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Posts Tagged ‘foreclosure crisis’

Economists debate whether or not we are going to fall into the dreaded “double dip” recession.  This occurs when you go through a recession, start a period of recovery, and then fall back into a recession again. 

Let’s look at the basics.  You have a Government that has spent 100’s of billions of dollars to stimulate the economy and yet we have very little to show for it and we still have a large unemployment problem.  Oh pardon the mistake –the politicians have a lot to show for it as they have been able to use our tax money to pay back favors. 

The realization is two fold.  First government spending isn’t going to be the solution to our economic problems.  If you want companies to start hiring, then build confidence back that the Obama Administration and the rest of the politicians are not going to destroy this country by turning us completely into a socialistic country.  You do that by passing legislation and using resources to help the small business owner.  Unfortunately, the opposite is happening.

Second, we are going to be hard pressed to recover without the participation of the consumer.  The consumer is not confident and for good reasons. 

  • We are well into this so called recovery and the unemployment problem is bad as it possibly could be.  That will continue to keep consumers in a less than confident state of mind. 
  • Confidence in spending money is also tied to the stock market.  If the stock market has begun a bear market, consumer confidence will fall off the cliff. 

Then there is the foreclosure crisis, the state of emergency in the Gulf, and the list goes on.   There isn’t much to be confident about in this environment.  So, it shouldn’t be a big surprise that Friday’s consumer spending fell off the cliff (comparatively speaking) when you look at how the above have performed recently. 

So, it really surprises me when economists are so bubbly about things.  The Wall Street Journal had this to say in their weekend edition.

“The surprisingly poor sales cast fresh doubt in consumer spending that had allowed economists to raise their forecasts for US growth this year despite a moribund housing market, a dismal job market, and tepid business investment.”

So economists really thought that the consumer facing the prospects of losing their home and their job or the consumer who is not employed or underemployed gave economists enough confidence to raise forecasts?  

The bottom line is that we are going to be extremely lucky to escape a double dip recession.  I think that the question on economists’ mind shouldn’t be whether we face it but how deep this one is going to be.

The probabilities are high that the decline that started in April in the stock market will start to resume again in short order.

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If I were a banker, I would dread Friday’s.  It is the day of the week that the federal regulators walk in and shut banks down.  This past Friday there were 4 more banks in Texas, California, Illinois, and Florida bringing the total bank closures for 2010 up to 20.  This is on the heals of 140 being closed in 2009, 25 in 2008, and 3 in 2007.

The troubling part of this whole process is that last year banks were able to push the problems aside as the Government allowed them in short to hide these bad loans on their books through an accounting adjustment.  In other words, all of those toxic bank killing loans are on the books and have not been dealt with. 

It gets better.  The FDIC gets to pick up the tab each week through the FDIC insurance fund.  Currently, the fund has $21 billion left.  They estimate $100 billion of losses will have to be covered over the next 3 years.  Oh, don’t worry – they have a credit line that can be tapped up to $500 billion dollars through the Treasury. 

Don’t forget, a massive foreclosure problem still lingers as we start a huge wave of adjustable rate mortgages re-setting over the next 3 years.  In 2009, we were in the calm of the storm as the first wave of adjustable rate mortgages which were sub-prime based were finishing up with their adjustments.  This next wave which represents Alt-A and Prime mortgages is much bigger.  In addition, the fun is just getting started in the commercial space where corporations are having to refinance debt on commercial properties and are having no luck because no one is lending money. 

John Mauldin writes this week in his www.frontlinethoughts.com newsletter “Bank loans are being written off at staggering rates. Over 700 banks (I think that is the figure I saw) are officially on watch by the FDIC, with more banks being closed each week.  There is at least $300-400 billion in losses on commercial real estate waiting to be written down. Housing foreclosures are rising and hundreds of billions have yet to be written off.”

He goes on to write that in January, “Foreclosures rang up at 4300 and Notice-of-Defaults at 5100 per day nationally.”

Think through with me what this could look like.  This last Friday’s 4 bank closures cost the FDIC approximately $1 billion.  That’s an average of $250 million per bank.  If we continue at this pace, we could be looking at 100 more bank closures this year.  That could be as much as $25 billion.  That would deplete all of the FDIC money and force the FDIC to borrow from the Treasury before year end. 

This can’t have a happy ending. 

This week the Sovereign Debt Problem will be front and center as Greece attempts to borrow money through a bond offering.  As I wrote last week, this could be a real problem in the event that Greece defaults.  Also this week we have the unemployment numbers that will be released.  It is a critical number each month.  Watch the risk!

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We have had all types of bubbles in the history of the investment markets.  According to Jeremy Grantham, there have been 28 different types of bubbles from gold to art to real estate to stocks and even tulips.  Yes, there was an enormous tulip mania.  Bubbles are created out of a mania.  Manias are created from the notion that a great money making opportunity exists.  For example, we saw the stock market bubble that was created in the 90s due to the notion that these internet stocks were the next great thing.  These companies didn’t have any substance.  People were investing into the belief that an idea was going to be successful. 

Investors are doing the same thing today. We have an economy that has had economic growth based for the most part on one time stimulus.  We have a stock market that acts as if all of the bad news is behind us when, in reality, we have had a government that has been propping up the system. 

The underlying fundamentals are just not there for this economy.  There are serious imbalances.  However, the government wants you to believe that they are solving the problem.  The unemployment problem is on top of the list of the greatest problems we face.  This government has done nothing to fix this glaring problem minus the creation of some government stimulus jobs.  What is President Obama’s solution to the latest bad news in unemployment?  He announced Friday that he was going to create a job “summit” in December to figure out what to do.

First of all, he needs to be addressing the problems yesterday and not waiting until December to form a “study” group.  The reality is that while this bubble of hope is being created and the market is acting as if the government has everything in control, Americans are losing jobs, the foreclosure crisis is getting worse, and the landscape of our country continues to change drastically. You have states and municipalities facing bankruptcy.  The commercial real estate market is in trouble and could represent the next shoe to drop. 

In a bubble environment, reality becomes a real show stopper.  Remember just 4 years or so when people were flipping homes and acting as if home prices would never go down?  Well reality hit and you know the rest of the story.  I think that we are on the verge of seeing the same thing today with this artificially stimulated economy.  Wall Street is acting as if this is a normal cycle and the worst is behind us.  The government is arrogant enough to think that they can be this irresponsible, get away with it, and fix the economy when, in reality, that is the farthest from the truth. 

Then there is all of the mania surrounding gold.  This is all based on the assumption that we are going to get wide spread inflation when we are really facing a deflationary recession.  Don’t be fooled in thinking the price of gold cannot be cut in half.

Confidence is a fragile element that is the glue that holds everything together.  We went through a serious crisis of confidence last year.  We got some of that confidence back.  The problem is that this confidence is like the house built on sand.  Reality has a funny way of showing up.  

If the stock market were facing reality and not investing in “hope,” this market would not be anywhere near the levels that we are experiencing now.  Of course, you can make the argument that the stock market can go up with all of these imbalances present.  I would argue that we are facing serious and large imbalances.  This is not your ordinary situation.

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Being in the business of money management, you are almost held hostage to financial television. You have to watch a certain amount of it to catch breaking news. Besides the CNBC cheerleaders celebrating Dow 10,000, that level is nothing more than a round number with 4 zeros. Sorry, President Obama, it is neither a milestone nor evidence that your economic stimulus package is working. However, that was a nice sound bite this past week.

So the question arises why can’t I just acknowledge the bullish case and join in with the madness of the crowds? Well, it comes down to those pesky fundamentals. They represent reality and not the fantasy world where the politicians reside and everyone else that has skin in the game live. The reality is that the economic backdrop does not support what is occurring in the stock market. As I have written before, it is going to be quite the rude awakening when those lights come back on and the clean-up of the after party begins.

Every week we get more reality. Soon enough it is going to be tough for this market to block it out. Last week we received the latest on the foreclosure crisis. During the last 3 months, 937,840 people received a foreclosure letter. That means 1 in 136 homes were in foreclosure. That is also the worst 3 months on record. All of this is going on at the same time that the government has rolled out all types of programs to prevent this from happening. This of course is just one example of reality. The real estate markets cannot even begin to bottom and recover while this is occurring.

Potentially further the problem is the fact that we are starting the second wave of adjustable rate mortgage adjustments. The re-setting of adjustable rate mortgages are a main contributor to the foreclosure crisis. You can read about it here.

There is some good news. Yes, I did utter the words “good news”. Businesses are figuring out how to work in the new normal. Beyond some improvement in the economic numbers the only thing that has been positive has been the stock market. Banks are still not lending and consumers are still in lock down mode and unemployment is still at dangerous levels.

Even within that backdrop, businesses are figuring out how to start getting deals done and activity is picking up. So, I don’t think that we are going to find ourselves again in the economic meltdown where everything comes to a grinding halt. Businesses are figuring out how to navigate in our new normal. The strong businesses will become stronger. The bad business models will go away. Well, the ones that are not on government life support.

So, how do you handle this environment? It is standing advice. You watch the amount of risk that you are taking with your investments. Know the risk, be comfortable with the risk, and have a plan B in the event that we run into trouble again.

As for this week, watch corporate profits. Minus the earnings report for Alcoa, the market didn’t particularly care for many of these reports. The Dow should be heavily impacted (one way or another) as many of the Dow components report this week.

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A recent article in the Dallas Morning News states that we just don’t have anything to worry about going forward regarding a “double dip” recession.  A double dip recession is one where you go through one recession, the recession concludes, and then it comes back again.  Of course, that would mean that the stock market would come tumbling down again as well.

September 14, 2009 edition

“I can now report that it’s time to lift up your melancholy spirits and go find something else to worry about.  Double-dip recessions are very rare events.”

“Since WWII, there are really no examples-except 1980-82….”

The writer also points out that, “you would think a 50% upside prance in the stock market would be met with some measure of confidence rather than such an undercurrent of distrust.”

The biggest mistake that the media is making in the reporting of this recession is comparing it to normal recessions and normal cycles.  The writer would need to go back further than 70 years to take a look at the full length of the Great Depression to get a better comparison. No, I don’t think that we are spiraling into a depression.  I do think that in the least a double dip recession is a high probability. 

People are distrustful regardless of the rise in the stock market.  There is rampant unemployment, a foreclosure crisis, and consumers faced with mountains of debt.  That is not even considering a Congress that is trying to ruin this country through socialistic policies. 

To get a good comparison, you can’t look at post WWII recessions.  It would be a lot like comparing apples to oranges.  This is what makes this situation so dangerous.  Yes, people are distrustful.  At the same time, people are also hopeful.  They are hopeful that the worst is behind us.  If that doesn’t turn out to be the case, confidence will be destroyed and that will be the biggest problem the markets and the economy face.  Today, at least confidence is on life support after a grueling 2008. 

Levels in the Market

I haven’t covered significant levels in the stock market in a long time.  (Click here for a description of what I mean by levels.) For the S&P 500, we are starting down a few key levels that are right in front of us.  It is a range of levels between 1042 and 1062.  The ability for the stock market to get above 1062 and stay there would be a very bullish event. 

Isn’t a rise of 55% in the stock market a bullish event in itself?  Only if the bear market is over.  Thus far, the levels necessary to declare the intermediate trend change from a bear to a bull have not occurred.  It would take the S&P 500 getting over and staying over the level of 1119 for that to occur.

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“Worst of the housing recession is now behind us” declares one economist.  New home sales rose last month at the fastest clip in more than 8 years.  There is a good reason why home sales are increasing but there is another reason not to get too giddy over this economic data. 

First, prices are falling to the levels where people are motivated to buy and sellers are motivated to dump properties.  Second, the Government has made a sweet deal with the federal tax credits good until the end of this year.  There is a huge fly in the ointment.  Prices are continuing to fall. In addition, there is a tremendous number of homes for sale or supply on the market.  This supply will keep prices low.  People are only looking for bargains. Plus, banks have thousands of homes on their books that they have yet to send to auction. 

In order to say we have bottomed, there is one area that has to get better.  The foreclosure crisis has to start to bottom out.  Here was the latest from Realtytrac who keeps up with the foreclosure crisis.

“RealtyTrac® (realtytrac.com), the leading online marketplace for foreclosure properties, today released its Q2 2008 U.S. Foreclosure Market Report™, which shows foreclosure filings were reported on 739,714 U.S. properties during the second quarter, a nearly 14 percent increase from the previous quarter and a 121 percent increase from the second quarter of 2007. The report also shows that one in every 171 U.S. households received a foreclosure filing during the quarter.”

Let’s backtrack for a second and look at what created these foreclosures.  It all comes down to the adjustable rate mortgage.  Starting in 2007, adjustable rate mortgages starting coming due for 100,000’s of subprime homeowners, causing the beginning of the foreclosure crisis.  Those peaked in the first quarter of 2008.  Through 2008 and into 2009, those adjustable rate mortgages subsided. 

However, now all of the other types of adjustable rate mortgages will start coming due and this cycle will not peak until 2012.  It is a much bigger cycle.  To assume that the housing market has bottomed would be to assume that there will not be a problem with all of these ARM’s that will reset over the next 2 to 3 years.  It is a big assumption. 

This is pretty typical.  The minute the data starts to be positive, economists declare the worst is behind us.  I would describe right now as a period that is in between 2 crises.  Unfortunately, I think that the second wave of crisis might be worse than the first.  Round two involves more housing foreclosure and the upcoming crisis in commercial properties.

Follow up from Last Week

I wrote about the similarity between the first major stock market rebound in 1929 and today.  If you have not read last week’s post, go back and read it so this makes sense.  We are now tracking almost identically in time (146 days) and gain (46% rise).  It will be interesting to see what happens from here.

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 As an investment manager, I am constantly looking into the future and evaluating indicators to determine which investments make the most sense.  Since originally warning of the risk in stocks back in 2007, my indicators have not given any signs that the risk for being in the stock market has changed.  As long as the bear market is around, investors really need to be careful regarding the amount of money that is invested in stocks and stock-based mutual funds.

 

What has to change for stocks to be a prudent choice again?  Although there is a laundry list of reasons for investors to be cautious, one risk remains at the top of the list.  It has been the driving factor for the credit crisis.  Until we get past the foreclosure crisis, I believe this bear market will remain in control.

 

In the simplest of explanations, the foreclosure problem can be explained this way.  For years, the mortgage industry gave loans to people who could not afford them.  For example, Joe wants to buy a home.  He goes to the mortgage company and finds out he can qualify for up to a $100,000 home.  The mortgage company determines that loan amount by looking at Joe’s income and expenses.  Joe can afford the $1,000 a month mortgage. 

 

The mortgage industry thought that it would be a good idea to come up with loans other than a 30-year or 15-year mortgage.  With these new loans, that $1,000 a month payment would purchase a much bigger house.  In fact, it is possible that the $1,000 a month payment could buy a house valued at as much as $400,000.

 

In order to accomplish that magic number, the mortgage company had to make a few adjustments to the traditional loan.  First, they arranged it to where Joe just paid the interest for that month versus interest and principle.  This one little change made a big reduction in the amount that he had to pay. 

 

Second, they were able to give him an adjustable rate feature.  This gives Joe a much lower payment the first 3 years or so.  However, that rate adjusts after the first 3 years and the $1,000 goes up to $2,500 a month.  By then, the mortgage company rationalizes with Joe that he can simply refinance the mortgage and get the payment more manageable.

 

So, imagine millions of people just like Joe taking out adjustable rate mortgages and facing a higher mortgage payment in the future.  This is what has happened.  Millions of adjustable rate mortgages had a payment change and the consumer couldn’t afford the mortgage anymore.  They couldn’t refinance the home because the home was now “under water” or worth less than the mortgage.  This is what led to the foreclosure crisis. 

 

So, if we had hundreds of thousands of people facing higher payments in the year ahead, would it be reasonable to assume that we could have a high number of foreclosures? 

 

Well, this is what I wrote to my clients in 2007.  I showed the following graph which pointed out the billions of dollars of mortgages that were about to have higher monthly payments. You can see by this graph that during the first quarter of last year, the largest number of mortgages changed.  As a result, we had the beginning of the worst of the foreclosure crisis last year. 

   

 

Unfortunately, that was round 1 of the foreclosure crisis.  That graph only represented sub-prime mortgages.  Now, we have all of the other types of mortgages whose monthly payments will change coming due this year and into next year.

 

  

This graph shows that we are at the beginning of payment changes for mortgages that will not peak until 2011.  It looks like we will not be out of this problem until 2012. 

 

When you have waves of foreclosures, you have problems with the banking system and everything that is tied to those mortgages.  It gets much more complicated.  To make the problem more challenging, a good percentage of these homeowners owe more than the house is worth.  Look at the following percentages of homeowners with the various types of mortgages:

 

73% homeowners with Option Adjustable Rate Mortgages owe more than the value of the house.

50% homeowners with Sub-prime Mortgages owe more than the value of the house.

45% homeowners with Alt-A Mortgages owe more than the value of the house.

25% of Prime Mortgages owe more than the value of the house. 

 

Contrary to what the Government and Wall Street want you to believe, the risk is still extremely high for the economy and the stock market.  What has plagued the stock market is still the problem. 

 

So what is the bottom line for investors?  There are two things to consider.  First, make sure you understand the amount of risk that you are taking in your company 401(k) plans.  Remember the easiest way to define risk is by looking at the overall percentage of your plan that is invested in stock-based mutual funds or individual stocks.  Second, if your money is with a financial advisor, find out what their strategy is in the event that the bear market is not over.  If they have no strategy and instruct you to just “ride it out,” move your money to an advisor that can manage money in a bear market. 

 

It has never been more important to understand risk than today.

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