US Banks: failures in a more 'traditional' manner

BFF UPDATE: Bank Failure #81 - Guaranty Bank, Austin, Texas
BFF UPDATE: Bank Failure #80 - CapitalSouth Bank, Birmingham, Alabama
BFF UPDATE: Bank Failure #79 - First Coweta, Newnan, Georgia
BFF UPDATE: Bank Failure #78 - ebank Atlanta, Georgia

It's bank failure friday and the full effects of the housing correction are starting to take hold in the United States.

As noted by the New York Times in this article, it is becoming clear that most of the bank failures this year have nothing to do with the strange financial products that seemed to dominate the news when the big banks were nearing collapse (Bear Sterns, Lehman Brothers, etc.).

The current wave of failures are from banks that are now losing money. They are going broke the old-fashioned way: They made loans that will never be repaid.

Those loans will never be repaid because they have been made for mortgages that were sound three years ago, but are now hopefully in excess of what the property is now worth.

More importantly they were made to homeowners who were, at the time, solid, employed borrowers.

As the defaults compound they are destroying many small US banks who did not get in over their heads with derivatives or hide their bad assets in off-balance sheet vehicles. Nor did their traders make bad bets; they generally had no traders. They did not make loans that they expected to sell quickly, so they had plenty of reason to care that the loans would be repaid.

But no matter. The loans are going bad, in some cases with stunning rapidity, in volumes that they never thought possible.

The sizeable drop in real estate values is triggering underwater mortgage conditions all over the United States. Homeowners are defaulting because of this condition and pulling their banks down with them.

This is exactly the condition that the Bank of Canada (and the real estate industry) have been desperate to stave off in Canada.

Jim Wigand, the F.D.I.C.’s deputy director of resolutions and receiverships, says banks that are failing now are in worse shape — in terms of the amount of losses relative to the size of the banks — than the ones that collapsed during the last big wave of failures, from the savings and loan crisis of the late 1980s/early 1990s.

The absence of problems in the middle of this decade was taken as proof that nothing very bad was likely to happen. Any bank that did not lower its lending standards from 2005 through mid-2007 would have stopped growing, simply because its competitors were offering more and more generous terms.

In Canada, the industry believes they have staved off disaster. So banks have returned to making loans with 0 down and 35% amortizations.

The New York Times article makes an interesting observation:

"Two years ago, when the subprime mortgage problems began to surface, Washington took great comfort from solid balance sheets, which regulators thought meant the banks could easily weather the problem."

"Last year, we learned that the regulators, like the bankers, did not comprehend the risks of some of the exotic instruments dreamed up by financial engineers. This year we are learning that the regulators, like the bankers, also failed to understand the risks of the generous loans that the banks were making in the middle of this decade."

Those in charge dramatically misread the situation.

If the economy does not restore itself quickly, and sales of US government debt push interest rates higher... then next year we will reading about the massive risks to our country posed by the huge number of loans made this year to first time buyers with little or nothing down and 35-year amortizations.

It won't be a pretty picture.

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The Oracle of Omaha sounds the inflation warning bell again

Seems I wasn't the only one engaging in a little inflation talk yesterday.

In an op-ed piece for the New York Times, the famous investor Warren Buffett was also sounding another alarm on the topic.

Sensing, as I do, that the US Federal Reserve should be moving now to remove it's stimulus money, Buffett let his thoughts be known by saying that the U.S. must address the massive amounts of “monetary medicine” that have been pumped into the financial system and now pose threats to the world’s largest economy and its currency.

The “gusher of federal money” has rescued the financial system and the U.S. economy is now on a slow path to recovery, Buffett wrote. While he applauds measures adopted by the Federal Reserve and officials from the Bush and Obama administrations, Buffett says the U.S. is fiscally in “uncharted territory.”

Indeed it is. But what does Buffett see as the danger to getting a handle on things?

Elected officials who won't make the difficult choices they need to, of course.

"Legislators will correctly perceive that either raising taxes or cutting expenditures will threaten their re-election. To avoid this fate, they can opt for high rates of inflation, which never require a recorded vote and cannot be attributed to a specific action that any elected official takes," said Buffett.

Too true.

But isn't that what everyone has been saying? That the stimulus money won't be withdrawn quickly enough because of the pain it will cause the economy?

Inflation is the easy way out. And politicians always take the easy way out.

Tick, tick, tick...

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Inflation Talk

Despite the fact 'official' statistics have inflation in negative territory, mainstream media is starting to pick up on what everyone can see and can't be denied... inflation is present.

In a Globe and Mail article, it is pointed out that even with the consumer price index (CPI) at a 56-year low, Canadians are feeling the pinch as food inflation persists.

And that's because food prices were one of those items removed from the CPI in the early 1990s.

Statistics Canada reported yesterday that food prices were 5.6% higher in grocery stores in July than they were a year ago, and 3.4% higher in restaurants, although the overall inflation rate fell by 0.9% year-over-year.

Pity the poor restaurant owner.

Restaurants' food costs jumped by 6.7% in the first seven months of 2009 and labour costs also rose, with the minimum wage increasing by an average of 6.9% across the country this year.

With labour and food accounting for 70% of the cost of doing business, restaurant operators are in a vise.

As much as restaurateurs would like to cut prices to attract what's left of the discretionary dining dollar, they are hard-pressed to do so.

“They're hanging in there, but their margins are getting thinner and thinner. Many restaurant operators are getting by on profit margins of 3%, 2%, even 1% in some jurisdictions,” said Garth Whyte, president of the Canadian Restaurant and Foodservices Association.

How can restaurant's raise prices and draw customers when all the public hears is that inflation is supposedly not there. "Prices are doing down, not up!", says the indignant consumer as he walks away.

Meanwhile bond investors are not duped by all the talk of negative inflation. In an article titled 'Bond Investors Gird for Inflation' we see that Canadian real return bonds have been outperforming conventional government bonds during the past month. Real return bonds could continue to outperform for several months, according to Merrill Lynch Canada Inc.

Real return bonds are domestic government bond issues that pay investors a rate of return that is adjusted for inflation as measured by the consumer price index, including food and energy. Unlike conventional bonds, this feature assures investors' purchasing power is maintained regardless of future rates of inflation.

Bond investors are already looking for protection from inflation. Perhaps they can see exactly what the Governor of the Bank of Canada saw when he warned two weeks ago that "the era of ultra-low interest rates are coming to an end and Canadians should prepare...".

It seems bond investors are.

Are you?

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Time Bomb

Yesterday I commented that central bankers are loath to pull back on their support for the financial system before it's clear the economy has staged a stronger recovery.

More importantly, the US Federal Reserve has a long and painful history of ignoring asset price inflation.

The current stock market boom is clearly another asset bubble. None of the market fundamentals support the astonishing gains the market has made since March 9, 2009. Stimulus money has fueled this mini-boom.

Yet the Fed is not taking any action. Through it all we are told the Fed will remove the stimulus before the funds find their way into general circulation and fuel inflation. "Trust us", we are told.

Hmmm...

Look at this chart (click on image to enlarge):

The official rate of Consumer Price Index shows that inflation currently stands at -2.01%. Officially, inflation is non-existant and in negative territory.

No need to remove the stimulus... right?

Not so fast.

As faithful readers will recall, I posted this piece in July which outlined how the method for calculating inflation was changed by the government in the 1990s.

How would the chart above look if we calculated inflation using the same formula in place from 1872 to 1990? Would we still be looking at a negative (-2.01) rate?

Shadowstats.com has produced this graph which makes that comparision (click on image to enlarge):

Calculated using the same method as the that used in the late 1970s reveals that inflation is, in fact, proceeding at 5.44%.

Inflation is here. And the US Federal Reserve is ignoring it.

So how can you have faith they will withdraw the stimulus before it triggers a similar period of 22% plus mortgage rates?

The short answer... you can't.

Inflation is already here and the US Federal Reserve has failed to act.

Now we have a giant bomb on the verge of igniting. How long before it triggers a huge run-up in rates?

Tick, tick, tick.

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Is the stock market the latest Fed bubble?

The transformation of Vancouver real estate prices from the stagnancy of the mid 1990s (when prices were flat or increased at historical normals) to a situation over the last 9 years where double digit increases became the norm was a result of the worldwide influx of cheap money.

After the dot-com collapse of 2000/2001, a dramatic wave of inducements entered the financial markets to resusitate the economy.

Led by the US Federal Reserve under Allan Greenspan, interest rates were dropped making money cheap to borrow at the highest levels of the finance world.

Thus began the greatest campaign in history to get you - the consumer - to borrow money.

That money instigated a world-wide boom in real estate (and consumerism).

Year after year property increased to the point where annual minimal 10% increases were not only anticipated... but expected. But the bubble has lead to a spectacular crash in most of the world, particularly the United States.

The US Federal Reserve has spent the past year cleaning up after the mess of that housing bubble crash, a mess it created.

But in attempting to cleen up, has the Fed been responsible for pumping up another bubble, this time in stocks?

To head off the worst downturn since the Great Depression, the US central bank has slashed interest rates while funneling money to banks.

Recently the Federal Reserve has won praise for its efforts. The pace of job losses has slowed (although losses still pile up), and there has been a modest recovery in output.

Stocks, however, defied that modest rebound, having bounced back with startling speed.

Since global markets hit their bottom in March, the S&P 500 has jumped 51% -- even as the outlook for economic recovery remains dim.

"This is the most speculative momentum-driven equity market since the early 1930s," Gluskin Sheff economist David Rosenberg wrote in a note to clients Monday.

The rally has occurred, in part, because investors perceive the worst-case scenario -- a 1930s-style Depression -- is off the table.

And while the gains have been remarkable, they come after an even bigger decline.

Keep in mind that despite the massive rally, the S&P is still down 16% since Lehman Brothers collapsed in September.

Has the bounce back been justified?

The underlying fundamentals of the economy appear week. If the foundation isn't there, the smart money still fears that this is a bear market rally.

Worse, the evidence suggests that the surge we currently have is nothing more than another Fed financed speculative mania that could end in another damaging rout.

Consider... recent weeks have brought huge rallies in some of the lowest-quality stocks -- including firms such as AIG (AIG, Fortune 500), Fannie Mae (FNM, Fortune 500) and Freddie Mac (FRE, Fortune 500). These firms are being propped up by the government and are unlikely to return to health any time soon.

What's more, this year has brought an 80% surge in emerging market stocks, while the dollar has posted a 10% decline since March.

A declining dollar and surging emerging markets were the hallmarks of the credit-fueled bull run earlier this decade.

"We have put the band back together on a lot of this," said Howard Simons, a strategist at Bianco Research in Chicago. "That couldn't have happened without liquidity."

And there's the rub. Liquidity is a nebulous concept. You can't dispute the fact that that central bankers around the globe have poured huge amounts of money into the markets to ease the financial crisis.

And given free money, investors' appetite for risk shoots higher and they start to gobble up stocks.

But when the outlook for economic growth doesn't seem to support the higher stock values, what happens?

"Many observers are wondering whether the strong stock market rebound since mid-March is already a forerunner of the next recovery or simply driven by a reflux of liquidity into riskier asset markets," Deutsche Bank Research analyst Sebastian Becker wrote in a report last month.

And that's exactly why I feel that the stage is being set for another huge crash.

Fed officials have stressed that investors shouldn't worry... that they will start to unwind their financial support programs at the earliest sign of inflation.

Given the cost of cleaning up after the last real estate bubble, Becker writes that "this time, policymakers are unlikely to remain inactive should they suspect the formation of another asset price bubble."

But isn't that exactly what we are experiencing with this stunning stock market rally? Another asset price bubble?

Central bankers are loath to pull back on their support for the financial system before it's clear the economy has staged a stronger recovery. And the Fed has a long and painful history of ignoring asset price inflation.

"The central bankers have this textbook belief that the only inflation is the kind that appears in consumer price indexes," said Simons. "They don't believe what they're doing could cause an asset price bubble."

But I would suggest to you that is exactly what they have done. Ben Bernanke's efforts to prop up the financial system has created a new bubble.

And I fear we will suffer the consequences again in very short order.

The bear market trap is getting ready to spring shut.

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Sunday Funnies - August 16, 2009

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US Banks

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BFF UPDATE: Bank Failure #77 - Union Bank, National Association, Gilbert, AZ
BFF UPDATE: Bank Failure #76 - Community Bank of Arizona, Phoenix, AZ
BFF UPDATE: Bank Failure #75 - Community Bank of Nevada, Las Vegas, NV
BFF UPDATE: Bank Failure #74 - Colonial Bank, Montgomery, Alabama
BANK FAILURE FRIDAY UPDATE: Bank Failure #73 - Dwelling House Savings and Loan Association, Pittsburgh, Pennsylvania

Well, it's Bank Failure Friday again. We follow the US banking system with keen interest because, as our Prime Minister said not too long ago, "there won't be an economic recovery until the U.S. financial system is repaired."

With that in mind, Bloomberg put out this story that "Toxic Loans Topping 5% May Push 150 Banks to Point of No Return".

Apparently more than 150 publicly traded U.S. lenders own nonperforming loans that equal 5% or more of their holdings, a level that former regulators say can wipe out a bank’s equity and threaten its survival.

Missed payments by consumers, builders and small businesses have pushed 72 banks into failure so far this year, the most since 1992.

More collapses may lie ahead as the recession causes increased defaults and swells the confidential U.S. list of “problem banks,” which stood at 305 in the first quarter.

Excluding the stress-test list, banks with nonperformers above 5% had combined deposits of $193 billion, according to the Bloomberg data. That’s almost 15 times the size of the FDIC’s deposit insurance fund.

The next six months could make this a very significant bank failure year.

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China: Something is amiss.

I continue to be amazed at all the hype about China. Article after article seems to hail it as the ‘miracle economy' that has decoupled from the rest of the world.

China, it is said, is growing at 8% per year while the rest of the world is mired in the worst recession since the 1930s.

What a crock!

As we have already posted here, the Chinese stock market is bloated by massive re-directed stimulus and is in a greater bubble than our own markets. How large is that stimulus? China is spending $586 billion US which is proportionally nearly 3 times as much as the United States.

Any of that money that is not being funnelled into their massive market bubble is being spent on infrastructure. The Chinese are doing what the Japanese did before them 10 years ago. Japan bailed out its banks and spent trillions on infrastructure. There were years when little Japan was pouring much more cement than the entire USA. – channeling rivers, building bridges to nowhere, and creating highways for no one.

And what did the Japanese get for their money?

Well, you could say they got a lot of infrastructure…and the most cemented–up country on the planet. Is that a good thing? I can tell you one thing they didn’t get: durable economic growth.

Speaking of economic growth, it continues to look more and more like China's economy is nothing but a fraud.

Chinese officials have a funny way of counting. When products are shipped from the factory, for example, they are counted as ‘sales’ even though no one may actually buy them.

Yet report after report in North America regurgitates the official statistics to tell us that China’s economy is supposedly growing at a breakneck speed.

Look beneath the surface and evidence seems to suggest China isn't really growing at all – at least not in a genuine and helpful way.

Chinese bureaucrats can jiggle and jive the numbers for employment, GDP, and inflation. But there is one number they can't 'spin' and it continues to raise a giant red flag: killowatt-house consumed.

The number of kilowatt-hours consumed in China is just a number. But it's a number that is not computed, not seasonally adjusted, not tortured by statisticians nor tormented by economists.

It is just a number.

And that number is, month after month, smaller than it used to be. “During January and May, electricity demand dropped about 4% year on year,” revealed Zhao Guobao, vice director of the National Development and Reform Commission and director of the National Energy Administration.

Now news comes that both June and July's numbers reveal yet another decline in consumption.

If China were really growing at 8% per year, how come its electricity consumption is going down?

Here's another disturbing question for you. China’s exports for July were down 22% from the year before.

How can an export led economy grow when its exports are collapsing? The answer, of course, is they aren't selling at all. Besides... who the hell would be doing the buying?

The Richebächer Letter’s Rob Parenteau has another disturbing item about China. “China needs at least 9% growth to soak up the 24 million new Chinese workers who come of age each year – something even the Chinese Premier doesn’t like to mention.”

Even if you accept the 'official' 8% growth (and trust me, the real numbers are lower), it means unemployment in China is rising. Combine that with the fact exports and energy consumption are down and you have no rational reason for the Chinese stock market to be rocketing.

Except for all the mis-directed stimulus money being pumped into it.

It's the classic bubble.

And since much of our stock market is rocketing because China is supposedly going to lead us out of recession... well, you get the picture.

It just doesn't pass the smell test.

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Prechter: Next Wave Down Will Be Bigger

Robert Prechter is a longtime technical analyst who forecast the 1987 stock market crash and authored a book in 2002 ("Conquer the Crash") in which he warned of the dangers of a U.S. debt bubble and deflationary depression.

In late February, Prechter said "cover your shorts," and predicted a sharp rally that would take the S&P into the 1000 to 1100 range.

With that prediction having come to pass, Prechter is now saying investors should "step aside" from long positions, and speculators should "start looking at the short side."

"The big question is whether the rally is over," Prechter says, suggesting "countertrend moves can be tricky" to predict. But the veteran market watcher is "quite sure the next wave down is going to be larger than what we've already experienced," and take major averages well below their March 2009 lows.

That's right, Prechter is one of those who believes the late 2007- early 2009 market crash was just a warm-up to what Prechter believes will be the bear market's main attraction. In this regard, he says the current cycle will echo past post-bubble periods such as America in the 1930s and England in the 1720s, after the bursting of the South Sea bubble.

Prechter calls the 2000 market peak market a "major trend change" for the market from a very long-term cycle perspective, and the downside is going to continue to be painful well into the next decade. "The extreme overvaluation, the manic buying and bubbles in the late 1990s [and] mid-2000s are for the history books - they're very large," he says. "The bear market is going to have balance that out with some sort of significant retrenchment."

His recent thoughts on video...


Meanwhile in Canada

Canadian personal bankruptcies soared by 54.3% in June according to the Office of the Superintendent of Bankruptcy Canada.

An earlier report released by Toronto Dominion Economics in May suggested that as many as 160,000 people will walk away from their bills in 2009 and 2010 because of high unemployment and debt.

"Unemployment and heightened household debt will drive a substantial increase in consumer insolvencies over the next two years," Craig Alexander, TD's deputy chief economist, said in the report.

Businesses, however, weren't hit as hard as consumers. In June business bankruptcies were up 10.8% year-over-year.

Alexander warned that even if business conditions improve, it may not help the individual bankruptcy situation, as consumers are still carrying a greater debt load and run a greater risk of falling prey to insolvency.

The fact of the matter is that the spectre of rising interest rates remains a massive ticking time bomb for individual Canadians.

If, heaven help us, the market crashes in tandem with a loss of confidence in US debt (triggering spikes in interest rates), the sonic boom against real estate will be profound.

Tick... tick...tick.

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The Fork in the Road

Click on the image above for the full size. It's a fascinating chart comparison of the four worst market collapses of the last 85 years from Doug Short at www.dshort.com.

It compares the 1929 Great Depression, the 1973/74 crash, the dot.com crash of 2000-02 and the current crash of 2007-09.

This particular chart has a riveting twist. Rather than overlay the four collapses (as this chart does), it shifts the point of alignment from the pre-bear highs to the bear bottom in the Oil Crisis, the Tech Crash bears, the first major low in the 1929 Dow, and the March 9th closing low for our current Financial Crisis.

As the chart illustrates, the lows in 1974 and 2002 marked the beginnings of sustained recoveries.

The low in 1929 didn't mark the start of a sustained recovery; the market failed again 11 months later.

As for our current market, since the March 9th low, the S&P recovery has outperformed the 1974 and 2002 rebounds over the equivalent period, and it has only just now fractionally surpassed the initial recovery from the 1929 Dow low.

A great many have stressed that this collapse is unlike anything since the Great Depression and, in fact, is a financial earthquake on par with the 1929 calamity.

So we have come to the fork in the road.

Will the recovery prove resilient?

Or are we on the cusp of a great reckoning as in 1929 with the market poised to plunge significantly again?

Either way, this excellent chart brings the precipice into excellent focus.

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More economic observations

Let me expand on Saturday's concerns about the economic outlook.

The most recent data on outstanding credit card and auto loan amounts was released on Friday.

US consumer credit fell for the fifth straight month as banks maintained more restrictive lending terms and households remained reluctant to borrow money for major purchases.

How can the U.S. economy expand if consumer credit continues to contract?

From Bloomberg;

• Consumer credit fell $10.3 billion, or 4.92 percent at an annual rate, to $2.5 trillion, according to a Federal Reserve report released today in Washington. Credit dropped by $5.38 billion in May, more than previously estimated. The series of declines is the longest since 1991.
• Stagnant wages and falling home values mean consumer spending, about 70% of the economy, will take time to recover even as the recession eases.
• “This string of declining credit should continue as long as the economy eliminates workers at an elevated pace,” said Richard Yamarone, director of economic research at Argus Research Corp. in New York. “We’re 20 months into the recession and the economy is still losing a quarter-of-a-million jobs per month.”

It's important to note that consumer credit contains no housing related debt at all. So it begs the question... how sharply are outstanding home equity lines of credit and home equity loans contracting?

I bet you that they are contracting even faster than consumer credit and auto loans.

Again I urge you to ask yourself the question, how can the U.S. economy expand if consumer credit (home equity loans, home equity lines of credit, consumer credit and auto loans) continues to contract?

Speaking of homes, interesting presentation by the San Diego County Assessor/County Clerk David Butler on Notice of Defaults (NODs) and foreclosures in the county.

The following is a handout from the presentation (click on image to enlarge).

San Diego real estate broker Edgewood121 attended the presentation and advised that San Diego county is "expecting a wave of foreclosures in the near future and they are gearing up for it" (quoting Edgewood121 paraphrasing Butler).

Butler thinks the banks are holding back, probably because of the various government programs.

Edgewood 121 was left with the impression that "it is [only] a matter of time before more properties become available." And that the only reason prices appear to have stabilized "is because of the artificial choking-off of inventory, thereby creating urgency and multiple-offer scenarios."

This situation is being repeated all over the United States.

Clearly banks are hoping that the modification programs will reduce the number of foreclosures. However, as we said last week, most loan modifications just capitalize missed payments and fees (so the banks can pretend they are still whole), and reduce interest rates for a few years (so the homeowner can pretend they still own something of value).

Extend and pretend... that's all the banks are really doing right now. Which is fine until the coming wave of commericial and prime mortgage defaults hits.

Meanwhile there is the topic of personal bankruptcies.

Last week I commented that bankruptcies in the United States were up 600%. Now comes word from the UK newspaper, the Independent, that the United Kingdom registered a record 33,000 people insolvent in the second quarter of the year, the largest number ever recorded.

Insolvency experts warned that the combination of rising unemployment and the lack of stigma attached to insolvency options meant the number of people affected would go on rising.

Mark Sands, director of personal insolvency at Tenon Recovery, predicted 140,000 people in the UK would be declared insolvent during 2009, 30% more than in 2006 – the worst year on record so far – when the figure was 107,000.

"The overall record level of personal insolvencies, whilst at first shocking, hides the detail which suggests the worst is yet to come," Mr Sands warned.

'The worst is yet to come'... hmmm.

On that note, did you catch Treasury Secretary Timothy Geithner's missive to Congress on Friday?

Geithner urged elected US officials to raise the $12.1 trillion debt ceiling since, according to current projections, that limit may be reached as soon as mid-October.

Said Geithner, "It is critically important that Congress act before the limit is reached so that citizens and investors here and around the world can remain confident that the United States will always meet its obligations."

Ummm... anyone care to explain to me what is the point of having a 'ceiling' if, as you get near that limit, you simply raise it time after time again?

Seriously.

How twisted is the logic that passes for policymaking in Washington that it becomes critically important that the limit be increased before it is reached?

Geithner says its important because investors may lose confidence in the entire system if it isn't raised.

Say whaaa?

You mean to say investors won't lose confidence because the United States has a spiraling debt so large that the government has to raise the absolute 'ceiling' they have imposed on that debt every few months?

And investors won't lose confidence because there seems to be a total lack of any realistic plan that would see the money repaid?

But somehow these same investors will, apparently, lose confidence because lawmakers hadn't paid close enough attention to the relationship between the debt and the debt 'ceiling'. And if lawmakers fail to move the ceiling upward when conditions required such action, this will trigger a loss of confidence?

Alrighty then.

As I said on Saturday, this economic maelstrom is not over, we are experiencing the calm that comes when the 'eye' of an economic hurricane passes over us.

As any weather watcher knows, once the 'eye' passes the back end of a big storm always hits harder than the front end.

Brace yourselves.

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Sunday Funnies, August 9th, 2009

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"Eye"

US Federal Reserve Chairman Ben Bernanke recently testified to Congress that he foresaw a “jobless recovery” on the horizon.

Jobless recovery?

How can an economy burdened with double-digit unemployment recover without new jobs?

In recent decades there have been some jobless recoveries from mild recessions, but they were built upon asset booms.

Today we face a very deep recession as the asset boom has collapsed (althought in the Village on the Edge of the Rainforest this is still pending). A jobless recovery in an economy based on 72% consumer spending is an oxymoron. Unless our economy can go through a needed and painful reorganization, in which the industrial sector is revitalized, recovery from this recession will have to be based upon consumer demand.

But with unemployment in the US increasing at over 500,000 workers a month (and 45,000 in Canada), with wages dropping, and with hours worked declining, it is hard to see consumer demand rising convincingly enough to provide the engine for a rebound.

Meanwhile, U.S. Treasury debt is exploding, the U.S. dollar falling, and unemployment rising.

Added to this conundrum, credit remains tight, despite the injection into the banks of vast amounts of Fed funds at zero percent. And, for the first time, banks are being paid interest on the reserves required to be held at the Fed. Paradoxically, this hidden taxpayer boost to banks’ earnings is one of the prime reasons for tight credit. What bank would lend to corporations or individuals, incurring risk, when it can lend to the Fed – at considerable profit – without risk?

With the consumer still in shock and denied credit, why do some indicators appear positive?

The short answer for this is massive deficit and stimulus spending by our federal governments.

That's why some consumers have ‘handout’ money to spend. And it’s no surprise that after a massive sell-off, certain retailers are refilling their inventories, causing the Purchasing Managers’ Index to rise.

But looking ahead, there is a $3.4 trillion commercial mortgage problem due to face the US banks in September and a huge wave of residential mortgage defaults to come.

When you combine this with the various pressures on consumers, it appears to me that we aren't on the cusp of any recovery, but that we are actually in the ‘eye’ of an economic hurricane.

When jobs fail to materialize and credit remains frozen, look for corporate earnings to remain depressed. This reality can only be ignored for so long.

US equities have just come off their best July since 1989. Overall, the market is up over 8% for the year. But history has a parrallel to today.

March 1989 also saw a huge run up. It was followed by an even stronger rally in July, during which volume dried up. It appears the same is happening now. What came next in 1989 was a big sell-off in September, followed by an even greater one in October.

Don't look now, but history tends to repeat itself.

Also, consider the fundamental picture. We have rallied 48% from the March lows on the back of what? Good earnings? Good employment figures? Good spending figures? Expanding GDP?

No.

We have rallied based on one of the largest and most concerted propaganda campaigns ever waged, supported by government stimulus. But no government can stimulate forever. The bottom line is this, if Americans and Canadians do not return to work, THERE IS NO RECOVERY.

Compounding all of this is another job-loss statistic.

According to Seeking Alpha, 13 million Americans will lose their benefits by years' end. And these Americans are not returning to work because they are losing their benefits, they are exhausting their benefits.

There are 30 million people in the United States on food stamps. There are only 200 million working-age Americans (age 15-64). Unemployment has been estimated by many good economists as being around 20%. Unfortunately for these people, their nanny-government lifeboats are slowly running out of air.

Those 3 million people who lost their jobs in the second half of last year? Once you factor in their dependants, that equals 10 million people who have no income and no savings.

And how about the other 4 million others who lost their jobs in the first half of this year? They will be next. The numbers get so depressing, I hate to even count them up.

As I have said before, unemployed people don't spend money. They don't buy technologies, or durables, or even pay their mortgage. US bankruptcies are up 600% in this recent downturn. And that includes the time after Congress affected new rules to make bankruptcy harder.

So who is going to pay for anything when they are struggling to buy groceries?

If the equity averages are already rallying on the back of these horrible stats, there is nowhere to go but down when the real truth sets in.

When the realization comes, look for another round of collapses. I see the stock market crashing below 5,000 on the DOW.

Particularly if autumn heralds a rise in interest rates.

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Vancouver: North America's most bubbly city?

Mark my words, dear reader. The dog days of summer, 2009 will go down in history as the pinacle of our housing folly.

In the same week that we find out that July broke all time sales records for real estate in the Village on the Edge of the Rainforest, Stats Can informs us that the July job loss number were five times worse that most analysts were predicting as 45,000 net workers were officially pushed to pogey.

The unemployment rate stayed steady at an 11-year high of 8.6%, but that's only because discouraged unemployed people, mainly youth, gave up searching for a job.

“[It's a] classic sign of discouraged workers throwing in the towel,” said Douglas Porter, deputy chief economist at BMO Nesbitt Burns.

An economy can still grow if employment stagnates. But an economy can't muster growth if jobs are being destroyed. The all-important consumer spending power will never jump start things under these conditions.

As we predicted several months ago, tourism jobs have been hit hard given the recession in the U.S. and Canada, border issues, fall-like weather in July in most of the country, and the high cost associated with the Canadian dollar.

But it's the private sector that is taking the heaviest blow. Employment fell by 75,000 positions, bringing total job losses since last October to 436,000.

July's private-sector losses were the worst since the record-breaking decline in January. A 35,000 rise in self-employment partially offset the drop, but economists tend to be leery about self-employment numbers in the depths of a recession because self-employment is often a last resort.

The self-employment gain “is not necessarily a good thing as it underscores the lack of opportunity in the formal job market,” said Charmaine Buskas, senior economics strategist at TD Securities Inc. “And as workers have fewer job prospects and bargaining power, wages have obviously suffered.”

Since October, the work force has contracted by 2.4%, all in full-time work. Most of the losses have been in manufacturing, construction, transportation and warehousing.

And yet, in the Village on the Edge of the Rainforest, we have a huge wave of first time homebuyers entering into bidding wars for real estate. They are assuming mortgages with record low downpayments and 35-year amortizations only because they can take advantage of dirt cheap, manipulated mortgage rates.

35-year amortizations on mortgages where only 5% is used as a downpayment (which is pretty much the norm with all new buyers)mean that the principal is barely touched with monthly payments

If housing prices drop by as little as 8%, anyone of these new home buyers who have bought in 2009 could end up in an underwater position - just like that.

And with a worsening job picture, a private sector being decimated by the economy, a federal finance minister who warns the country to "prepare for even more job losses", it all adds up to a precarious position where all it will take is a little push for our bubble to burst in a spectacular fashion.

Sound crazy? Well how's this for a sign of the crazy times? BCTV (or Global), the undisputed king of private broadcasting in BC, just reported that it's parent company defaulted on an $18.5 million US interest payment to bondholders.

This in not an environment that can support a rising real estate market.

Spectacular fashion... mark my words.

(P.S. For those keeping track there were three bank failures in the United States today bringing the year's total to 72)

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DDOS Service Attack

Like Twitter and Facebook and other services this last week, Blogger is currently under a significant DDOS attack. Due to temporary prevention efforts put in place to try to squash the attack, I have been unable to post today. Sorry for any inconvenience.

I will, hopefully, post later tonight.

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Mission Accomplished

That's what their calling it. A result of he busiest July ever for Vancouver Real Estate, both in Greater Vancouver and in the Fraser Valley.

And according to the Vancouver Sun, first-time homebuyers are driving the market.

Faithful readers will recall several posts I made earlier this year about how all the propaganda being pushed out by the Real Estate Associations was targeting first time homebuyers in a desperate attempt to grease the wheels of a real estate machine that had begun seizing up.

And now?

Paul Penner, president of the Fraser Valley board, notes the effect of luring the first timer's back. “That volume creates a significant ripple effect as the sellers of those homes move up,” Penner said in a news release.

Jake Moldown, president-elect of the Vancouver real estate board, concurred.

He said first-time buyers who entered the market during the boom a couple of years ago now feel comfortable moving up the property ladder.

“They understand what a mortgage is and they’re comfortable with their payments, and now they’re looking to step up,” Moldown said.

So it's Mission Accomplished for the real estate associations.

But I have said it before, and I will say it again... cheap interest rates are the one and only reason real estate is selling.

We have created a mini bubble, which was the whole point of the Bank of Canada flooding the market with 2% and 3% mortgages.

It's as if the nation has completely forgotten about collateralized debt obligations.

This boom you are seeing is the last silver bullet that our central bank and government can fire. It has staved off the wholesale collapse we have seen in the United States.

When we look back at the stock market collapse of 1929, no one could foresee the subsequent collapses of 1932 and 1937.

Investors are banking on the belief that the economic recovery has started. But just because believe something doesn't make it true. People believe that there is a recovery... and that it is the result of stimulus efforts by the feds.

However the results from the second quarter show the economy still contracting... albeit at a slower pace, just -1% annually, rather than the -6.4% recorded in the first quarter. This is heralded throughout the world as proof that the crisis is receding.

It if weren't for stimulus spending, the contraction [in the 2nd quarter] would have been closer to -4%.

It's how the government has been staving off collapse in the general economy.

In 1930 the world had thought the economy had recovered. Seventy-nine years later, most people cannot remotely fathom how a populace couldn't have realized that they were in the grips of 15 years of difficult economic times.

The stage is being set for our generation to understand it... succinctly.

On Vancouver Condo Info, there was an interesting comment posted by a mortgage broker:

“I am lender and have first hand knowledge regarding speculators holding out. Most of them have VRM (variable rate mortgages) of 0.75% to 0.90% below Prime. So currently their mortgage rate is between 1.35 to 1.50%. How many of them lock up into 5 year term when the rate was 3.5%? Very few. It is very hard for a person to lock up with a 2.0% rate increase rightaway especially if they are thinking short term to sell. I have none of my clients lock up. So if the Prime goes up next year by big numbers, you will see lots of blood.”

Yes, yes we will.

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More US housing/economic news

As we said yesterday, US housing statistics are significant because mortgages are a significant part of the foundation of the U.S. banking system. If they stabalize, it will encourage more lending and, in turn, help get the economy on the mend.

Today RealtyTrac came out with their U.S. Foreclosure Market Report.

A total of 336,173 foreclosure filings — default notices, auction sale notices and bank repossessions — were reported in June 2009, a 5% increase from the previous month and a 33% jump from June of 2008.

The foreclosure filings were the fourth straight monthly total exceeding 300,000 and helped to boost the second quarter total to the highest quarterly total since RealtyTrac began issuing its report in the first quarter of 2005.

Meanwhile another report estimates the percentage of properties “underwater” will rise to 48%, or 25 million homes, as property prices drop through the first quarter of 2011. Deutsche Bank analysts Karen Weaver and Ying Shen note that Deutsche Bank estimates 26% of homeowners are currently underwater. That means this figure will almost double in the coming year.

I guess Deutsche Bank didn't get the memo about house prices finding a bottom.

And where does Deutsche Bank sees the next wave of trouble coming from?

From the formerly secure, blue chip mortgages involving larger valued mortgages for properties from prime mortgage holders (in the US known as Jumbo and Jumbo Prime).

"While subprime and Option ARMs are currently the worst cohorts with underwater borrowers, we project that the next phase of the housing decline will have a far greater impact on prime borrowers (conforming and jumbo) ... By Q1 2011, we estimate that 41% of prime conforming borrowers and 46% of prime jumbo borrowers will be underwater, a significant increase over the percentage of these borrowers in Q1 2009. The impact of this is significant given that these markets have the largest share of the total mortgage market outstanding."

One of the biggest components of the US government plan to help US homeowners is to encourage banks to modify mortgage loans and 'work with' homeowners.

The problem is modification won't help these home, errr... debt-owners. Most modifications just capitalize missed payments and expenses, and either lower the interest rate for a few years or extend the term leaving the homeowner underwater.

In fact so ineffective is the US goverment 'modification' initiative that these modifications have come to be jokingly referred to as 'pretend and extend'.

Pretend and extend. Almost sounds like they're describing this 'supposed' recovery phase we are entering.

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Conflicting US Housing News

Last week the Vancouver Sun carried a story out of New York that proclaimed home prices in major US cities rose in May for the first time in nearly three years.

The closely watched Case-Shiller home-price index, put out by Standard & Poor’s, marked its first increase since July 2006. The index gained 0.5% in May from the previous month.

A small increase, to be sure, but after several months of sharp declines of 2% or more the increase was hearlded as a welcome sign of stability for the U.S. housing market.

This turnaround in housing market statistics is considered significant because it will help stabilize the U.S. banking system and encourage more lending, which would help get the economy on the mend.

But... as always... the news might not be as good as it appears.

This week two analysts for Barclay's (one of the leading providers of personal loans and mortgages) came out and disputed the statistics.

Barclays' analysts Ajay Rajadhyaksha and Glenn Boyd wrote that while the S&P/Case-Shiller index for May showed the first month-over-month price increase since 2006 and a 2 percent seasonally adjusted annualized drop, a more-accurate reading probably would have been an annualized decline of 10 to 15%.

"Seasonally adjusted home-price data has been skewed higher during the spring months of this year and last year by an 'amplified' version of typical patterns, according to the analysts. More homeowners sell their properties during those months, cutting the share of foreclosed homes being offloaded at distressed prices, as new buyers focus on 'desirable neighborhoods' where values hold up better."

"Data reflecting a reversal of the seasonal benefit, as well as a tide of new foreclosure sales' as a moratorium on the seizing of homes put in place by banks subsides, will lead to 'renewed weakness' in the fall," they said.

Rajadhyaksha and Boyd project that U.S. home prices will fall an additional 11% on average before bottoming next year, bringing the total decline to 40% nationally from their peak.

The Barclay's analysts are raining on the parade of some soothsayers who are seeing green shoots that indicate the recession is nearing an end. They cling to the belief that this would mean that even if prices and economic activity don’t shoot back up to boom levels, they would at least stop falling.

But the Barclay's analysts are seeing the same thing that we have been talking about on this blog... another mortgage problem looming on the horizon before this whole situation calms down.

Option ARM's.

The bulk of Option ARM's are going to reset in 2011. These are the ‘pick a payment‘ mortgage products that were marketed as perfect for sophisticated buyers with growing incomes.

The problem was they could quickly get out of hand if the buyer chooses the negative amortization route. In the US about 40% of these loans made in 2006 - 2007 are already delinquent.

New Barclay's Capital research shows that the recasts in the next year or so are expected to be a minor event. But by mid-2011, these borrowers are forecast to see payments that are 50% to 80% higher than what they are grappling with now. (Many of these option ARM's are concentrated in former hot-spot real estate markets, such as California and Florida.)

Loan modification attempts by banks don’t seem to be working with these particularly noxious loans.

In the face rising payments, borrowers don’t have an incentive to keep up with their current payments for homes that are already so horrendously under water, i.e. the loan amount is far above the current value of the property.

Barclay's says that many of the option ARM loans that do get modified turn delinquent soon afters anyway.

They’ve crunched some numbers and forecast that 95% of the loans that are slated for modification will eventually default.

If you think that sounds bad, get this: They say that 80% of the option ARM loans out there that are ok and up-to-date as of right now will eventually default, too.

The message?

There's a heap o' mortgage pain still on the horizon. Pain which is going to wreck havoc on the U.S. banking system, continue to impair lending, and further prevent the world economy from mending.

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A Yang for your Ying

According to the philosophy, yin and yang are complementary opposites within a greater whole. Everything has both yin and yang aspects, which constantly interact, never existing in absolute stasis.

If you come to this blog on a daily basis, then allow me to provide a ying for your yang: a bullish retort to my bearish sentiments.

I stumbled across this blog appropriately titled "Van Housing Bull".

The author hopes his blog will become "the antidote to some of the more popular bear blogs out there."

Our newly publishing bull would like to explain the hard, cold reality of the "Invisible Hand of Income Inequality" to you.

Why are Vancouver's real estate prices so high?

It's simple: Rich people have money, you don't. Vancouver is a great place to live, so rich people from all over the world will pay to live here here.

Our Bull blogger opines that a recent Dunbar area home (recently listed and sold for $949,000), could easily have been sold to a couple who were both high income earners of $90,000 per annum each.

This dual family income of $180,000 per year would have necessitated an downpayment of $195,000 - feasible if, as the bull contends, it came "from inheritance, from an asset sale, from the sale of a business, or maybe it was just saved earnings! Is it that hard to imagine our hypothetical couple saving $50,000 to $100,000 each – maybe because they’re too busy working to spend their earnings – and then topping it off with a gift from both sides of the family towards their first purchase? Or what if these people are just stinking rich or come from very well-off families? Why is this so hard to believe? Maybe bears aren’t good at empathizing with bull."

Our 'bull' goes on to list 5 detailed problems with the bear arguments about Vancouver real estate and then summarizes that, "Bears are complaining about high prices because they’re too high. But too high for whom? They don’t think the prices are worth it. But does it compute that it might be the right price for other buyers? How can one justify buying a $250,000 car? Because it’s worth it to them... The bottom line is that the reason why prices are so 'high' is because there is, amongst the buying public, a huge and large income inequality. It’s that simple."

So there you have it from a bull's mouth. Prices aren't high because they are out of whack. They are high because people with money want to live here and will pay what it takes. Stop whining and suck it up, losers!

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Sunday Funnies - August 2nd, 2009

(Click on image to enlarge)

And, lastly, Arnold's Schwarzenegger's California in debt...

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Economist: "China numbers are fake"... And Bank Failure Friday.

As faithful readers know, I have made several posts warning about the 'supposed' economic growth in China and have questioned the wisdon in pinning our hopes of economic recovery on China's growth.

Now noted economist Marc Faber, in his latest Gloom, Boom and Doom report, states that "China's economy is growing at 2%, not the 7.8% its government claims."

A growing number of investors turned bullish on China after its markets began to rise last March. But as we have noted here, China has been throwing massive amounts of stimulus money at it's economy.

As Faber notes, “if you throw money at the system, lots of things go up in value — but maybe they go up for the wrong reasons. What disturbs me today … is that the lows in March and late last year, sentiment was incredibly bearish about everything.”

Now, Faber observes, “there’s this incredibly bullish sentiment when insiders are actually selling and the technical picture of the market doesn’t look that great.”

China is in the midsts of a massive bubble buildup. Watch for a global impact when it bursts.

Bank Failure Friday

After seven failures last Friday in the United States, another five banks failed today brining the year's total to 69.

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Why Interest Rates Will Collapse Real Estate Prices

We've discussed this before, but it's worth re-iterating.

Rising interest rates will collapse real estate prices in Vancouver.

And make no mistake, interest rates are going up.

Last week the govenor of the Bank of Canada (Mark Carney) urged that "Canadians should be preparing for the day when their borrowing costs eventually return to more normal levels."

Canada's historic 'normal' is 8%. That represents more than a doubling of current rates.

Real estate prices can be set to whatever level the seller desires, however the value of a house will eventually settle to the price that buyers can actually afford.

And since very, very few people buy a house with cash, what people can afford will be determined by interest rates.

A doubling of interest rates will slash what people can afford in half.

Charles Hugh Smith (www.oftwominds.com) has produced these charts to demonstate the see-saw relationship between housing prices and interest rates (click on image to enlarge).

In the graph above, a low interest rate (in this case 4.5%) will produce a monthly mortgage payment of $1,850 on a $500,000 mortgage.

But if the interest rates doubles, in this case to 9%, then...

... then a monthly payment of $1,850 will only allow a buyer to assume a $250,000 mortgage.

Which brings us back to the original issue: "The value of a house will eventually settle to the price that buyers can actually afford."

In the absence of a vibrant economy that generates more income for buyers to assume larger mortgages at higher rates, buyers are forced to reduce the size of a mortgage they can assume.

And a voracious demand for global capital is on the cusp of forcing interest rates back to historic norms (if not higher), it means a return to 'normal' interest rate levels will wipe out the market for average Vancouver homes that sell in the current bubble inflated $800,000 to $1.5 million range.

Buyers will only be able to afford mortgages at half the current amounts... a stalled economic recovery will guarantee this.

(lower, if rates spike to 11% or higher)

Canadians snapping up $600,000 plus mortgages today because they can 'finally' afford them with these historic low interest rates of 3% are making the worst financial decision of their entire lives.

Not only will 'normal' interest rates reduce other homes to half of what they paid for theirs... when these Canadians go to renew their mortgages after their 1-5 year term expires... they will be in a massive underwater position and they will default on their own mortgages.

It's an outcome that will only further depress market prices.

Their only hope lies in interest rates returning to low levels very quickly once they rise to this point.

And that's not going to happen.

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The Capital Trap

When you think about it, interest rates are the story in real estate now... and they are the story in the foreseeable future.

The current mini-boom in real estate sales/values is the artificial creation of the Bank of Canada's stimulus efforts.

The lowest central bank rate in history has Canadians back on the home-buying binge re-creating rising prices and multiple offers from the bubble years. All despite the fact that we are in the middle of the greatest recession since the Great Depression.

But it is these very interest rates that are dooming many buyers who are making the worst financial decision of their entire lives.

The Bank of Canada has lured them into a Capital Trap.

The first key concept here is that a house is only worth what someone can afford to pay for it. The second key concept is that very, very few people buy a house with cash.

The vast majority of real estate purchases are financed with mortgages-- with debt.

And credit is lent to homebuyers at a rate of interest... a rate that is currently at historic lows.

We've all read about the $2 trillion Federal deficit for this fiscal year and I have posted many entries about it. At the right is a US National Debt clock showing the exploding interest on that debt that the US government must service.

But that's only one element you have to consider. Every other government on the planet (yes, even the Chinese government as I posted here recently) is also anxious to borrow huge sums of money from someone to fund their exploding deficit spending.

Don't forget the corporations, local governments, agencies and real estate buyers who want to borrow money.

The point is: the demand for surplus capital far exceeds the supply of global surplus capital.

And as the voracious US government demand for debt servicing continues to grow, surplus money looking for a home is drying up even as the demand for surplus capital skyrockets.

The net result is interest rates will have to rise--and soon. While it is impossible to predict exact dates, simple laws of supply and demand dictate that rates will soon rise and will rise steeply as the shortfall between what governments want to borrow and what's available to borrow becomes visible (not to mention private demand for capital).

Most observers, which include the governor of the Bank of Canada (see post earlier this week), agree rates will double from the current market rate of about 4% to at least 8-9%.

Real estate prices can be set to whatever level the seller desires. However the value of a house will eventually settle to the price the buyers can actually afford.

And since since very, very few people buy a house with cash, when interest rates double, house prices will drop in half, regardless of any other conditions.

Interest rates are driving the buying frenzy/mini-boom now. And shortly interest rates will drive the market collapse.

Tomorrow we will discuss why house prices will be dropping by half in the very near future.

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