Mortgage timebomb about to explode

Source: The Daily Reckoning [dailyreckoning@electricmessage.co.uk], Bill Bonner
28/06/2007 19:20

“A recent research piece by Bank of
America estimates that approximately $500 billion of
adjustable rate US mortgages are scheduled to reset
skyward in 2007 by an average of over 200 basis points,”
says Bill Gross. “2008 holds even more surprises with
nearly $700 billion ARMS subject to reset, nearly
three-quarters of which are subprimes.”

Here in the UK, one million home-owners
will meet the end of their fixed-rate deals in the next
12 months, says the Financial Times – your correspondent
amongst them. The trouble has barely begun, in short. “It
is only since last month that those whose fixed rates
were expiring found themselves facing a bigger bill for a
new fix,” notes Gary Duncan in today’s Times. “Now ever-
rising numbers of people with expiring fixed-rate loans
will face an unappetising choice between a more expensive
variable rate, or a new, more costly fixed offer.”

None of this would need to cause trouble beyond a mere
house-price crash and consumer slump – if only it weren’t
for the credit derivatives issued against so much of the
world’s outstanding housing debt. Running up debt – a
promise to pay in the future – can only last as long as
the promise comes good. Squaring that promise by issuing
a derivative against it only increases the chance – and
the cost – of it failing.

Bond Market Calls Time on Cheap Money Era

Source: The Daily Reckoning [dailyreckoning@electricmessage.co.uk]

by Brian Durrant

Yields have fluctuated, but each successive peak in yields has been lower than the preceding one. Those peaks provide the points of contact for a downtrend line that has survived for 20 years. Traders that have bought Treasury bonds when yields were on the line made money time after time. Accordingly the line has been a source of great confidence. Such trends give traders something to hang on to.

TM2: Expectations of low interest rates makes it much easier to sell debt, since pay back rates seem affordable

But when trend that has been in place for so long breaks, there is pandemonium in dealing rooms. This is what happened in the US Treasuries market on Thursday June 7. Once the downtrend line had been crossed at the yield of 5.05% on 10-year paper, there was indiscriminate selling of US Treasury bonds.

To some traders the breaking of the trend line marks the end of an era of ever cheaper credit. Hitherto the stock market has gained enormously from cheap credit. It has made it worthwhile for companies to buy back their stock at a record rate. It has also enabled the private equity industry to go on its buy-out binge, taking out public companies at values significantly higher than priced by the market.

TM2: Blackstone’s recent share offering may not be a coincidence. It is they kind of companies that they buy out which are liable to suffer most from any credit tightening, not to mention Blackstone’s own liability. The key decision in speculative financial markets is when to activate your exit strategy i.e. pass the risk on to someone else.

Moreover the long-term optimism engendered by low stable bond yields allowed the rapid development of credit derivatives. These have made it easier for lenders to spread their risks. This in turn reduced the rates at which companies could borrow.

The last time bond yields were as high was in mid-2002 when stock markets were in free fall. In the last three months the cost of 10-year money has risen from 4.5% to a high of 5.33%. If bond market losses are compounded in the future, it will force a more widespread flight out of risky investments that have been founded on cheap money and low volatility.

Although it is too early to say that we are at the end of the four-year rally in equities, we may be at
the beginning of the end.

TM2 – It looks very like the trends are really starting to reverse.

Couple this historic cheapness with the fact that larger companies tend to have the highest dividend yields, strongest cash flows and highest return on equity and the case for shifting into mega-cap stocks
becomes quite compelling.

TM2 – Returns on these stocks will be much lower than those which traders have become accustomed to. Plus it is unlikely that these megacap stocks will be immune from the consequences of a credit squeeze.

Markets tumble

Yesterday, the Dow went down nearly 200 points. All 30
Dow stocks fell. The index has gone down more than 400
points in the last 3 days. Morgan Stanley issued a ‘Sell’
signal to its customers. And US household borrowing
dipped to a 9-year low; now that the air has gone out of
the housing bubble, the poor householder has nothing to
borrow against. (Bill Bonner, Daily Reckoning, Jun 8, 2007

Metaclip: Watch out! Indications of imminent economic reversal

Metaclip, April – May 2007: All the articles in the Economy category, clipped by Trend Monitor 2.0 from Clipmarks , are suggesting that the global economy is teetering on the brink of a serious, perhaps un-precedented reversal. Consumers and corporates are up to their eyes in debt, and hedge funds are described as nearing the exploding point. The US housing market is deflating faster than ever before, while the stock market is described as a “Dead Man Walking”.

Consumers: Consumers are portayed as “taking a break” on spending as major US retailers reported April sales which were described as “the worst on record”.

Housing: With home sales estimated by the US National Association of Realtors to have suffered their biggest drop in nearly two decades, Robert Shiller, the Yale Economist who predicted the Internet bubble, is cited in ‘The Financial Times’ warning of a housing bubble “to match the Internet bubble”. He says UK and Spanish house prices are twice as over valued as in the US.

Trade: The US trade deficit is reported reaching a six month high on May 11, while China’s trade surplus is said to have doubled in March continuing a two year accelerating trend with its main trading partners, the US and Europe.

Markets: Companies are reported re-purchasing shares in un-precedented numbers boosting sharing prices, but setting the stage for “coming tsunami” of equity supply. The cost of borrowing is expected to increase, which will add to “the swollen ranks of lowly-rated firms that are up to their necks in debt” which will have to sell shares — as well as various other assets — as a matter of survival, often regardless of price. Meanwhile, Warren Buffet calls the $1.6 trillion hedge fund industry with its fast trades in and out of assets “a fool’s game”. On May 5 ‘The Daily Reckoning’ suggests “Practically every one of them is walking around with dynamite taped to its belt”.

Debt: According to the Bank of England, a “surge” in cheap corporate lending and looser credit standards is an increasing danger to the global financial system. ‘The Financial Times’ quotes Larry Fink, the chief executive of BlackRock, the $1,000bn-plus fund management group, saying “lending to highly indebted companies was becoming lax in ways similar to those that have undermined the US subprime mortgage market, making the leveraged loan market tomorrow’s problem”.

Hedge funds – The perfect storm

The New York Fed warned this week that hedge funds posed
the biggest threat to investors since the LTCM crisis of
’98. Back then, the Fed organised a $3.6 billion bailout.
But that kind of money is peanuts today. Another $60
billion was raised by the funds last year alone. Today,
they are a $1.6 trillion industry. And they are much
more leveraged than they were 10 years ago. Practically
every one of them is walking around with dynamite taped
to its belt.

What’s makes the situation especially dangerous is that
they all tend to show up in the same places at the same
time. “Returns are increasingly correlated,” says the
Fed, which is the Fed’s way of saying they are all doing
the same thing. So, when one blows up…they all might
blow up. And when they all blow up…it’s likely to send
a cloud of smoke and debris over the entire world’s
financial markets. (Bill Bonner Daily Reckoning 04/05/07)

Factor in corporate and consumer debt and the future for the global economy is challenging to say the least. On the other hand, local economies should do relatively well, as might the virtual / knowledge economies.

Commercial debt bubble inflates

Money…money…money!  Deals…deals…deals..!

It is glorious to get rich…as Deng Tsaio Ping put it.
And many people, all over the world, think they are bound
for glory.

Meanwhile, the other head hangs down in despair. “Actual
underlying conditions of the world economy continue to
deteriorate,” it mumbles.

Larry Fink, CEO of Black Rock, a trillion-dollar fund
management company, spoke out last week and said that all
these mergers and acquisitions were going to cause “tomorrow’s problems.”

Why? Because they are all funded with debt. And lending standards for big, commercial deals have gone the same way as the lending standards for people buying trailers. “Standards have deteriorated to a level that we never even dreamed we would see,” said Fink.

Source -The Daily Reckoning, May 2, 2007 [dailyreckoning@electricmessage.co.uk]