We’re sticking with our views and our investments – either until we’re proven wrong or we go broke, or both.
Our view is that the great dollar-based credit expansion of the last half-century is coming to an end. And our guess is that it will end with BOTH a bang and a whimper – that is, both a deflationary contraction…and an inflationary blow-off. A deflationary contraction is the market’s normal response to an inflationary boom. And an inflationary blow-off is the market manipulators’ normal response to a deflationary contraction; but, we hasten to add, there is no guarantee that they can pull it off.
So, as usual, we live in a world of great unknowns…and lesser unknowns…and things we don’t even know we don’t know. What we do know is that stocks have not yet bottomed out (they are nowhere near their low points)…and bonds are still expensive (people still lend to the U.S. government for 10 years at less than 4% – that’s substantially less than the current consumer inflation rate)…and the dollar is still treated with respect, even though its long-term value is zero. There is a lot that can go wrong that hasn’t gone wrong yet, in other words. Until it does, we’ll stick with gold.
*** “The worst is to come.” Sometimes it’s nice to hear things laid out bluntly – and long time sufferers know that we aim to do that at Markets and Money, as well. Former chief economist of the IMF, Professor Kenneth Rogoff is not one to sugarcoat or mince words. He told attendees of a conference in Singapore that in the worldwide credit crunch, “The U.S. is not out of the woods. I think the financial crisis is at a halfway point, perhaps. I would even go further to say the worst is to come.”
Professor Glass-is-Half-Full went on to say: “We’re not just going to see mid-sized banks go under in the next few months, we’re going to see a big one – one of the big investment banks or big banks.”
And the dark twins of mortgage finance didn’t escape unscathed, not by a long shot. Yesterday, on the heels of a report that suggested that the Treasury may have no choice but to nationalise Fannie and Freddie, investors began dumping shares.
The chance of nationalisation of the mortgage giants scares the beejeezus of out foreign investors, especially our friends in Asia. And with good reason…while Japan wasn’t too exposed to subprime, they do hold around ?9.6 trillion in bonds and mortgage-backed paper issued by finance groups. We all know that these securities aren’t guaranteed by the U.S. government. Whoops…
*** As if there wasn’t enough bad press for Fannie, David Hilzenrath at the Washington Post printed a pretty damning article, titled “Fannies’s Perilous Pursuit of Subprime Loans.”
The article is definitely worth a read through, and here are some highlights to tide you over:
In a confidential memo to his board, chief executive Daniel Mudd (has anyone ever had a more unfortunate last name?) “said one of Fannie Mae’s achievements in 2006 was expanding its involvement in the market for subprime and other nontraditional mortgages. He called it a step ‘toward optimising our business.'”
We know…yikes. But wait, it gets worse. The Post continues:
“Internal documents show that even late in the housing bubble, Fannie Mae was drawn to risky loans by a variety of temptations, including the desire to increase its market share and fulfill government quotas for the support of low-income borrowers.
“Fannie Mae documents from the period, obtained by The Washington Post, paint a picture of a company with the dual incentives of fostering affordable housing and making money, and of one caught between the imperatives of increasing its market share while avoiding excessive risk. In a bid to juggle these demands, the company’s executives took on risks they either misunderstood or unduly minimised.
“Fannie Mae aimed to benefit from subprime loans and expand the market for them – and hoped to pass much of the risk on to others, documents show. Along with subprime loans, which were typically issued to borrowers with blemished credit, the company targeted so-called Alt-A loans, which were often made with no verification of the borrower’s income.”
And so on. While it’s not a pretty picture, the article doesn’t say anything that everyone didn’t already assume.
for Markets and Money