Sunday, October 31, 2010

All Hallows' Eve



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Saturday, October 30, 2010

Riddle me this

The big debate in the financial world right now is "how large will next week's second round of American Quantative Easing be?"

it's the wrong question for a variety of reasons and I hope to touch on them at some point during the week.

The mantra being repeated over and over is the looming threat of deflation. The supposed intent of QE 2 is to lower interest rates to promote job growth and avoid the apparently growing threat of deflation. But the very idea that the economy is weak because interest rates are too high is laughable.

One of the greatest elements that threatens deflation, as the US Federal Reserve is quick to point to, is falling real estate prices.

But here's a question for you.

Why, when real estate prices were rising, didn't the Federal Reserve (or our own Bank of Canada) raise interest rates to bring them down?

Now that they are falling, the US central bank (as well as the BOC) feels compelled to lower rates to prop them up.

If falling real estate prices threaten deflation, why was there not concern about an inflation threat when real estate prices were rising?

Under the new way CPI is calculated, housing is neither inflationary or deflationary.

In his weekly Op Ed column, Peter Schiff has a theory. He thinks the spectre of deflation is a red herring;

  • "All this deflation talk is a red herring. The true purpose of QE 2 is to disguise the decreasing ability of the Treasury to finance its debts. As global demand for dollar-denominated debt falls, the Fed is looking for an excuse to pick up the slack. By announcing QE 2, it can monetize government debt without the markets perceiving a funding problem. If the truth were known, a real panic would ensue. So, the Fed pretends buying treasuries is simply part of its master plan to boost the economy, even though, in reality, it is simply acting as the buyer of last resort."

Monetization of the debt under the guise of economic stimulus. More on this as the week goes on.



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Friday, October 29, 2010

Only 24% of BC Boomers own their home mortgage free

How's this for a looming disaster on the horizon?

According to a news release by TD Canada Trust, only 24% of BC Boomers own their home mortgage free (hat tip to pipewrench in yesterday's comments section).

In addition to that chilling statistic, TD Canada Trust found that only 40% of BC Boomers are likely to live in their current home during retirement.

This is consistent with an new Ipsos-Reid poll that says 64% of BC homeowners plan to sell their homes within the next 10 years.

Can you see the recipe for disaster here?

We already know that 70% of all Boomers don't have funds set aside for retirement. Any retirement funds they hope to have will come from the sale of their home.

These two studies all but confirm that Boomer's plans are to down-size, pay off their mortgages, move to a smaller home and use the left over funds as their retirement income.

And to make that work more effectively, TD Canada Trust has found that almost half of boomers in B.C. will consider buying a property south of the border where real estate has completely crashed in the United States.

The chilling statistic here is that since over 75% of BC Boomers have an outstanding mortgage to pay off, it leaves them in a potential retirement pickle.

Once they pay off the mortgage, and then buy a smaller, cheaper house free and clear... there's only so much room left over for a retirement fund.

When you consider that this is the first year that Boomers are hitting retirement age, and that right now they are selling into a stagnating market, how long before we see the significant price reductions start?

And when the downward slide begins, how long before those other Boomers - a couple of years out from retirement - start to panic?

How long before they see the margins on their bubble inflated homes begin to shrink to the point where they fear prices dropping below a level they need to cash out and still have a retirement fund?

Bank of Canada Governor Mark Carney has suggested there is a possibility of "an abrupt drop in the housing market". What sort of mad dash will there be to slash prices and 'get out' if there is a perception the market has started that 'abrupt drop'?

If there is a 15% market drop, without a rebound like we saw in 2009, you will see a lot of Boomers panicking.

And panicking Boomers who fear their retirement is at stake will slash prices to move their property ASAP.

There is far too much at stake not to.

It all strengthens my belief that Vancouver is shaping up to experience the mother of all housing collapses.

I can easily see a 50% price correction and firmly believe it will be closer to 70% as the Boomer wave moves into retirement.



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Thursday, October 28, 2010

Afternoon Update on Silver-Gate

Following up on Silver-Gate (see this morning's post) comes this news...

JPMorgan Chase & HSBC have been hit with two lawsuits by investors who accused them of conspiring to drive down silver prices.

The accusation is that these two banks manipulated the market for COMEX silver futures and options contracts from the first half of 2008 by amassing huge short positions in silver futures contracts that are designed to profit when prices fall.

The lawsuits were filed one day after the Commodity Futures Trading Commission proposed regulations to give it greater power to thwart traders who try to manipulate prices. The CFTC began probing allegations of silver price manipulation in September 2008.

As we mentioned this morning, CFTC Commissioner Bart Chilton has publicly stated that there had been "fraudulent efforts to persuade and deviously control" silver prices.

Earlier this year, the CFTC began looking into allegations by a London trader that JPMorgan was involved in manipulative silver trading.



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Carney-Speak and Silver-Gate

Yesterday was an interesting day and I would be remiss not to touch on a couple of significant real estate developments.

First off there was a survey by the well respected Economist magazine which shows Canadian real estate overpriced by 23.9%. If that's the national average, how overpriced do you think real estate is in this town? To say at least 50% wouldn't be far off the mark.

Meanwhile, in Ottawa, Bank of Canada Governor Mark Carney was appearing before the Commons finance committee and was asked the following question:

"Do you think the housing market could collapse here, as it did in the States?"

Replied Carney:

"I am not predicting a significant drop in prices, but given how far prices have risen and the high level of Canadians’ household debt, an abrupt drop in the housing market cannot be ruled out."

An abrupt drop in the housing market cannot be ruled out!

Now... if you know anything about the Governor of the Bank of Canada, you know that markets can rise and fall on what this man says. Speeches and statements are very, very carefully worded for just that reason.

This was no slip of the tongue by Carney. It's significant and telling.

A few words on Silver

As you know, one of the topics I speak about regularly on this blog is Quantitative Easing, aka money printing.

I have stated in the past that, with all the money printing and currency devaluing going on, it is a no-brainer that the price of Gold and Silver is going to rise significantly in the years ahead. How far it will rise is a matter of debate.

And within that debate there is a sub debate that rages about price fixing that goes on in the paper Gold and Silver markets.

Now, I'm not going to delve into that debate, but an interesting development surfaced yesterday.

As reported by Reuters, a commissioner of the Commodity Futures Trading Commission made a stunning accusation.

Giving credence to the claims of critics, CFTC Commissioner Bart Chilton said, "there have been fraudulent efforts to persuade and deviously control that price (of silver)." Chilton's prepared remarks were made before a Commodity Futures Trading Commission meeting on Tuesday as events heat up for a full scale investigation into manipulation in the silver markets.

Critics has longed maintained the the metal has been suppressed. Historically silver has always floated at a 16:1 ratio with Gold.

Currently Silver fluctuates between $23 and $24 an ounce (US$). If the historic 16:1 ratio were at play, critics argue Silver should be at $82 an ounce today.

Many claim the dramatic gains Silver has made recently are due, in part, to the heightened scrutiny the manipulation claims have been getting.

Last month Garth Turner suggested Gold could go to $3,000 an ounce. If Silver were to float back to it's 16:1 ratio with Gold, at that level Silver would sit at almost $190 an ounce.

I know I'll be watching the investigation by the CFTC with keen interest.



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Wednesday, October 27, 2010

Mid Morning Update: Run Turkey Run - it's a Ponzi Scheme!

(This is the 2nd post of the day: below is a post on collapsing new unit real estate sales)

Bill Gross is a hugely successful bond fund manager and the co-chief investment officer of Pimco. He personally manages the company's flagship, the Total Return Fund, which has $158 billion in assets.

Gross is highly influential and US Treasury secretaries call him for advice. Warren Buffett, the Berkshire Hathaway chairman, and Alan Greenspan, the former Federal Reserve chairman, sing his praises.

So keen attention is being paid to comments Gross made today in an investment outlook report he put out this morning.

He calls next Wednesday's planned QE2 by the Federal Reserve an attempted hypodermic straight to the economy’s heart; an adrenaline injection with a following morphine drip.

Gross then makes a stunning statement. He says:
  • We are, as even some Fed Governors now publically admit, in a “liquidity trap,” where interest rates or trillions in QE2 asset purchases may not stimulate borrowing or lending because consumer demand is just not there. Escaping from a liquidity trap may be impossible, much like light trapped in a black hole

Gross supports Bernanke's moves because "it is, to be honest, all he can do. He can’t raise or lower taxes, he can’t direct a fiscal thrust of infrastructure spending, he can’t change our educational system, he can’t force the Chinese to revalue their currency – it is all he can do."

But while Gross gives Bernanke his 'qualified endorsement', he admits bondholders will likely eventually be delivered on a platter to more fortunate celebrants.

  • (Cheque) writing in the trillions is not a bondholder’s friend; it is in fact inflationary, and, if truth be told, somewhat of a Ponzi scheme. Public debt, actually, has always had a Ponzi-like characteristic.

Then Gross delivers this stunning conclusion which so many bloggers have been saying for over two years now. Remember... this is not a tin foil hat blogger, but a respected confidant of both Buffet and Greenspan:

  • Now, however, with growth in doubt, it seems that the Fed has taken Charles Ponzi one step further. Instead of simply paying for maturing debt with receipts from financial sector creditors – banks, insurance companies, surplus reserve nations and investment managers, to name the most significant – the Fed has joined the party itself. Rather than orchestrating the game from on high, it has jumped into the pond with the other swimmers. One and one-half trillion in checks were written in 2009, and trillions more lie ahead. The Fed, in effect, is telling the markets not to worry about our fiscal deficits, it will be the buyer of first and perhaps last resort. There is no need – as with Charles Ponzi – to find an increasing amount of future gullibles, they will just write the check themselves. I ask you: Has there ever been a Ponzi scheme so brazen? There has not. This one is so unique that it requires a new name. I call it a Sammy scheme, in honor of Uncle Sam and the politicians (as well as its citizens) who have brought us to this critical moment in time.

The Ponzi of all Ponzi schemes. Couldn't have said it better, Bill.



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Days go by...

I'm itching to talk more about inflation and Quantative Easing as the investment community sits on pins and needles in anticipation of QE 2 on November 3rd, but let's switch back to real estate here in the Village on the Edge of the Rainforest.

Days go by and still no movement from sellers or buyers.

Cruise through Yaletown and you can't help but marvel at all the developments moving along, soon to come onto the market. Developers must be freaking out.

For four consecutive months real estate numbers have been abysmal. Not only are they down 40% from the same time last year (and October is shaping up to make it 5 months in a row), but the totals are the lowest in the last 10 - 15 years.

But that horror show is nothing compared to what is shaping up in the new units category for October.

Thanks to Inventory, who as posted numbers in the comments section once again over on VCI, we learn that October's numbers for brand new condos, townhouses and houses are absolutely falling off a cliff.

As of October 25th, total new units sold for the month sits at 131 which is an astonishing 70% below last years totals.

Zeroing in on new condo sales total sales as of October 25th is sitting at 62, which is 71% below last years totals.

The slow melt continues and sales of new units are completely cratering. It's 5 months and counting... the days go by.

Oct New unit sales

1994 = 379
1995 = 492
1996 = 450
1997 = 321
1998 = 266
1999 = 325
2000 = 212
2001 = 257
2002 = 336
2003 = 813
2004 = 490
2005 = 705
2006 = 391
2007 = 428
2008 = 158
2009 = 445
2010 = 131 (as of Oct 25: -70%)

Oct New Condo sales

1994 = 181
1995 = 322
1996 = 253
1997 = 159
1998 = 134
1999 = 217
2000 = 84
2001 = 130
2002 = 165
2003 = 606
2004 = 354
2005 = 478
2006 = 195
2007 = 262
2008 = 94
2009 = 219
2010 = 62 (as of Oct 25: -71%)



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Tuesday, October 26, 2010

More on inflation and... why we will see the US print money to infinity

Adding further to my argument that we are actually dealing with inflation and deflation at the same time comes this little treatsie from McDonalds.

Yesterday McDonald's said it was preparing to raise prices to cover higher costs of commodities.

McDonald's has not raised prices since late 1990 and the firm has said it expected commodity costs to rise up to 3% in 2011. The price hikes are expected in Europe and the United States, but the firm did not release details.

Meanwhile, if it interests you, check out this excellent post on Washington's Blog on the real dangers of the Foreclosure Crisis.

As we have talked about the past few weeks, the potential securitization problem is why bank stocks are now in trouble. Along with those concerns come this intriguing quote from former Managing Director of Goldman Sachs, Nomi Prins. He points out that US Federal Reserve Chairman Ben Bernanke and US Secretary of the Treasury, Timothy Geithner are both terrified of a meltdown in the securitization market:
  • The reason TARP and all the other subsidies happened was that Hank Paulson, Ben Bernanke, Tim Geithner (the pillage gang) and the most powerful Wall Street CEOs were scared. Banks had stopped trusting each other (no one cared about the person who couldn’t pay their mortgage, or had their home taken, whatever the reason). When there is no confidence in the market, there is no bid for securities, no matter what the reason.

    The banks couldn’t pay for all their leverage and they were facing bankruptcy if the system remained seized up. So the gang paid to keep the securitization market going, by finding a home or back-up home for the assets. They did not propose any remotely effective plan to help individuals at the loan level .... They merely enabled the worst practices and excesses to keep going in the name of saving the country from a greater depression, by shifting them to Washington and providing the illusion of demand for them.

Follow that up by checking out this interview with Chris Whalen on the Foreclosure Crisis, mortgage backed securities and the slow moving time bomb represented by the whole mess...

Then there is this from Nouriel Roubini on CNBC.

Roubini says U.S. states are in for it.

Municipal debt is up to 20% of GDP, he said. And unfunded liabilities of state and local pension funds? Those are as high as $3 trillion — another 20% of GDP. So, basically, get ready — especially in Quarter 1 when states can no longer use federal money to plug their budget holes.

“The issue is whether the Federal government will bail out state and local governments with a federal guarantee of their debt,” Roubini said, likening the scenario to the money received by Greece and to be generalized to other Eurozone members in trouble via the new European "stabilization fund."

Some might call it the trillion dollar question: what will the government do if the states fail?

The possibility of states failing, is no longer a scary hypothetical. Roubini said that many US states are semi-insolvent. According to a report by the Center on Budget and Policy Priorities, forty-eight states addressed shortfalls in their fiscal year 2010 budgets, totaling $191 billion or 29% of state budgets — the largest gaps on record.

QE 2 is not the question. The real question is, how large will QE 3 and 4 be.

Finally, via John Maullin, comes this excerpt from Michael Hudson's new book "How a Gang of Predatory Lenders and Wall Street Bankers Fleeced America - and Spawned a Global Crisis". The introduction gives an excellent peak into the beginnings of the Foreclose Mess.

  • Introduction:
    Bait and Switch

    A few weeks after he started working at Ameriquest Mortgage, Mark Glover looked up from his cubicle and saw a coworker do something odd. The guy stood at his desk on the twenty-third floor of downtown Los Angeles's Union Bank Building. He placed two sheets of paper against the window. Then he used the light streaming through the window to trace something from one piece of paper to another. Somebody's signature.

    Glover was new to the mortgage business. He was twenty-nine and hadn't held a steady job in years. But he wasn't stupid. He knew about financial sleight of hand—at that time, he had a check-fraud charge hanging over his head in the L.A. courthouse a few blocks away. Watching his coworker, Glover's first thought was: How can I get away with that? As a loan officer at Ameriquest, Glover worked on commission. He knew the only way to earn the six-figure income Ameriquest had promised him was to come up with tricks for pushing deals through the mortgage-financing pipeline that began with Ameriquest and extended through Wall Street's most respected investment houses.

    Glover and the other twentysomethings who filled the sales force at the downtown L.A. branch worked the phones hour after hour, calling strangers and trying to talk them into refinancing their homes with high-priced "subprime" mortgages. It was 2003, subprime was on the rise, and Ameriquest was leading the way. The company's owner, Roland Arnall, had in many ways been the founding father of subprime, the business of lending money to home owners with modest incomes or blemished credit histories. He had pioneered this risky segment of the mortgage market amid the wreckage of the savings and loan disaster and helped transform his company's headquarters, Orange County, California, into the capital of the subprime industry. Now, with the housing market booming and Wall Street clamoring to invest in subprime, Ameriquest was growing with startling velocity.

    Up and down the line, from loan officers to regional managers and vice presidents, Ameriquest's employees scrambled at the end of each month to push through as many loans as possible, to pad their monthly production numbers, boost their commissions, and meet Roland Arnall's expectations. Arnall was a man "obsessed with loan volume," former aides recalled, a mortgage entrepreneur who believed "volume solved all problems." Whenever an underling suggested a goal for loan production over a particular time span, Arnall's favorite reply was: "We can do twice that." Close to midnight Pacific time on the last business day of each month, the phone would ring at Arnall's home in Los Angeles's exclusive Holmby Hills neighborhood, a $30 million estate that once had been home to Sonny and Cher.On the other end of the telephone line, a vice president in Orange County would report the month's production numbers for his lending empire. Even as the totals grew to $3 billion or $6 billion or $7 billion a month—figures never before imagined in the subprime business—Arnall wasn't satisfied. He wanted more. "He would just try to make you stretch beyond what you thought possible," one former Ameriquest executive recalled. "Whatever you did, no matter how good you did, it wasn't good enough."

    Inside Glover's branch, loan officers kept up with the demand to produce by guzzling Red Bull energy drinks, a favorite caffeine pick-me-up for hardworking salesmen throughout the mortgage industry. Government investigators would later joke that they could gauge how dirty a home-loan location was by the number of empty Red Bull cans in the Dumpster out back. Some of the crew in the L.A. branch, Glover said, also relied on cocaine to keep themselves going, snorting lines in washrooms and, on occasion, in their cubicles.

    The wayward behavior didn't stop with drugs. Glover learned that his colleague's art work wasn't a matter of saving a borrower the hassle of coming in to supply a missed signature. The guy was forging borrowers' signatures on government-required disclosure forms, the ones that were supposed to help consumers understand how much cash they'd be getting out of the loan and how much they'd be paying in interest and fees. Ameriquest's deals were so overpriced and loaded with nasty surprises that getting customers to sign often required an elaborate web of psychological ploys, outright lies, and falsified papers. "Every closing that we had really was a bait and switch," a loan officer who worked for Ameriquest in Tampa, Florida, recalled. " 'Cause you could never get them to the table if you were honest." At companywide gatherings, Ameriquest's managers and sales reps loosened up with free alcohol and swapped tips for fooling borrowers and cooking up phony paperwork. What if a customer insisted he wanted a fixed-rate loan, but you could make more money by selling him an adjustable-rate one? No problem. Many Ameriquest salespeople learned to position a few fixed-rate loan documents at the top of the stack of paperwork to be signed by the borrower. They buried the real documents—the ones indicating the loan had an adjustable rate that would rocket upward in two or three years—near the bottom of the pile. Then, after the borrower had flipped from signature line to signature line, scribbling his consent across the entire stack, and gone home, it was easy enough to peel the fixed-rate documents off the top and throw them in the trash.

    At the downtown L.A. branch, some of Glover's coworkers had a flair for creative documentation. They used scissors, tape, Wite-Out, and a photocopier to fabricate W-2s, the tax forms that indicate how much a wage earner makes each year. It was easy: Paste the name of a low-earning borrower onto a W-2 belonging to a higher-earning borrower and, like magic, a bad loan prospect suddenly looked much better. Workers in the branch equipped the office's break room with all the tools they needed to manufacture and manipulate official documents. They dubbed it the "Art Department."

    At first, Glover thought the branch might be a rogue office struggling to keep up with the goals set by Ameriquest's headquarters. He discovered that wasn't the case when he transferred to the company's Santa Monica branch. A few of his new colleagues invited him on a field trip to Staples, where everyone chipped in their own money to buy a state-of-the-art scanner-printer, a trusty piece of equipment that would allow them to do a better job of creating phony paperwork and trapping American home owners in a cycle of crushing debt.

    Carolyn Pittman was an easy target. She'd dropped out of high school to go to work, and had never learned to read or write very well. She worked for decades as a nursing assistant. Her husband, Charlie, was a longshoreman.In 1993 she and Charlie borrowed $58,850 to buy a one-story, concrete block house on Irex Street in a working-class neighborhood of Atlantic Beach, a community of thirteen thousand near Jacksonville, Florida. Their mortgage was government-insured by the Federal Housing Administration, so they got a good deal on the loan. They paid about $500 a month on the FHA loan, including the money to cover their home insurance and property taxes.

    Even after Charlie died in 1998, Pittman kept up with her house payments. But things were tough for her. Financial matters weren't something she knew much about. Charlie had always handled what little money they had. Her health wasn't good either. She had a heart attack in 2001, and was back and forth to hospitals with congestive heart failure and kidney problems.

    Like many older black women who owned their homes but had modest incomes, Pittman was deluged almost every day, by mail and by phone, with sales pitches offering money to fix up her house or pay off her bills. A few months after her heart attack, a salesman from Ameriquest Mortgage's Coral Springs office caught her on the phone and assured her he could ease her worries. He said Ameriquest would help her out by lowering her interest rate and her monthly payments.

    She signed the papers in August 2001. Only later did she discover that the loan wasn't what she'd been promised. Her interest rate jumped from a fixed 8.43 percent on the FHA loan to a variable rate that started at nearly 11 percent and could climb much higher. The loan was also packed with more than $7,000 in up-front fees, roughly 10 percent of the loan amount.

    Pittman's mortgage payment climbed to $644 a month. Even worse, the new mortgage didn't include an escrow for real-estate taxes and insurance. Most mortgage agreements require home owners to pay a bit extra—often about $100 to $300 a month—which is set aside in an escrow account to cover these expenses. But many subprime lenders obscured the true costs of their loans by excluding the escrow from their deals, which made the monthly payments appear lower. Many borrowers didn't learn they had been tricked until they got a big bill for unpaid taxes or insurance a year down the road.

    That was just the start of Pittman's mortgage problems. Her new mortgage was a matter of public record, and by taking out a loan from Ameriquest, she'd signaled to other subprime lenders that she was vulnerable—that she was financially unsophisticated and was struggling to pay an unaffordable loan. In 2003, she heard from one of Ameriquest's competitors, Long Beach Mortgage Company.

    Pittman had no idea that Long Beach and Ameriquest shared the same corporate DNA. Roland Arnall's first subprime lender had been Long Beach Savings and Loan, a company he had morphed into Long Beach Mortgage. He had sold off most of Long Beach Mortgage in 1997, but hung on to a portion of the company that he rechristened Ameriquest. Though Long Beach and Ameriquest were no longer connected, both were still staffed with employees who had learned the business under Arnall.

    A salesman from Long Beach Mortgage, Pittman said, told her that he could help her solve the problems created by her Ameriquest loan. Once again, she signed the papers. The new loan from Long Beach cost her thousands in up-front fees and boosted her mortgage payments to $672 a month.

    Ameriquest reclaimed her as a customer less than a year later. A salesman from Ameriquest's Jacksonville branch got her on the phone in the spring of 2004. He promised, once again, that refinancing would lower her interest rate and her monthly payments. Pittman wasn't sure what to do. She knew she'd been burned before, but she desperately wanted to find a way to pay off the Long Beach loan and regain her financial bearings. She was still pondering whether to take the loan when two Ameriquest representatives appeared at the house on Irex Street. They brought a stack of documents with them. They told her, she later recalled, that it was preliminary paperwork, simply to get the process started. She could make up her mind later. The men said, "sign here," "sign here," "sign here," as they flipped through the stack. Pittman didn't understand these were final loan papers and her signatures were binding her to Ameriquest. "They just said sign some papers and we'll help you," she recalled.

    To push the deal through and make it look better to investors on Wall Street, consumer attorneys later alleged, someone at Ameriquest falsified Pittman's income on the mortgage application. At best, she had an income of $1,600 a month—roughly $1,000 from Social Security and, when he could afford to pay, another $600 a month in rent from her son. Ameriquest's paperwork claimed she brought in more than twice that much—$3,700 a month.

    The new deal left her with a house payment of $1,069 a month—nearly all of her monthly income and twice what she'd been paying on the FHA loan before Ameriquest and Long Beach hustled her through the series of refinancings. She was shocked when she realized she was required to pay more than $1,000 a month on her mortgage. "That broke my heart," she said.

    For Ameriquest, the fact that Pittman couldn't afford the payments was of little consequence. Her loan was quickly pooled, with more than fifteen thousand other Ameriquest loans from around the country, into a $2.4 billion "mortgage-backed securities" deal known as Ameriquest Mortgage Securities, Inc. Mortgage Pass-Through Certificates 2004-R7. The deal had been put together by a trio of the world's largest investment banks: UBS, JPMorgan, and Citigroup. These banks oversaw the accounting wizardry that transformed Pittman's mortgage and thousands of other subprime loans into investments sought after by some of the world's biggest investors. Slices of 2004-R7 got snapped up by giants such as the insurer MassMutual and Legg Mason, a mutual fund manager with clients in more than seventy-five countries. Also among the buyers was the investment bank Morgan Stanley, which purchased some of the securities and placed them in its Limited Duration Investment Fund, mixing them with investments in General Mills, FedEx, JC Penney, Harley-Davidson, and other household names.

    It was the new way of Wall Street. The loan on Carolyn Pittman's one-story house in Atlantic Beach was now part of the great global mortgage machine. It helped swell the portfolios of big-time speculators and middle-class investors looking to build a nest egg for retirement. And, in doing so, it helped fuel the mortgage empire that in 2004 produced $1.3 billion in profits for Roland Arnall.

    In the first years of the twenty-first century, Ameriquest Mortgage unleashed an army of salespeople on America. They numbered in the thousands. They were young, hungry, and relentless in their drive to sell loans and earn big commissions. One Ameriquest manager summed things up in an e-mail to his sales force: "We are all here to make as much fucking money as possible. Bottom line. Nothing else matters." Home owners like Carolyn Pittman were caught up in Ameriquest's push to become the nation's biggest subprime lender.

    The pressure to produce an ever-growing volume of loans came from the top. Executives at Ameriquest's home office in Orange County leaned on the regional and area managers; the regional and area managers leaned on the branch managers. And the branch managers leaned on the salesmen who worked the phones and hunted for borrowers willing to sign on to Ameriquest loans. Men usually ran things, and a frat-house mentality ruled, with plenty of partying and testosterone-fueled swagger. "It was like college, but with lots of money and power," Travis Paules, a former Ameriquest executive, said. Paules liked to hire strippers to reward his sales reps for working well after midnight to get loan deals processed during the end-of-the-month rush. At Ameriquest branches around the nation, loan officers worked ten- and twelve-hour days punctuated by "Power Hours"—do-or-die telemarketing sessions aimed at sniffing out borrowers and separating the real salesmen from the washouts. At the branch where Mark Bomchill worked in suburban Minneapolis, management expected Bomchill and other loan officers to make one hundred to two hundred sales calls a day. One manager, Bomchill said, prowled the aisles between desks like "a little Hitler," hounding salesmen to make more calls and sell more loans and bragging he hired and fired people so fast that one peon would be cleaning out his desk as his replacement came through the door.As with Mark Glover in Los Angeles, experience in the mortgage business wasn't a prerequisite for getting hired. Former employees said the company preferred to hire younger, inexperienced workers because it was easier to train them to do things the Ameriquest way. A former loan officer who worked for Ameriquest in Michigan described the company's business model this way: "People entrusting their entire home and everything they've worked for in their life to people who have just walked in off the street and don't know anything about mortgages and are trying to do anything they can to take advantage of them."

    Ameriquest was not alone. Other companies, eager to get a piece of the market for high-profit loans, copied its methods, setting up shop in Orange County and helping to transform the county into the Silicon Valley of subprime lending. With big investors willing to pay top dollar for assets backed by this new breed of mortgages, the push to make more and more loans reached a frenzy among the county's subprime loan shops. "The atmosphere was like this giant cocaine party you see on TV," said Sylvia Vega-Sutfin, who worked as an account executive at BNC Mortgage, a fast-growing operation headquartered in Orange County just down the Costa Mesa Freeway from Ameriquest's headquarters. "It was like this giant rush of urgency." One manager told Vega-Sutfin and her coworkers that there was no turning back; he had no choice but to push for mind-blowing production numbers. "I have to close thirty loans a month," he said, "because that's what my family's lifestyle demands."

    Michelle Seymour, one of Vega-Sutfin's colleagues, spotted her first suspect loan days after she began working as a mortgage underwriter at BNC's Sacramento branch in early 2005. The documents in the file indicated the borrower was making a six-figure salary coordinating dances at a Mexican restaurant. All the numbers on the borrower's W-2 tax form ended in zeros—an unlikely happenstance—and the Social Security and tax bite didn't match the borrower's income. When Seymour complained to a manager, she said, he was blasé, telling her, "It takes a lot to have a loan declined."

    BNC was no fly-by-night operation. It was owned by one of Wall Street's most storied investment banks, Lehman Brothers. The bank had made a big bet on housing and mortgages, styling itself as a player in commercial real estate and, especially, subprime lending. "In the mortgage business, we used to say, 'All roads lead to Lehman,' " one industry veteran recalled.Lehman had bought a stake in BNC in 2000 and had taken full ownership in 2004, figuring it could earn even more money in the subprime business by cutting out the middleman. Wall Street bankers and investors flocked to the loans produced by BNC, Ameriquest, and other subprime operators; the steep fees and interest rates extracted from borrowers allowed the bankers to charge fat commissions for packaging the securities and provided generous yields for investors who purchased them. Up-front fees on subprime loans totaled thousands of dollars. Interest rates often started out deceptively low—perhaps at 7 or 8 percent—but they almost always adjusted upward, rising to 10 percent, 12 percent, and beyond. When their rates spiked, borrowers' monthly payments increased, too, often climbing by hundreds of dollars. Borrowers who tried to escape overpriced loans by refinancing into another mortgage usually found themselves paying thousands of dollars more in backend fees—"prepayment penalties" that punished them for paying off their loans early. Millions of these loans—tied to modest homes in places like Atlantic Beach, Florida; Saginaw, Michigan; and East San Jose, California—helped generate great fortunes for financiers and investors. They also helped lay America's economy low and sparked a worldwide financial crisis.

    The subprime market did not cause the U.S. and global financial meltdowns by itself. Other varieties of home loans and a host of arcane financial innovations—such as collateralized debt obligations and credit default swaps—also came into play. Nevertheless, subprime played a central role in the debacle. It served as an early proving ground for financial engineers who sold investors and regulators alike on the idea that it was possible, through accounting alchemy, to turn risky assets into "Triple-A-rated" securities that were nearly as safe as government bonds. In turn, financial wizards making bets with CDOs and credit default swaps used subprime mortgages as the raw material for their speculations. Subprime, as one market watcher said, was "the leading edge of a financial hurricane."

    This book tells the story of the rise and fall of subprime by chronicling the rise and fall of two corporate empires: Ameriquest and Lehman Brothers. It is a story about the melding of two financial cultures separated by a continent: Orange County and Wall Street.

    Ameriquest and its strongest competitors in subprime had their roots in Orange County, a sunny land of beauty and wealth that has a history as a breeding ground for white-collar crime: boiler rooms, S&L frauds, real-estate swindles. That history made it an ideal setting for launching the subprime industry, which grew in large measure thanks to bait-and-switch salesmanship and garden-variety deception. By the height of the nation's mortgage boom, Orange County was home to four of the nation's six biggest subprime lenders. Together, these four lenders—Ameriquest, Option One, Fremont Investment & Loan, and New Century—accounted for nearly a third of the subprime market. Other subprime shops, too, sprung up throughout the county, many of them started by former employees of Ameriquest and its corporate forebears, Long Beach Savings and Long Beach Mortgage.

    Lehman Brothers was, of course, one of the most important institutions on Wall Street, a firm with a rich history dating to before the Civil War. Under its pugnacious CEO, Richard Fuld, Lehman helped bankroll many of the nation's shadiest subprime lenders, including Ameriquest. "Lehman never saw a subprime lender they didn't like," one consumer lawyer who fought the industry's abuses said.Lehman and other Wall Street powers provided the financial backing and sheen of respectability that transformed subprime from a tiny corner of the mortgage market into an economic behemoth capable of triggering the worst economic crisis since the Great Depression.

    A long list of mortgage entrepreneurs and Wall Street bankers cultivated the tactics that fueled subprime's growth and its collapse, and a succession of politicians and regulators looked the other way as abuses flourished and the nation lurched toward disaster: Angelo Mozilo and Countrywide Financial; Bear Stearns, Washington Mutual, Wells Fargo; Alan Greenspan and the Federal Reserve; and many more. Still, no Wall Street firm did more than Lehman to create the subprime monster. And no figure or institution did more to bring subprime's abuses to life across the nation than Roland Arnall and Ameriquest.

    Among his employees, subprime's founding father was feared and admired. He was a figure of rumor and speculation, a mysterious billionaire with a rags-to-riches backstory, a hardscrabble street vendor who reinvented himself as a big-time real-estate developer, a corporate titan, a friend to many of the nation's most powerful elected leaders. He was a man driven, according to some who knew him, by a desire to conquer and dominate. "Roland could be the biggest bastard in the world and the most charming guy in the world," said one executive who worked for Arnall in subprime's early days. "And it could be minutes apart."He displayed his charm to people who had the power to help him or hurt him. He cultivated friendships with politicians as well as civil rights advocates and antipoverty crusaders who might be hostile to the unconventional loans his companies sold in minority and working-class neighborhoods. Many people who knew him saw him as a visionary, a humanitarian, a friend to the needy. "Roland was one of the most generous people I have ever met," a former business partner said.He also left behind, as another former associate put it, "a trail of bodies"—a succession of employees, friends, relatives, and business partners who said he had betrayed them. In summing up his own split with Arnall, his best friend and longtime business partner said, "I was screwed."Another former colleague, a man who helped Arnall give birth to the modern subprime mortgage industry, said: "Deep down inside he was a good man. But he had an evil side. When he pulled that out, it was bad. He could be extremely cruel." When they parted ways, he said, Arnall hadn't paid him all the money he was owed. But, he noted, Arnall hadn't cheated him as badly as he could have. "He fucked me. But within reason."

    Roland Arnall built a company that became a household name, but shunned the limelight for himself. The business partner who said Arnall had "screwed" him recalled that Arnall fancied himself a puppet master who manipulated great wealth and controlled a network of confederates to perform his bidding. Another former business associate, an underling who admired him, explained that Arnall worked to ingratiate himself to fair-lending activists for a simple reason: "You can take that straight out of The Godfather: 'Keep your enemies close.' "

    Excerpted from The Monster by Michael W. Hudson
    Copyright 2010 by Michael W. Hudson
    Published in 2010 by Times Books/Henry Holt and Company



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Monday, October 25, 2010

Casting Shadows

In case you haven't seen it, the Globe and Mail has started a series on the Canadian Real Estate market called 'the long shadow over Canada's Housing Market'.

I encourage you to read the full story.

I disagree with parts. The writer states, "The trouble is not that Canada is on the brink of a gruesome real estate bust like the U.S. – because it isn’t. It has been shielded by more cautious lending practices, and avoided such bad practices as zero-down-payment or no-documentation mortgages. With few exceptions, Canadians have equity in their homes."

As faithful readers know, this blog has contantly talked about how Canada has done exactly all of those things. We aren't 'shielded' at all. When our market starts collapsing in earnest, those practices will be clearly exposed.

The Globe article, however, does focus on the emerging trend that is raising alarm bells in the real estate industry.

We are nearing the completion of the 5th consecutive month of year over year sales declines of 40% or more. More significantly, each of those 5 months will have registered sales totals that are the lowest in the last 10 - 15 years... meaning that the sales drop is not simply the year over year fallout of a blistering hot sales year in 2009.

The fear identified in the Globe article is that we have entered a period of stagnation or slowly falling prices. And weak home sales coupled with waning construction activity will cut off one of the engines that drove impressive economic growth and job creation in the years before the 2008 financial crisis.

Housing has played a stunning role in keeping Canada's economy rolling. And a significant correction in housing will hit our nation hard.

As the Globe notes the primary reason for that, of course, is the mountain of debt carried by many Canadian households. Canadians will soon owe more than $1.50 for every dollar of disposable income, an unprecedented level.

It all adds up to a simple, unpleasant equation: High debts, plus high home prices, plus high unemployment, plus slow growth in incomes will all have dramatic implications for employment and consumer spending levels – and for an economy that has grown accustomed to relying on housing-related spending for about 20%t of its gross domestic product.

Adding to this precarious situation is the fact that growth in consumer credit has collapsed by over 50%. As Jonathan Tonge notes on his blog, after an unprecedented rebound in borrowing and spending in 2009, growth in consumer credit has collapsed over the summer.

Consumer credit accounts for practically all household borrowing outside of residential mortgage debt. Personal debt such as credit lines, credit cards and loans make up the majority of outstanding consumer credit.

After last year’s record borrowing binge, if the trend holds, we could see retail purchases drop by as much as $6 billion YOY in just the final quarter of 2010.

The fear is that the economy begin to sputter, weighted down under record debt, falling home prices and a sudden collapse in spending as exhausted consumers refuse to borrow.

The Globe and Mail article notes that market forecasters are near-unanimous in the belief that prices will fall in the coming years, though few foresee the sort of rapid declines that savaged the American market.

I would suggest to you that analysis is wrong.

We arrogantly proclaim the American disaster was largely fuelled by loans made to people who weren't creditworthy and that Canada's problem is different.

We insist that easy credit is luring people into buying houses they may not be able to afford when rates rise to more historically normal levels.

But when those rates do rise to more historically normal levels, then it will be Canadians who are now no longer creditworthy. Almost all Canadian home mortgages are structured like the infamous American subprime loans. Who do you know who has a 25 or 30 year mortgage here?

Those 'deadbeat Americans' were able to afford the mortgage payments when they were are the subprime teaser interest rate levels. They only became a problem when the interest rates reset higher and they couldn't secure another loan at the low teaser rate level.

Our situation is as different from the American situation as we want to believe.

The vast majority of Canadians have 5 year mortgages. And they all have emergency level low interest rates attached to them... teaser rates, if you will.

And all are going to reset... at higher rates.

I personally know an astonishing number of people in Vancouver who have bought in the last 3 years. And almost all have bought the maximum amount of house they could afford under these ultra low interest rates.

None can handle a return to the average interest rate of the last 20 years: 8.25%.

At 8.25% they are most certainly uncreditworthy.

The Globe and Mail outlines the short term looming crisis of the slow melt and I agree with them.

It's what could will get the 'fire' burning.

Toss in higher interest rates and the conditions for implosion are complete.

Remember... calculate inflation as it was calculated prior to 2000 and inflation in September was 8.5%. Add to that the fact the US Federal Reserve wants a significantly higher level of inflation than the one we are currently experiencing.



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Friday, October 22, 2010

The American Debate Begins...



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Thursday, October 21, 2010

Sign, sign, everywhere a sign.

So the big item on a lot of Canadian blogs today is a report from TD Bank titled Canadian Household Debt a Cause for Concern.

No kidding.

A couple of salient points:

  • At 146% of average after-tax personal income, Canadian household debt has become excessive.

  • Nowhere was the impact of lower borrowing costs and greater household confidence more clearly observed than in the housing market, where ownership rates increased steadily over the past two decades. A self-perpetuating cycle occurred. Strong increases in demand bid up housing prices, which together with equity market gains prior to the 2008/2009 recession, raised net wealth. This positive wealth effect encouraged households to increase their rate of investment and consumption, further driving up borrowing and debt levels.

  • Based on the new figures, a slightly higher 6.5% of households are currently financially vulnerable (or have a debt-service ratio of 40% or above).

  • More striking, the share of those on the verge of becoming vulnerable (those with a debt-service ratio of 30-40%) had risen from 7.2% in 2009 to 9.3% – up almost two percentage points.

  • Given the change in the distribution of debt, we have estimated that as much as 10-11% of households may become financially vulnerable if the overnight rate rose to 3.5%.

Thus we have a situation whereby if the Bank of Canada rate rises to 3.5% from the current 1%, over 10% of all households will be diverting over 40% of their pay to debt servicing.

And I can guarantee you that in the Village on the Edge of the Rainforest this will apply to more than 10% of all households.

As I have said over and over, it is going to be rising interest rates that will trigger an implosion of our housing market, with Vancouver as ground zero of a massive correction.

Those who wring their hands in frustration at the stubborn persistance of the housing bubble here only have to look at interest rates to find the reason why.

The Bank of Canada has issued endless warnings about the levels of our debt and the threat of rising interest rates. Bank after bank has come out with similar warnings.

Interest rates are at emergency levels. They will not stay there.

If you own, now is the time to cash in on your equity. Well invested it will multiply exponentially in the coming years as we are hit with the ravages of currency induced cost push inflation.

If you're afflicted with housing lust, DON'T BUY! Rent and force yourself to invest the difference between what you pay in rent and what you would be paying on a mortgage. When inflation and cost push inflation strikes, and the housing market collapses under rising interest rates, you will be in a position to buy a house outright - double digit interest rates be damned.

The warning signs are everywhere. I do not yearn for the carnage they portent, but neither do I deny the ominous calamity they give warning to.

Recognize those warning signs... and position yourself to take advantage of what's coming.



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Wednesday, October 20, 2010

Even Goldman Sachs is starting to worry about Hyperinflation.

It's been one of those days when there is so much to write about.

But one of the items that caught my eye were some comments made by Goldman Sach's Senior US Economist, Ed McKelvey.

McKelvey was ruminating on the looming prospect of Quantative Easing 2 (aka: money printing by the US Federal Reserve).

As you know, Fed Chairman Ben Bernanke is getting ready to flood bank basements with another $2 Trillion in excess reserves to stimulate bank lending.

If successful, and bank lending actually picks up, we are suddenly faced with an explosion of over 300% in the amount of currency in circulation (moving from under $1 trillion to around $4 trillion).

Wages are certainly not guaranteed to increase concurrently. So this explosion in will lead to a very rapid and drastic destabilization in the concept of a dollar-based reserve currency.

The only thing that could prevent this are the Federal Reserve's mechanisms to extract liquidity from the system.

Now Bernanke insists over and over again that he can accomplish that extraction. There has been much focus on the “tools” the Fed is readying to implement its “exit strategy.” Bernanke dwelt on how the Fed intends to eventually tighten credit in Feb. 10 Congressional testimony.

Bernanke has made it clear the rate of interest it pays on excess reserves (IOER) will play a lead role when the time comes to extract liquidity. The Fed hopes raising that rate will pull up the funds rate and other rates. The Fed has also tested reverse repurchase agreements and plans to extend their use to government sponsored enterprises, which can’t earn interest on reserves. Also in the works is a new term deposit facility, which will allow banks to convert their reserve holdings into a kind of CD.

Those tools “would together allow the Federal Reserve to drain hundreds of billions of dollars of reserves from the banking system quite quickly,” Bernanke testified.

The problem is IOER process completely unproven. Should animal spirits kindle at the peak of the biggest liquidity tsunami in history, that money will inevitably make its way to Main Street, not back into the Federal Reserve coffers.

All this has made Goldman Sach's Ed McKelvey warn that should increased bank lending be the end result of QE2 then, "this would cause too much money to chase too few goods."

And, as liquidity extraction then would likely be impossible, it would be the beginning of the end: "The obvious risk to this last point is if inflation expectations surge. In a stronger growth environment than now prevails, such a surge could prove difficult to control."

When you toss into the fire the fact that the Federal Reserve will soon be forced to once again buy up Mortgage Backed Securities, REITs, ETFs and pretty much everything else, and you have the conditions for a situation that can very easily spin out of control.

Every previous economic miscalculation has always failed to consider the Law of Unintended Consequences.

And you just know there is an "oh shit" moment brewing.

Speaking of unintended events, China is gearing up for a ban on selling rare earth minerals.

Earlier this month Chinese customs officials prohibited all exports of rare earth minerals to Japan.

As the United States gears up to brand China a currency manipulator, look for these actions to expand. It is already expected that silver exports from China, the world’s largest, may drop about 40% this year as domestic demand from industry and investors climbs, according to Beijing Antaike Information Development Co.

As Business Week notes, "Reduced exports will almost certainly bolster silver prices that are trading near a 30-year high on speculation that governments worldwide will take further steps to stimulate their economies, weakening currencies and increasing demand for assets that are a store of value."



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Tuesday, October 19, 2010

A Death Knell for Over the Counter (OTC) Derivatives?

It's amazing how the Foreclosure Crisis keeps drawing me back, even on a day when the big news story is the Bank of Canada deciding not to raise interest rates today.

Locally most people are completely oblivious to the import of this topic and the impact it can have on EVERYTHING!

As you may be aware, in an attempt to create the illusion that this issue is over, Bank of America plans on resuming foreclosures in at least 23 states starting next week.

Ally Financial Inc's GMAC Mortgage unit is also resuming foreclosures once documents are fixed. Gina Proia, a spokeswoman for Ally, said that "as we review the affected files and take any remediation needed, the foreclosure process then resumes."

Problem resolved, right?

Not quite.

PIMCO (Pacific Investment Management Co.), BlackRock Inc. and the Federal Reserve Bank of New York are seeking to force Bank of America Corp. to repurchase soured mortgages packaged into $47 billion of bonds by its Countrywide Financial Corp.

The presence of the NY Fed in this potential litigation says that the Fed is holding paper which does not qualify for holding according to its own indenture.

The New York Fed, Pimco and others are threatening litigation via demand letters to force the Bank of America to buy back $47 billion in OTC derivatives known as securitized mortgage debt.

Because the OTC derivative cannot stand the light of day in court, a demand letter is a powerful first tool.

The pile of OTC derivatives out there is over $2 Trillion and this move, certainly the start of many, is going to have massive reprecussions.

Look for the drop in gold and silver today, a result of the mindless actions of the computer algorithmic programs working their trades, to be quickly reversed.



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Monday, October 18, 2010

Hitting the snooze button...

Last Thursday we commented how real estate sales in Vancouver are on track for another dismal month.

If the trend holds out, sales will once again be among the lowest in the last decade - the fifth consecutive such month.

But as the Vancouver Housing Blogger noted in the comments section of the Vancouver Condo Info blog (VCI), "not only will sales be the 2nd lowest over the last 10 Octobers, but listings will be the lowest in the last 5 years. If it were a hot market, sales would be booming. They’re not."

That's a stunning situation. Low listings and low sales.

Sellers are yanking their listings off the market and waiting until 2011. The hope is that the dearth of listings will re-ignite the market.

But with interest rates at their lowest levels in history, where are the buyers?

In 2009 prices had dropped by 10%. Emergency level interest rates combined with the 10% price drop drew many into the market.

But prices have not begun to drop yet.

As I have already mentioned, many observers anticipate ongoing minor price drops through October, November and December. Then, in the first half of 2011, you will probably start to see speculators, boomers, foreign holders, overextended locals and developers all come to the market.

By then we will probably be looking at 8-10 consecutive months of the worst sales in over a decade.

As VHB noted, "the Vancouver real estate market has hit the great snooze button."

Will the market wake up in Spring 2011 with a giant hangover?

Meanwhile in West Vancouver...

This isn't to say we aren't seeing price reductions, especially at the high end (where are those wealthy Asian buyers who will keep luxury prices where they belong?)

This Arthur Erickson built home at 1812 Palmerston Avenue was originally constructed as a four-bedroom family home but was renovated into a three-bedroom by the previous owners.

Sold in 2003 for $2,375,000, it has been laguishing for sale on the market for over six months with an asking price of $5,695,000.

Recognizing the current state of the market, the seller came down on his asking price and the home has sold for $4,750,000.

That's a drop of 17%.



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Sunday, October 17, 2010

Itsy Bitsy Spider... the impact of the US Foreclosure Crisis explained

If you follow this blog you know I tend to write about four things.

Real Estate, the Economy, the Banking System and Gold/Silver.

The four are inter-connected.

Lately I have spent a lot of time on the looming Foreclosure Crisis in the United States. I cannot stress enough how major and significant this story is.

A website I like to follow, Pragmatic Capitalism, recently sumarized the significance of this story. I hope you will indulge me with this condensed summary of the issue.

By the end I am confident you will have a crystal clear understanding of it's significance.


We are currently sitting on the precipice of a dangerous cliff. The confluence of a looming bank credit crisis in the US and a sovereign debt banking crisis in Europe could lead to another full-blown world banking crisis.

The potential is there.

Right now the housing recovery in the United States is stalled. Lending is tighter, as is reasonable. Banks actually expect you to have the ability to pay back the mortgage you take out (solid FICO scores) and want reasonable down payments. Only 47% of applicants have the FICO score to get the best mortgage rates.

Enter the Foreclosure Mess. What is actually happening here?

Homeowners can only be foreclosed and evicted from their homes by the person or institution who actually has the loan paper. Only the note-holder has legal standing to ask a court to foreclose and evict. This is important. It is not the mortgage that is important here. The note, which is the actual IOU that people sign, promising to pay back the mortgage loan is what is crucial.

Before mortgage-backed securities (MBS), most mortgage loans were issued by the local savings & loan. So the note usually didn’t go anywhere: it stayed in the offices of the S&L down the street.

But once mortgage loan securitization became a part of the industry, things got sloppy... they got sloppy by the very nature of mortgage-backed securities.

The whole purpose of MBSs was for different investors to have their different risk appetites satiated with different bonds. Some bond customers wanted super-safe bonds with low returns, some others wanted riskier bonds with correspondingly higher rates of return.

Therefore, as everyone now knows, the loans were ‘bundled’ into REMICs (Real-Estate Mortgage Investment Conduits, a special vehicle designed to hold the loans for tax purposes), and then “sliced & diced”... split up and put into tranches, according to their likelihood of default, their interest rates, and other characteristics.

This slicing and dicing created ‘senior tranches,’ where the loans would likely be paid in full, if the past history of mortgage loan statistics was to be believed. And it also created ‘junior tranches,’ where the loans might well default, again according to past history and statistics. (A whole range of tranches was created, of course, but for the purposes of this discussion we can ignore all those countless other variations.)

These various tranches were sold to different investors, according to their risk appetite. That’s why some of the MBS bonds were rated as safe as Treasury bonds, and others were rated by the ratings agencies as risky as junk bonds.

But here’s the key issue: When an MBS was first created, all the mortgages were pristine ...none had defaulted yet, because they were all brand-new loans. Statistically, some would default and some others would be paid back in full... but which ones specifically would default? No one knew, of course.

So in fact, it wasn’t that the riskier loans were in junior tranches and the safer ones were in senior tranches: rather, all the loans were in the REMIC, and if and when a mortgage in a given bundle of mortgages defaulted, the junior tranche holders would take the losses first, and the senior tranche holder last.

But who were the owners of the junior-tranche bond and the senior-tranche bonds?

Two different people.

Therefore, the mortgage note was not actually signed over to the bond holder. In fact, it couldn’t be signed over. Because, again, since no one knew which mortgage would default first, it was impossible to assign a specific mortgage to a specific bond.

So how do you make sure the safe mortgage loan stayed with the safe MBS tranche, and the risky and/or defaulting mortgage went to the riskier tranche?

This is where the famed MERS, the Mortgage Electronic Registration System, comes into play.

MERS was the repository of these digitized mortgage notes that the banks originated from the actual mortgage loans signed by homebuyers. The purpose of MERS was to help in the securitization process. Basically, MERS directed defaulting mortgages to the appropriate tranches of mortgage bonds. MERS was essentially where the digitized mortgage notes were sliced and diced and rearranged so as to create the mortgage-backed securities. Think of MERS as Dr. Frankenstein’s operating table, where the beast got put together.

However, legally... and this is the important part... MERS didn’t hold any mortgage notes: the true owner of the mortgage notes should have been the REMICs.

But the REMICs didn’t own the notes either, because of a fluke of the ratings agencies: the REMICs had to be “bankruptcy remote,” in order to get the precious ratings needed to peddle mortgage backed securities to institutional investors.

So somewhere between the REMICs and MERS, the chain of title was broken.

Now, what does ‘broken chain of title’ mean?

Simple: when a homebuyer signs a mortgage, the key document is the note. As I said before, it’s the actual IOU. In order for the mortgage note to be sold or transferred to someone else (and therefore turned into a mortgage-backed security), this document has to be physically endorsed to the next person. All of these signatures on the note are called the ‘chain of title.’

You can endorse the note as many times as you please... but you have to have a clear chain of title right on the actual note: I sold the note to Moe, who sold it to Larry, who sold it to Curly, and all our notarized signatures are actually, physically, on the note, one after the other.

If for whatever reason any of these signatures is skipped, then the chain of title is said to be broken. Therefore, legally, the mortgage note is no longer valid. That is, the person who took out the mortgage loan to pay for the house no longer owes the loan, because he no longer knows whom to pay.

To repeat: if the chain of title of the note is broken, then the borrower no longer owes any money on the loan.

Read that last sentence again.

The broken chain of title might not have been an issue if there hadn’t been an unusual number of foreclosures. Before the housing bubble collapse, the people who defaulted on their mortgages wouldn’t have bothered to check to see that the paperwork was in order.

But as everyone knows, following the housing collapse of 2007-2010 (and counting), there has been a boatload of foreclosures... and foreclosures on a lot of people who weren’t sloppy bums who skipped out on their mortgage payments, but smart and cautious people who got squeezed by circumstances.

These people started contesting their foreclosures and evictions, and so started looking into the chain-of-title issue, and that’s when the paperwork became important. So the chain of title became crucial and the botched paperwork became a nontrivial issue.

Now, the banks had hired ‘foreclosure mills’... law firms that specialized in foreclosures... in order to handle the massive volume of foreclosures and evictions that occurred because of the housing crisis. The foreclosure mills, as one would expect, were the first to spot the broken chain of titles.

Well, what do you know, it turns out that these foreclosure mills started to fake and falsify documentation so as to fraudulently repair the chain-of-title issue, thereby ‘proving’ that the banks had judicial standing to foreclose on delinquent mortgages. These foreclosure mills even began to forge the loan note itself.

Again, let's repeat that.

The foreclosure mills deliberately, and categorically, faked and falsified documents in order to expedite these foreclosures and evictions. Bloggers have even uncovered a price list for this ‘service’ from a company called DocX, a price list for forged documents.

Talk about your one-stop shopping!

So a massive fraud was carried out, with the inevitable innocent bystanders getting caught up in the fraud. There has been the guy who got foreclosed and evicted from his home in Florida, even though he didn’t actually have a mortgage, and in fact owned his house free and clear. And there was the family that was foreclosed and evicted, even though they had a perfect mortgage payment record.

Now, the reason this all came to light is not because too many people were getting screwed by the banks or the government or someone with some power saw what was going on and decided to put a stop to it... that would have been nice, but it isn't what happened.

No, alarm bells started going off when the title insurance companies started to refuse to insure the titles.

In every sale, a title insurance company insures that the title is free and clear... that the prospective buyer is in fact buying a properly vetted house, with its title issues all in order. Title insurance companies stopped providing their service because, of course, they didn’t want to expose themselves to the risk that the chain of title had been broken, and that the bank had illegally foreclosed on the previous owner.

That’s when things started getting interesting: that’s when the attorneys general of various states started snooping around and making noises.

The fact that Ally Financial (formerly GMAC), JP Morgan Chase, and now Bank of America have suspended foreclosures signals that this is a serious problem...obviously.

Banks that size, with that much exposure to foreclosed properties, don’t suspend foreclosures just because they’re good corporate citizens who want to do the right thing, and who have all their paperwork in strict order... they’re halting their foreclosures for a reason.

The move by the United States Congress last week, to sneak by the Interstate Recognition of Notarizations Act, was all about the banking lobby.

They wanted to shove down that law, so that their foreclosure mills’ forged and fraudulent documents would not be scrutinized by out-of-state judges. The spineless cowards in the Senate carried out their master’s will by a voice vote... so that there would be no registry of who had voted for it, and therefore no accountability.

And President Obama’s pocket veto of the measure? He had to veto it... if he’d signed it, there would have been political hell to pay, plus it would have been challenged almost immediately, and likely overturned as unconstitutional in short order.

As soon as the White House announced the pocket vet, the very next day the Bank of America halted all foreclosures, nationwide.

Why do you think that happened? Because the banks are in trouble... again. Over the same thing as last time... the damned mortgage-backed securities!

The reason the banks are in the tank again is, if they’ve been foreclosing on people they didn’t have the legal right to foreclose on, then those people have the right to get their houses back. And the people who bought those foreclosed houses from the bank might not actually own the houses they paid for.

And it won’t matter if a particular case... or even most cases... were on the up and up: It won’t matter if most of the foreclosures and evictions were truly due to the homeowner failing to pay his mortgage. The fraud committed by the foreclosure mills casts enough doubt that, now, all foreclosures come into question. Not only that, all mortgages come into question.

The full import of what this means is only starting to seep into the collective consciousness.

And as it does, it won't be long before enough mortgage-paying homeowners realize that they may be able to get out of their mortgage loans and keep their houses, scott-free. Once they realize this, that’s basically a license to halt payments right now, thank you. That’s basically a license to tell the banks to take a hike.

What are the banks going to do... try to foreclose and then evict them? You can already hear the cries of "show me the paper, Mr. Banker."

This is a major, major crisis.

The Lehman bankruptcy could be a spring rain compared to this hurricane. It has the potential to bring the system down.

Who will want to buy a mortgage that is in a securitized package with no clear title? Who will get title insurance? Some judge somewhere is going to make a ruling that is going to petrify every title company, and the whole thing grinds to a halt.

Let’s be very clear. If the banks in the US cannot securitize mortgages, there is no American mortgage market. To go back to where lenders warehouse the notes will take a decade for the infrstructure to be built. In the meantime, housing prices are devastated. Whatever wealth effect remains from housing gets worse, and the economy rolls over.

Meanwhile all those subprime and Alt-A mortgages written in the middle of the last decade? They were packaged and sold in securities. They have had huge losses.

But those securities had representations and warranties about what was in them. And guess what, the investment banks may have stretched credibility about those warranties.

There is the real probability that the investment banks that sold them are going to have to buy them back. We are talking the potential for multiple hundreds of billions of dollars in losses that will have to be eaten by the large investment banks.

And all this coming as European banks are going to have to sort out their own sovereign debt problems.

Shades of 2008? It’s all inter-connected. And if you are have stocks in anything related to the financials in any way, you may want to take steps to protect yourself.

Oh what a tangled web has been weaved.



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Saturday, October 16, 2010

Inflation... and Realtor 'Incentive'

On the right side of this blog some of you will have noticed that under the spot price of Gold and Silver, there is a chart called the US Dollar Index.

This index measures the strength of the US Dollar. A few weeks ago it was up over 80. This week it slid below 77 - which is big news.

It's indicative of a weakening US Dollar.

Perhaps at work you know some co-workers who this week are all giddy that the Canadian Dollar and the US Dollar moved to parity. Some, no doubt, rushed out to exchange loonies for greenbacks for upcoming trips to Vegas or other locals south of the border.

It's not so much a testament to the strength of the loonie, but it owes more to the weakening of the US Dollar.

Such developments are a big concern to OPEC. The oil producing Arab nations trade oil in US Dollars. And a weakening US Dollar means they are getting less for the same amount of product.

"The U.S. currency’s weakness means the 'real price' of oil is about $20 less than current levels," said Venezuelan Energy and Oil Minister Rafael Ramirez after yesterday’s meeting of the Organization of Petroleum Exporting Countries in Vienna.

Their response?

The OPEC nations want to push the price of oil from the current $80 to $100 to offset the declining value of the dollar.

And since the Canadian Dollar is at par with the American Dollar, it means you and I will also feel this 20% increase in the cost of everything oil related - which is just about every aspect of our lives.

This is another example of currency induced cost push inflation at work.

'Real' inflation last month raged at 8.5%. Look for it to accelerate in the coming months.

Vancouver Real Estate

As we noted earlier this week, the slow melt is meeting the winter freeze and the chilling sales climate will clash with stubborn sellers in a stalemate which will probably last until spring.

Come springtime many observers believe you will start to see sellers move on their prices and the decline will finally start.

And a primary impetus that will push the stubborn sellers to move on their asking price will be Realtors.

This month BCREA's pumper-in-chief, Cameron Muir, has made much of the declining numbers of listings on the market. He pumps this as a move to a 'more balanced market'.

Through the late summer and early fall, many owners have tested the market waters. They put properties on the market, only to remove them when buyer interest proved to be reduced. Many of these owners plan to put those same properties back on the market and many will likely do so in spring of 2011

As our friends over at VREAA have noted these sellers will be re-entering a market in which local Realtors has seen sales (and by 'sales' we actually mean to say 'commissions') have been at 10 - 15 year lows.

There are a great many Realtors feeling an income pinch right now, a situation which will be greatly exacerbated come Spring 2011.

As VREAA notes,

  • Sales are down year-over-year in the lower mainland, in some areas of BC they are down as much as 50%. There are twice as many Realtors in BC now than there were 10 years ago, and they are now competing for a shrinking pie. In many markets we are seeing Realtors talk about the importance of ‘sharp pricing’. They are applying pressure on sellers to drop prices to points at which they meet buyers. They are a force against the ‘sticky pricing’ that is characteristic of this stage of a bubble burst.

Look for this pressure to be severely ramped up when many of these sellers return to the market in Spring 2011.

Many observers anticipate ongoing minor price drops through October, November and December. Then, in the first half of 2011, you will probably start to see significant changes.

Speculators, boomers, foreign holders, overextended locals and developers will all come to the market and be met by hungry Realtors desperate for income after 8-10 months of the worst sales in over a decade.

Eager to close deals at almost any price, significant pressure will be exerted to speed the price decline.

It could be an intense spring.



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