deals are done, mean the costs of issuing securities are higher, as are the risks for doing so."

I cannot disagree with logic. And for just these same reasons, I'm waiting to see what happens before taking my profits. When Goldman Sachs fell below $200, I was tempted to cash out. Of course, I did not. And when Goldman Sachs broke through the $200 dollar mark last week, I was regretful. I waited and saw GS lose even more value. For that reason, I'm holding off on covering my short. I think we've got a ways to go before banking stocks begin a recovery. Mortgage rate resets have yet to reach a peak, while overall business credit is trending tighter and tighter. The Chrysler deal is a great example. With every new story coming out of the financial main stream media, psychological factors will push banking stocks lower. And if Hank Paulson has his way, the federal deficit will crowd private investment even more, but that's for a different post.

Of course there are some people who will disagree with me. Here, James Altucher of The Street wonders why Goldman Sachs is so cheap. He even goes so far as to say that the company might be subject to a private buyout. Here, Mr. Altucher continues his faulty reasoning by indicating that investors should buy Goldman Sachs, as well as JP Morgan, and Citigroup, all of which I've indicated at sell or short sell status. At least James didn't try and convince investors to buy Bear Stearns. Ha!

I may be wrong about this next point, and if that's the case, then call me out. I think the credit cycle is at least as easy to predict as the housing market. Why is this? Because the credit (ie: banking) industry moves at a pace that is similar to the housing market. Complete cycles in both sectors take years to complete. As soon as one realizes that the credit cycle downturn is beginning, a savvy investor would take bank stock shares from Mr. Altucher's account and sell them short. When the credit cycle peaks as high as it has this last go around, the drop should act in symmetry. What does this mean? Big money for "danger-seeking" investors who know how to play the game.

Dow(n) Drops Another 200

Stocks took another deep hit today as the Dow dropped another 200 points. Amazingly, the bulls decided that a better than expected GDP growth report wasn't enough to quell the risky fundamentals. From Yahoo:

Wall Street extended its steep decline Friday, propelling the Dow Jones industrials down more than 500 points over two days after investors gave in to mounting concerns that borrowing costs would climb for both companies and homeowners. It was the Dow's worst week in nearly five years.

The credit squeeze is on. Investors are facing the hard fact that homeowners and businesses alike are seeing a tightening lending trend. For months, investors ignored the fact that the mortgage rate reset was going to get worse and worse this year. The reset chart has been available on the internet since the beginning of the year. It wasn't hard to find with Google. And there have been news reports warning of the looming problem. On July 10th, there was an article on CNN Money warning that October of 2007 was to be a record month.

Despite that the Dow surged up to 14,000. Psychology was trumping fundamentals. Now, the tide has turned.

A Bad Omen: Subprime Defaults Drop the "Sub"

It's not just a subprime problem anymore. Countrywide has reported that mortgage defaults are now starting to affect quality borrowers:

"The subprime mortgage meltdown has begun to spread to prime loans as even credit-worthy borrowers have started to fall behind on payments."

"'Unable to afford their own homes, [borrowers] turned to increasingly risky mortgage products,' said Amy Klobuchar, a member of the House of Representatives from Minnesota, speaking Wednesday before a hearing of the Joint Economic Committee examining the national foreclosure crisis."

"Some home buyers, caught up in red-hot markets and afraid of getting locked out of homeownership forever, overpaid for houses."

Home prices rose so high in the early part of this decade, that most people couldn't afford a traditional 30 year mortgage. Well, I guess they couldn't really afford non-traditional mortgages either.

The inability to live within your means and to recognize the limits of your means is going to make a relatively small problem (subprime defaults), a very big problem. This is the kind of widespread problem that could wipe out the middle class in this country: going into a loan based on highly inflated property values that then begin to deflate. As mortgage rates reset, more and more families will find themselves upside down in terms of property values versus loan balance. That will not be easy for the economy to iron out.

But wait, there's more:

"Analysts said the trend could continue, particularly in areas of the country that have been hardest hit by job losses in general or seen a decline in speculation-driven construction, such as South Florida, parts of California and Las Vegas."

Job loss? Rising mortgage payments? Rising energy costs? Rising food costs? This doesn't sound very good, considering consumerism accounts for over two-thirds of our economy.

S&P, Moody's to Downgrade Subprime Securities - World Stocks Falter

Well, it's about time. How long has it been since we've known about the risks? Months and months. Finally, the two credit ratings organizations are coming around:

"Credit ratings on 612 classes of residential mortgage-backed securities backed by U.S. subprime collateral have been put on CreditWatch with negative implications, S&P said. Beginning in the next few days, the agency said most of these classes will be downgraded."

"That covers about $12.078 billion in rated securities, or 2.13% of the $565.3 billion in U.S. RMBS rated by S&P between the fourth quarter of 2005 and the fourth quarter of 2006, the agency noted."

Meanwhile, in a related story:

"Moody's cut ratings on 399 subprime residential mortgage-backed securities, or RMBS, and said that it may downgrade another 32 because of higher than expected delinquencies on the underlying home loans."

I don't know how many more securities there are that are at risk, but I would bet there are more. Any literate investor should have known for weeks of the great risk associated with subprime mortgage securities; the looming interest rate reset will be devastating. Here's the simple picture:

"A lot of debt will be downgraded to junk status. A lot of that debt will have to be sold at fire-sale prices. A lot of pension funds and hedge funds that once thrived on the high returns they could get from investing in subprime junk will now lose a lot of money."

"S&P's announcement is a death warrant for the subprime industry. No longer will mortgage brokers be able to help buyers lie their way into a home. Fewer stressed homeowners will be able to refinance their mortgage, thus extending and exacerbating the housing bust."

Unwinding this tangled mess is taking time; along the way, it will affect more than just the mortgage industry. Of course it has already hurt the homebuild sector. Higher foreclosure rates have contributed to a rising supply of homes; also, looser loans standards helped fuel a housing boom which assisted in creating future projections that were grossly inflated.
And the subprime mortgage fiasco has not and will not be kind to the banking industry. Depending on who's holding what, investors could be rewarded greatly for making the right bets.

Another sector that could feel the hurt is retail. Fewer homeowners refinancing mean less being spent at home depot or at the mall. We've already seen home depot's hurt. Bed Bath and Beyond has also lowered it's expectations in the last few weeks. The housing downturn might be blamed as the number one reason, but subprime is not far behind. And as the noose tightens around lending standards, the infusion of cash that has helped fuel earnings in retail will evaporate.

Today, just one day after flirting with a record close, the Dow faltered by more nearly 150 points. Following the Dow decline, Asian markets followed suit. Something will act as the catalyst initiating a world-wide economic slowdown. It could be subprime, it could be something else. All that needs to happen is for a spark to start the wheel spinning. The next couple weeks should give us a decisive answer.

The US Economy - Speed Bumps and Corn Fields

As far as financial main stream websites go, Bloomberg wins the prize for keeping it real:

"The U.S. economy's take-off from a near standstill in the first quarter may prove bumpier than the Federal Reserve and many on Wall Street expect as tighter credit acts as a headwind to growth."

"...economists at International Strategy & Investment Group, UBS AG and Commerzbank AG see growth below 2 percent as consumer spending slows and business investment fails to pick up under the weight of tougher financing conditions."

"So far, economists with a gloomy outlook are in the minority. If they are correct, stock-market investors are in for a disappointment."

Remember that all-important investing rule-of-thumb: Don't follow the herd? Investing against the grain takes courage and discipline, but it gets easier when the facts are staring you in the face. For example, the FED recently reported that consumer credit (ie: credit cards, auto loans, etc.) increased at an annual rate of 6.4 percent in the month of May. From Yahoo:

"Consumer borrowing posted a hefty increase in May, reflecting the biggest jump in credit card debt in six months. The Federal Reserve reported Monday that consumer credit rose at an annual rate of 6.4 percent in May, far above the small 1.1 percent gain of April."

The cash in the home ATM has been running out. Thus, consumers are substituting credit cards to feed their materialistic urges. Or perhaps it's food itself. The cost of eating has been growing in a subtle way. Higher prices in meats and dairy seem to be gradual enough for us not to get alarmed. Perhaps no more. This, from the Bureau of Labor Statistics:

"Through the first five months of 2007, beef prices have risen 5.1 percent, poultry prices, 4.3 percent, and pork prices, 3.4 percent. The index for fruits and vegetables, which rose 0.4 percent in April, declined 0.5 percent in May. (Prior to seasonal adjustment, prices for fruits and vegetables rose 1.0 percent.) The indexes for fresh vegetables and for processed fruits and vegetables declined 1.8 and 0.3 percent, respectively, while the index for fresh fruits increased 0.7 percent. The index for dairy products increase 0.5 percent as a 2.2 percent increase in milk prices more than offset a 0.4 percent decline in prices for cheese."

Through the first five months of the year, we've seen a dramatic increase in the cost of meat and milk, two staples of most American meals. And there's no indication that this trend will reverse. When populations are forced to spend more for items of necessity, they either: (a) borrow more, or (b) consume less. Eventually, the 'borrow more' option dries up as credit lines are maxed out, forcing consumers to 'consume less'. And when that happens, earnings (and Wall Street) will take a hit. For the last eight to ten years, our economy has been driven by credit expansion. It cannot, nor will not, continue in perpetuity.

Gold Funds, Mining Stocks

Gold is getting primed to take a shot up. To cash in, I suggest these ETFs: iShares Comex Gold Trust (IAU) and Streettracks Gold Trust (GLD). The former ended trading today at $65.10 while the latter ended trading at $65.02. I also recommend two mining companies: Newmont Mining Corp (NEM) and Barrick Gold Corp (ABX). The former ended trading today at $39.89 while the latter ended trading at $29.79.

This graph displays the three measures of the money supply:


You'll notice that M1 and M2 extend further out than M3. (Definitions of the components of the money supply can be found here.) The government claimed in 2006 that M3 didn't produce enough useful information to justify the cost of tracking it. You can see where it was heading - up up up. The textbook definition of inflation is an increase in the supply of money. An increase in the money supply causes prices to increase. Since the beginning of the NASDAQ bubble, the money supply has taken off. Major contributing factors include low interest rates, relaxed mortgage lending standards, and major expansions in revolving credit. With every loan made, the money supply expands causing inflation. Inflation is WONDERFUL for gold, gold funds, and mining stocks, thus my recommendations.

Are You Saving Too Much??

Are you saving too much? That is the stupidest question I've heard in a long time. And this is coming from the 'personal finance' department at Yahoo (via Fortune). Americans have had a negative personal savings rate since April of 2005. Why else would there be a credit bubble?
These articles certainly don't help; they only feed into the consumerist ideals that have driven the economy for the better half of two decades. Contrast that headline to this one: Retire at 40: Here's How. This article is much more worth your while:

"If you were to take 20% of your annual income starting at age 20 and put it in a fund following the S&P 500 Index ($INX), that fund continued to grow at the long-term historical rate (12%) and you received a 4% raise each year, you could walk away from your job and live off the interest at age 41 matching your current salary -- or quit at 43 and be able to give yourself a 4% "raise" each year from the interest, which is probably the better plan because it combats inflation."

One article teaches you how to be poor, while the other article teaches you how to be rich. It's your choice.

Credit Check...

Total consumer credit outstanding has increased by 57 percent since 2000. Contained in that is revolving credit debt (ie: credit cards), which has increased 44.5 percent since 2000. Mortgage debt has increased 105 percent since 2000.
Going further back, we can see that total credit has increased 205 percent since 1990. Revolving credit debt has increased 315 percent over the same period of time. Finally, mortgage debt has increased 294 percent since 1990.
There have been articles questioning the effect that consumer credit may have on the economy since 2004. The bubble hasn't burst yet, but it's coming due. But how did we get here? Two rulings helped the credit card companies: 1978's Marquette National Bank v. First of Omaha Corp and 1996's Smiley v. Citibank.
In 1978, the Supreme Court ruled that credit card companies could charge interest rates based on the state laws where the companies were located. The laws where cardholders lived were circumvented. And guess what - the companies that issued the cards moved to Delaware and South Dakota and any other state willing to deregulate interest rates. Then, in 1996, the Supreme Court took it a step further and ruled that credit card companies could charge any fees that were allowable by the state law in which they were headquartered.
These two rulings completely deregulated the credit card industry and, when coupled with more stringent bankruptcy rules (implemented in 2005), are helping to usher in a new era of serfdom. Stay out of the pocket of the credit card companies or surrender as a virtual slave.