How Bad Does It Get?

I hate to tell you this, but if you thought this past week was bad, you better get ready for a whole lot more downside action...and when I say a lot - I mean a whole friggin' huge gob more, and starting rather soon, although I wouldn't panic just yet, as I explained to subscribers at mid week that I'm waiting for one last bounce up to the 13,500-13,700, next week.   I'll be selling into that one, with a few commodity precious metals calls that should be delightfully green.

The specific reason that the headline "Stocks End Volatile Week with Huge Drop" is likely only the foretaste of a horror to come (that may whack more than half the Dow average off) is that Elaine and I had a long conversation with a genuine Wall St. insider friend last night, a fellow that knows exactly (or more precisely, within mathematical bounds of mark to index models) where things are headed.  "It's going to be a whole lot worse than LTCM, for example, much worse" he told us. 

How much worse?  I've got six pages of notes to go over with subscribers to Peoplenomics on Sunday. But if you think in terms of  20% of subprime homes being foreclosed on or more, and a Dow under 6,000, you'd have some idea of future being priced by the inside markets right now.  How will it be saved?  Inflation will be tried, and you know what the implications of that are for things like the metals, the cost of living, and so forth.

None of this is to be taken as financial advice - I'm just thinking out loud, reflecting on our chat and about my personal account, and outlining where I think things are headed.  Besides my 'insider' friend there's also this chart that I've been watching...

Linguistically, come next year (or even late this) we are expecting 'restrictions on travel' and 'encounters with scarcity' - and the leading edge of that wave seems to be showing up in language use today, although the results from the Google search of news stories may be attributable to more sites being searched, or a change in caching. Still, the  chart is what it is:

How big a hole will 20% of subprimes (or more) being foreclosed on make?  I don't know for sure, but 2-3% of the US population going homeless isn't a pretty picture.

You'll see that in Ohio, the state is going after predatory lenders already - and more of this kind of action can be expected.

Some of the hot spots - once the darlings of the house-flipping crowd - are blowing up now.  An official of an Arizona mortgage company tells me its much worse than reported, and you know that's got to be pretty damn bad because the public number is foreclosures in the valley are up 566% in 2008 compared with 2006.  Worse to come, he tells me.

Other fall out: Fannie Mae losses have about doubled.

And as if this isn't enough, the new FSAB rules requiring more disclosure of tier-three fair values, largely swept under the rug by big companies, will be required disclosure when FASB 157 goes active  next Thursday.  As those new disclosures work their way through the system, you can expect more fist (and other body part) clenching.  It says in part:

"This Statement emphasizes that fair value is a market-based measurement, not an entity-specific measurement."

So, how will this impact tranches marked to an index like the ABX?  Stand by for fireworks to come.

It's not all bad though, as my source is optimistic that the only way out of the still coagulating mess will be inflation: "There's no other way out from a policy standpoint," he offered.

But while we're waiting for the other shoes to drop in the financial markets, readers are sending in first-hand experiences from all over the country saying inflation is already here big time - here's just one example:

"From Manti,Utah. The last time we went to Wal-Mart in Ephraim,UT about two weeks ago.(Seven miles from Manti) Black Plumbs were $.50 lb, yesterday (11-8-07) they were $2.24 lb up 348%. Cantaloupe was $.97 each, now $2.50 each up 158%,Cabbage was $.40 lb now $.58 lb up 45%, Sour Dough Bread 24 oz was $2.12, now $3.07 up 45%. Bananas were still $.54 lb. And I will get 2.13% raise on my Social Security, Oh and Gas went up $.24 to $3.05 in the last two weeks. The Gov. inflation numbers look OK to me. Right? Sarcasm Off. You can use this if you want to. Thanks for all the good information you give us each day.

I can hardly wait for the CPI figures, which the central bankers look to for the core rate (inflation less energy less food), having concluded (wrong-headedly, I think) that food and energy don't matter.  Maybe if you're in league with space aliens, or something, but the rest of us have those two real earthy problems to cope with.  Gotta eat and gotta heat.

Earlier this week (or was it last?  Times flying right now...) I told you that once the Tuesday elections were past, we would see gasoline prices do a moon shot.  No sooner had polls closed than were were reading about $5 gas in some parts of the L.A. area and headlines are softening us up for a lot more to come:  "Gasoline prices toi get higher, forecasters say."  Well, gee, duh, how about that.

---

Obviously, there's more - a lot more from those 6-pages of notes taken last night, while I watched a perfectly good T-bone I had pulled off the BBQ go cold, so as not to be munching during my chat with my source.  Covered in Saran Wrap, it survived last night intact.  After hearing what my friend had to say, I didn't feel much like eating.

Today, braced with two cups of coffee and able to pass on a glimpse of the storm still developing along with the suggestion that you consider getting a year or two of house payments together while you can, the appetite is back.

But maybe not for long.  If I had to throw two darts for 'thousand point down days' they would land right next to each other: Thursday November 29 and Friday 30, with a 600 point bounce the following Monday.  Just darts, mind you, but if anywhere near right, the appetite will go missing again.

Friday November 9, 2007

Cliff's Edge, and Other Vantage Points

It's time we had us a serious think-about on the topic of a Chinese trade embargo of the USA.  While it's true that in the past, during the heady 'getting started' days of globalism, China really needed the USA as a consumer of her goods, that picture is swiftly changing today with (last time I heard) China's exports to the USA were only about 20% of her total exports and the growth of the domestic Chinese economy has been tremendous.  An email from a reader makes an interesting (and not yet reported)  point:

"The web bot is right, we are standing on the edge of a cliff with sharp rocks below economically. My son is an engineer and manages the rolls at [regional US steel company] in [somewhere], a division of [parent steel company] He told me this evening that he has just learned today that Chinese steel has quit coming into the country, along with a number of other products. Good for them and U S steel, but bad for the unaware U S populace and the U S $."

My linguistic pals always warn me "Don't ask "Why?" so much - just observe the data and move on.  In the case of China, however, the "Why?" of such a move - if true - would be incredibly obvious:  We have not exactly be the kind of "handshake you can take to the bank" trading partners we might wish to image ourselves to be, and the landscape is changing quickly:

• Our US Treasury Secretary is telling the Chinese that they are out of step on exchange rate policy.  How would the US react if someone from China were to tell us our asset markets were insanely over-valued?

• China's trade surplus is about to top $30 billion - per month.  The US runs about -$60 billion as a trade deficit.  Who should be advising Hu?

• China is also looking long term at its strategic interests, and despite the chomping at the vit of vulture capitalists, they are altering their foreign investment rules to ensure that China doesn't fall  into the same kind of corpgov flat spin the US seems to be in presently.

• China is concurrently developing increased trade with countries like Canada.

China has several reasons to be less than happy with the USA right now.  For one, we have dumped a lot of paper assets on them denominated in dollars to buy goods and services.  As the US dollar declines (the long term trend, although we may see a bounce for a few days) the picture is definitely one of us taking the Chinese profits away by dropping the purchasing power of the dollar; all that's been made necessary because of the current tendency to bail out bankers (not foreclosed homeowners) to preserve, best I can tell, Long Island real estate prices.

While I don't foresee an actual trade war breaking out any time soon, what I do look for is steadily increasing dollar denominated prices of goods coming from China - bound to show up at X-Mart and other big box stores where much of the inventory is imported.  And that will in turn be reflected in higher prices, which then in turn, may or may not, be reflected in the Consumer Price Index.

It's all a matter of timing.  The Fed is eyeing another rate cut and there's a log of investor cheer-leading behind the idea.  On the other hand, if China begins to throttle back USA exports, that ought to drive up prices, which in turn should show up as inflation 3-4 months out.

The only conclusion I can reach is that while the Fed rate may indeed come down another quarter, the likelihood of it being a long-term rate at low levels seems pretty low.  There's too much global currency jockeying going on for it to be otherwise.

Just as a 'fer instance' take Australia where the Central Bank(sters) have just pushed rates up to an 11-year high.  That, in turn will put the screws to homeowners both in Australia and Tasmania.

(Dropping into my best Japanese martial arts voice track mode) "Hai!  And, so you see Gozo, the pen is mightier than the sword, but the money is more powerful than the pen, and the greed more powerful than the money..."  Fade to black.

But seriously, or as best I can manage on Friday:  How long would you sell things to a country that paid you with money that was dropping in value quite quickly?

Balance of Trade

Still negative:

"Goods and Services

The U.S. Census Bureau and the U.S. Bureau of Economic Analysis, through the Department of Commerce, announced today that total September exports of $140.1 billion and imports of $196.6 billion resulted in a goods and services deficit of $56.5 billion, compared with $56.8 billion in August, revised. September exports were $1.5 billion more than August exports of $138.6 billion. September imports were $1.2 billion more than August imports of $195.4 billion.

In September, the goods deficit decreased $0.3 billion from August to $65.7 billion, and the services surplus was virtually unchanged at $9.3 billion. Exports of goods increased $1.2 billion to $100.2 billion, and imports of goods increased $0.9 billion to $166.0 billion. Exports of services increased $0.3 billion to $39.9 billion, and imports of services increased $0.2 billion to $30.6 billion.

In September, the goods and services deficit was down $7.7 billion from September 2006. Exports were up $16.8 billion, or 13.6 percent, and imports were up $9.1 billion, or 4.9 percent. "

Ben's Assessment

In a nutshell, it is being summarized as 'gonna get worse, then better'...but here's the whole text because Ben Bernanke presents good testimony, and its really important to get the whole sense of it.  Economically, this is important enough to go right to the source and ignore the spin.  (click here to skip Ben's speech and get to the Ron Paul cross examination)

"Chairman Ben S. Bernanke

The economic outlook

Before the Joint Economic Committee, U.S. Congress

November 8, 2007

Chairman Schumer, Vice Chairman Maloney, Representative Saxton, and other members of the Committee, thank you for inviting me here this morning to present an update on the economic situation and outlook.

Developments in Financial Markets
Since I last appeared before this Committee in March, the U.S. economy has performed reasonably well.  On preliminary estimates, real gross domestic product (GDP) grew at an average pace of nearly 4 percent over the second and third quarters despite the ongoing correction in the housing market.  Core inflation has improved modestly, although recent increases in energy prices will likely lead overall inflation to rise for a time.

However, the economic outlook has been importantly affected by recent developments in financial markets, which have come under significant pressure in the past few months.  The financial turmoil was triggered by investor concerns about the credit quality of mortgages, especially subprime mortgages with adjustable interest rates.  The continuing increase in the rate of serious delinquencies for such mortgages reflects in part a decline in underwriting standards in recent years as well as softening house prices.  Delinquencies on these mortgages are likely to rise further in coming quarters as a sizable number of recent-vintage subprime loans experience their first interest rate resets.  I will have more to say about this problem and its implications for homeowners later in my testimony.

At one time, most mortgages were originated and held by depository institutions.  Today, however, mortgages are commonly bundled together into mortgage-backed securities or structured credit products, rated by credit-rating agencies, and then sold to investors.  As mortgage losses have mounted, investors have questioned the reliability of credit ratings, especially those of structured products.  Because many investors had not developed the capacity to perform independent evaluations of these often-complex instruments, the loss of confidence in the credit ratings, together with uncertainty about developments in the housing market, led to a sharp decline in demand for these products.  Since July, few securities backed by subprime mortgages have been issued.

Although the problems with subprime mortgages initiated the financial turmoil, credit concerns quickly spilled over into a number of other areas.  Importantly, the secondary market for securities backed by prime jumbo mortgages also contracted, and the issuance of such securities has declined significantly.  Prime jumbo loans are still being made to prospective home purchasers, but they are at higher spreads and have more-restrictive terms.  Concerns about mortgage-backed securities and structured credit products (even those unrelated to mortgages) also greatly reduced investor appetite for asset-backed commercial paper, although that market has improved somewhat recently.  In the area of business credit, investors shied away from financing leveraged buyouts and from purchasing speculative-grade corporate bonds.  And some larger banks, concerned about potentially large and difficult-to-predict draws on their liquidity and balance sheet capacity, became less willing to provide funding to their customers or to each other.   

To be sure, the recent developments may well lead to a healthier financial system in the medium to long term:  Increased investor scrutiny of structured credit products is likely to lead ultimately to greater transparency in these products and to better differentiation among assets of va