[LA_Renter]

(cont)
The process of transforming risky mortgage loans into coveted perceived safe and liquid (“money”-like) Credit instruments has broken down on several fronts. Not only is the risk intermediation community impaired, marketplace confidence and trust in the quality, safety, and liquidity of mortgage (and mortgage-related) securities is being shattered. There are apparently serious problems developing throughout the massive marketplace for (“repo”) financing MBS. And it is precisely the market for financing the top-rated mortgage securitizations – where the perceived risk was minimal – where I suspect the greatest abuses of leverage occurred. The marketplace is now experiencing forced de-leveraging and a liquidity Dislocation – with major systemic ramifications.

I mostly downplayed the marketplace liquidity and economic impact of the housing downturn last fall and the subprime implosion this past February. For the system as a whole, the Credit spigot remained wide open. My view of current developments is markedly different. I cannot this evening overstate the dire ramifications for the unfolding Credit Market Dislocation. There is today serious risk of U.S. financial markets – distorted by years of accumulated leverage and derivative-related risk distortions – of “seizing up.” A system so highly leveraged is acutely vulnerable to speculative de-leveraging and a catastrophic “run” from risk markets. At the same time, the Bubble Economy and inflated asset markets – by their nature – require uninterrupted abundant liquidity. The backdrop could not be more conducive to a historic crisis, yet most maintain unwavering confidence that underlying fundamentals are sound.

I am this evening unclear how the enormous ongoing demand for new California mortgage Credit will be financed going forward. With the market having lost all appetite for “jumbo” MBS, mortgages must now be priced generally in accordance with the standards of increasingly cautious loan officers willing to live with these loans on their banks’ balance sheets (a radical departure from pricing set by originators selling loans immediately in an overheated MBS market). And, let there be no doubt, the prospective Credit tightening will hit grossly inflated and highly susceptible “Golden State” housing prices hard – a scenario that will force lenders to incorporate significantly higher Credit losses into their loan pricing terms (perhaps Cramer was speaking to CA homeowners when he jingled house keys in front of the camera during Wednesday’s show and suggested it was perfectly rational to mail your keys to the bank). Furthermore, I expect the pricing and availability of Credit required to refinance millions of rate-reset mortgages in California and elsewhere to turn prohibitive for many. And the home equity well is about to run dry – from a combination of sharply tightened Credit conditions and accelerating home price declines.

A severe tightening in mortgage Credit is in itself sufficient to pierce a vulnerable U.S. Bubble Economy. But there is as well an abruptly brutal tightening in corporate Credit. The junk bond market has basically closed for business. The leveraged loan marketplace is in turmoil and scores (46 – see WSJ above) of debt deals have been pulled. And, more ominously, the previously booming ABS and CDO markets have slowed to a crawl. Perhaps not immediately, but it will not be long before the economy succumbs to recession.

Credit Market Dislocation now dictates the assumption that Federal Reserve liqudity assurances and rates cuts are on the near horizon. And while they will likely incite the expected knee jerk response in the equities market, I don’t expect they will have much lasting effect on our impaired Credit system. Current issues are much more complex and serious than ’87, ’98, 2000, or 2002. The dilemma today is that confidence in “Wall Street finance” has been shattered. The manic Bubble in Credit insurance, derivatives, and guarantees is bursting. The manic Bubble in leveraged speculation is in serious jeopardy. The currency markets are a derivative accident in waiting. Fed rates cuts risk a dollar dislocation and/or a further destabilizing (for spreads) Treasury melt-up.

[LA_Renter]

(cont)
The process of transforming risky mortgage loans into coveted perceived safe and liquid (“money”-like) Credit instruments has broken down on several fronts. Not only is the risk intermediation community impaired, marketplace confidence and trust in the quality, safety, and liquidity of mortgage (and mortgage-related) securities is being shattered. There are apparently serious problems developing throughout the massive marketplace for (“repo”) financing MBS. And it is precisely the market for financing the top-rated mortgage securitizations – where the perceived risk was minimal – where I suspect the greatest abuses of leverage occurred. The marketplace is now experiencing forced de-leveraging and a liquidity Dislocation – with major systemic ramifications.

I mostly downplayed the marketplace liquidity and economic impact of the housing downturn last fall and the subprime implosion this past February. For the system as a whole, the Credit spigot remained wide open. My view of current developments is markedly different. I cannot this evening overstate the dire ramifications for the unfolding Credit Market Dislocation. There is today serious risk of U.S. financial markets – distorted by years of accumulated leverage and derivative-related risk distortions – of “seizing up.” A system so highly leveraged is acutely vulnerable to speculative de-leveraging and a catastrophic “run” from risk markets. At the same time, the Bubble Economy and inflated asset markets – by their nature – require uninterrupted abundant liquidity. The backdrop could not be more conducive to a historic crisis, yet most maintain unwavering confidence that underlying fundamentals are sound.

I am this evening unclear how the enormous ongoing demand for new California mortgage Credit will be financed going forward. With the market having lost all appetite for “jumbo” MBS, mortgages must now be priced generally in accordance with the standards of increasingly cautious loan officers willing to live with these loans on their banks’ balance sheets (a radical departure from pricing set by originators selling loans immediately in an overheated MBS market). And, let there be no doubt, the prospective Credit tightening will hit grossly inflated and highly susceptible “Golden State” housing prices hard – a scenario that will force lenders to incorporate significantly higher Credit losses into their loan pricing terms (perhaps Cramer was speaking to CA homeowners when he jingled house keys in front of the camera during Wednesday’s show and suggested it was perfectly rational to mail your keys to the bank). Furthermore, I expect the pricing and availability of Credit required to refinance millions of rate-reset mortgages in California and elsewhere to turn prohibitive for many. And the home equity well is about to run dry – from a combination of sharply tightened Credit conditions and accelerating home price declines.

A severe tightening in mortgage Credit is in itself sufficient to pierce a vulnerable U.S. Bubble Economy. But there is as well an abruptly brutal tightening in corporate Credit. The junk bond market has basically closed for business. The leveraged loan marketplace is in turmoil and scores (46 – see WSJ above) of debt deals have been pulled. And, more ominously, the previously booming ABS and CDO markets have slowed to a crawl. Perhaps not immediately, but it will not be long before the economy succumbs to recession.

Credit Market Dislocation now dictates the assumption that Federal Reserve liqudity assurances and rates cuts are on the near horizon. And while they will likely incite the expected knee jerk response in the equities market, I don’t expect they will have much lasting effect on our impaired Credit system. Current issues are much more complex and serious than ’87, ’98, 2000, or 2002. The dilemma today is that confidence in “Wall Street finance” has been shattered. The manic Bubble in Credit insurance, derivatives, and guarantees is bursting. The manic Bubble in leveraged speculation is in serious jeopardy. The currency markets are a derivative accident in waiting. Fed rates cuts risk a dollar dislocation and/or a further destabilizing (for spreads) Treasury melt-up.

[LA_Renter]

It is called playing the Ref. Cramer to a lesser extent did the same thing when the FED was raising especially from 4.75 to 5.25. When they raised to 5 and kept the language in place for further hikes he went ballistic on his show. I think he even mentioned a housing crash back then. Bill Gross of Pimco has been uber bearish on housing and pleaded with the FED to lower at the beginning of this year or else. Of course being the largest bond trader he stood to benefit the most from an easing. To me watching CNBC is no different than watching the Cartoon Network. The should open each show with the Warner Bros Looney Toons intro. I’m like you Temeculaguy “I am just some dude who thinks economics is a cool hobby”. I don’t have the info that these guys have but I have a gut feeling that this problem is more than they can chew and they have known that for quite some time.

[LA_Renter]

It is called playing the Ref. Cramer to a lesser extent did the same thing when the FED was raising especially from 4.75 to 5.25. When they raised to 5 and kept the language in place for further hikes he went ballistic on his show. I think he even mentioned a housing crash back then. Bill Gross of Pimco has been uber bearish on housing and pleaded with the FED to lower at the beginning of this year or else. Of course being the largest bond trader he stood to benefit the most from an easing. To me watching CNBC is no different than watching the Cartoon Network. The should open each show with the Warner Bros Looney Toons intro. I’m like you Temeculaguy “I am just some dude who thinks economics is a cool hobby”. I don’t have the info that these guys have but I have a gut feeling that this problem is more than they can chew and they have known that for quite some time.

[LA_Renter]

Dr Chaos,

Thanks for that post. In theory I can see how they could cut rates now. So in essence the FED won’t actually be adding liquidity to the system rather than slowing down the money contraction of the private banks. If dollars are still being destroyed in the credit contraction in lieu of rate cuts then the value of the Dollar will hold because there are fewer of them. So putting Cramer in context here, being the mouth piece of his hedge fund and investment bank buddies, he is saying the credit contraction taking place is now getting out of control. The third and possibly fourth Bear Stearns hedge fund blow ups and the belly flop of AHM this week acted as the catalyst for his psychotic rant yesterday. I imagine there is some very large ugly blow ups simmering under the surface right now getting ready to pop up. I also imagine most central banks across the globe are saying good riddance to this excess liquidity and the pesky inflation (possibly hyper-inflation) threat but are sitting on pins and needles to avoid a global systemic shock in the credit markets. From my very limited view there is little margin for error here. We do live in interesting times.

[LA_Renter]

Dr Chaos,

Thanks for that post. In theory I can see how they could cut rates now. So in essence the FED won’t actually be adding liquidity to the system rather than slowing down the money contraction of the private banks. If dollars are still being destroyed in the credit contraction in lieu of rate cuts then the value of the Dollar will hold because there are fewer of them. So putting Cramer in context here, being the mouth piece of his hedge fund and investment bank buddies, he is saying the credit contraction taking place is now getting out of control. The third and possibly fourth Bear Stearns hedge fund blow ups and the belly flop of AHM this week acted as the catalyst for his psychotic rant yesterday. I imagine there is some very large ugly blow ups simmering under the surface right now getting ready to pop up. I also imagine most central banks across the globe are saying good riddance to this excess liquidity and the pesky inflation (possibly hyper-inflation) threat but are sitting on pins and needles to avoid a global systemic shock in the credit markets. From my very limited view there is little margin for error here. We do live in interesting times.

[LA_Renter]

If they let the dollar tank you are possibly looking at $150 oil. That will act like sledgehammer on the economy. It’s a catch 22.

[LA_Renter]

If they let the dollar tank you are possibly looking at $150 oil. That will act like sledgehammer on the economy. It’s a catch 22.

[LA_Renter]

The recession risk is the real story here. The possibility of that happening, especially S. California, just shot up with the mortgage market crisis as it stands now. No one forecast this much of a downturn in housing even many bears. Somebody will do something, this is basically hitting crisis level. Something to take into consideration, if someone like me could see this coming over 2 years ago then I have a feeling the FED and Treasury had some conversations about this. I imagine they do have some type of strategy in place to deal with this, at least I like to think so, call me naive. I mean they can’t be that stupid…….Can they???

[LA_Renter]

The recession risk is the real story here. The possibility of that happening, especially S. California, just shot up with the mortgage market crisis as it stands now. No one forecast this much of a downturn in housing even many bears. Somebody will do something, this is basically hitting crisis level. Something to take into consideration, if someone like me could see this coming over 2 years ago then I have a feeling the FED and Treasury had some conversations about this. I imagine they do have some type of strategy in place to deal with this, at least I like to think so, call me naive. I mean they can’t be that stupid…….Can they???

[LA_Renter]

The FED is the wild card here but he’s looking at weak dollar and oil over $75 a barrel. Also if the FED injects liquidity back into the market it will not go back into RE, it will more than likely find it’s way to something that’s inflationary like energy. There is no easy fix here. Like I said earlier interest rates will only help a little, the lax underwriting is history. I always wonder what Ben really thinks of Greenspan. THANKS AL! I’ll handle it from here……A**hole.

[LA_Renter]

The FED is the wild card here but he’s looking at weak dollar and oil over $75 a barrel. Also if the FED injects liquidity back into the market it will not go back into RE, it will more than likely find it’s way to something that’s inflationary like energy. There is no easy fix here. Like I said earlier interest rates will only help a little, the lax underwriting is history. I always wonder what Ben really thinks of Greenspan. THANKS AL! I’ll handle it from here……A**hole.

[LA_Renter]

That’s a good point Nor-La-Temcu-SD-GUY. It will be interesting to see how aggressive the home builders become in this environment. Talk about ripe conditions for a fire sale. Existing home owners are not going to like what they see and will try hold their price in vain as long as they can. These things do take time though.

[LA_Renter]

That’s a good point Nor-La-Temcu-SD-GUY. It will be interesting to see how aggressive the home builders become in this environment. Talk about ripe conditions for a fire sale. Existing home owners are not going to like what they see and will try hold their price in vain as long as they can. These things do take time though.

[LA_Renter]

I don’t think that a 20% decline in prices this year is actually possible given the illiquid nature of RE and the number of transactions that would have to take place in order for that to happen. The thing that will stand out for the balance of the year as you pointed out will be a severe drop off in volume, more than the severe drop off in volume we have today. I agree this last round of developments in mortgages has more punch. We are only 5% off the peak prices and all of a sudden we have 1990’s lending standards in place if not tighter. The real story here is the economy, this is a shock to the system. I guess the real question is will the credit markets stay this locked up and for how long? What will the Fed do? In areas like Southern California this is not as much of an interest rate story as it is a quality of loan story. The Fed could drop half a point (which IMO would be a dangerous move for a variety of reasons that have discussed on this site) but that won’t bring back the lax underwriting that fueled the market. I like many others on this site have been following this for a couple of years now, this has the feel of a major shift in the market. It’s still like watching ice cream melt but now that ice cream is sitting on a concrete bench in Phoenix in August at noon. JMHO

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