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Random Musings IV

June 27th, 2007

 

The wit makes fun of other persons; the satirist makes fun of the world; the humorist makes fun of himself, but in so doing, he identifies himself with people --that is, people everywhere, not for the purpose of taking them apart, but simply revealing their true nature 

James Thurber 1894-1961, American Humorist, Illustrator

  

Housing bust; will it really affect the Equity markets 

Normally the answer would be yes. However the banks and Wall Street decided to find some new exotic way of selling of mortgages and as result many hedge funds etc have invested heavily in sub prime mortgages because they were re bundled and sold of as so called collateralised instruments. We are not going to go into this whole process as that alone could take up an entire market update. Suffice to say things are not as safe as they are made to look as this was quite clearly illustrated by the recent bail out of one Bear Sterns fund in the amount of 3 billion. Long story short banks have actually dumped a lot of this paper and as a result they are not as exposed as they would have been say 20-30 years ago.

 So let’s look at a scenario.  The mortgage risk has been spread out and mostly so called sophisticated money via hedge funds, private equity funds etc have gobbled up these newly re packaged mortgages. So how did Wall Street re package these junk mortgages. They came out with something called CDO’s otherwise known as Collateralised debt obligations. These investments (CDO’s) package together a pool of assets and pay investors interest which is based on the payments received from these assets. However in many cases the only asset backing these CD0’s are sub prime mortgages and the reason many were willing to take this risk was due to the high rate of interest they paid.  It is estimated that 40% of CDO’s are mortage backed securities and of this 40%, 75% are sub prime mortgages. The other CDO’s are backed by property and in some cases are backed by a combo mortgage and real estate.  However if the sub prime mortgage market tanks then it will push more houses onto the market which in turn will force the prices of existing houses lower which will then  affect the value of the CDO’s fully backed by real estate.  Thus even those so called safe CDO’s are not really all that safe because they depend on a robust housing market. The situation can change rather rapidly as was indicated by the rapid turn around of events surrounding the two Bear Sterns funds. One minute they were rolling in profits the next minute they were swimming in a pool of red blood.  

If a whole bunch of individuals start to default the risk will actually be borne by many of the players who had deep pockets to begin with and might not immediately affect the equity markets as it would spare or reduce the amount of risk banks were exposed to significantly.   Many banks are not sitting with mortgages on their balance sheets as they once used to; as stated above they have spread the risk around via CDO’s. The biggest losers would be hedge fund players, some mutual funds and a lot of private equity firms.   

 On the other side of the equation we have the home owner (most of these new buyers should have never bought a house in the first place) many of which bought their first homes in the last 2-3 years.  Now for them the solution is rather simple even though it would carry a lot of emotional pain; once the payments become too large to handle they can simply walk away from the property and rent instead of owning. Then we have individuals that had good credit and stretched themselves beyond their limits; well push comes to shove they can also take the loss and walk away from the property. Yes they will lose some money but in most cases it won’t be much as for the first 10 years 90% plus of the mortgage goes to pay off interest; thus their only real loss will be a paper loss on potential profits and the money they put down to buy the house which in most cases was next to nothing. The real losers will be the mortgage holders and since the risk has been spread so widely the downfall might not be as bad it would have been in the past. This does not mean housing prices will not drop; they will.   

 The small chap who walked away from the markets in 2000 and into real estate might actually now start looking for away to try to get his money back. Remember bad credit does not prevent one from playing in the stock market.   Many will say there is no way in hell that the small guy is going to move from the fire into the frying pan but is that not what they did after the stock market collapsed. They forgot their loses and start to pile into the real estate market so on the same token its quite possible that they could very easily jump back into the equity markets.

In addition individuals today are not prepared to wait; they all live in an express mode and they want to be rich by yesterday.   Gambling on a world wide basis is on the increase, everyone is speculating and everyone is looking for away to move into the so called rich category.   

Here are some interesting facts.  Macau has now surpassed Las Vegas in Gambling revenue and Singapore has now allowed the construction of major casinos for the first time ever.  These developments indicate that on a global basis the majority are becoming speculators in one form or another.

 There is a pretty good chance that the above scenario could come to fruition; especially given the fact that most small players are going to feel that they missed a huge part of this ride up in the equity markets. They are notorious for jumping onto the train long after it has left the station.

  Conclusion 

There is nothing to stop a person from simply walking away from their home. Yes they are going to damage their credit but if you are facing the choice of literally starving or having good credit I am sure most will be willing to sacrifice their credit. The only real loss for these people will be the money they put down which in most cases was nothing and a potential paper profit they lost after the market turned on them. The monthly payments could be viewed as rent and these individuals could simply pick up and rent a new place instead of owning one.   

As everyone now lives in the express and get rich quick mode these same individuals could look back at the stock market as means to re coup their losses just as they did with the real estate market after the stock market crashed in 2000.  This could potentially drive the markets to even new highs.  Is this a definite scenario? No nothing is definite but it’s certainly a possibility and given human nature it appears to be a potentially strong one.  

Please note the above is just one scenario out the many scenarios out there. It does not necessarily mean that it will come true and has pretty much the same chance as many of the other scenarios that are floating out there.

  

Protectionism and ramblings about China lifting restrictions on the Yuan

 Its pure garbage to think that if china allows its currency to float freely it will in effect reduce our enormous budged deficit; that’s the equivalent of trying to put out a forest fire with a portable fire extinguisher.  We are the biggest currency manipulators in the world, printing useless Paper dollars and forcing other nations to except this garbage. One way to cut the deficit down would be for Americans in general to cut down their debt and live within their standards; off course such a solution is to simple for the mutton heads in Washington. 


All we have to look at is Japan. Once upon a time one dollar used to buy over 290 Yen and back then the argument was that if the Japanese let their currency appreciate then the deficit with Japan would be lowered. Well fast forward one dollar now buys roughly only 123 yen and thus the Japanese deficit should have been wiped out but that’s not the case.  The same outcome will hold true for China. What these big shots should be doing is preventing the dollar from depreciating so fast; in other words they should stop printing so many dollars.  

We should also be aware that almost our entire manufacturing base has shifted to China or the surrounding neighbouring countries. Thus if the Yuan were allowed to appreciate say another 20%, consumers would feel that impact immediately and then the idiotic central bankers and Penguins  on Wall Street would start screaming that huge inflationary forces are hitting the markets.   

In the end an old adage comes to mind; first clean up your own house before you start instructing your neighbour on how to clean theirs. 

 

Immigration Reform  

There is a lot of noise about this potential new law; you have one side that is for it and the other side that’s completely against it. We are not going to go into the different arguments both the sides are you using to support their claims.  We are going to go after the real story the story within the story. The thing of interest is that this bill has broad support from both democrats and Republicans. So why would they support it when there is so much opposition to it and it could adversely affect them in the next elections.  Politicians are known for not taking undue amounts risk but right now it appear that members in both parties are willing to take on quite a bit of risk. So why are they doing it? Well we spoke about this problem several times in the past; the government is not really interested in helping anyone. The reason they are trying to pass this reform is because they have a huge problem on their hands one that can and will only get worse with the passage of time unless something is done to address it.  We are talking about social security; a huge number of baby boomers are going to retire in the coming years and there are simply not enough workers out there to support this system indefinitely.  

The only way to shore up social security is to suddenly create a huge pool of new workers who will pay into the system. Thus the law makers are hoping that the legalisation of 12 million plus illegal aliens will be the answer to this huge problem. They cannot go out and admit to the public that social security is in trouble as then they would also have to admit that they are responsible for potentially bankrupting it.  In the end this is just business, they are just looking for a huge group of individuals that will be ready and willingly to support this Ponzi scheme. Remember very few individuals go out and do things for free but one’s government, hum the answer to that is NEVER.   

From an investment perspective these 12 plus million immigrants would indirectly provide even more liquidity to the markets as they would finally be able to invest in the markets by opening bank and brokerage accounts something most of them are unable to do now or are fearful of doing so.

 

 

Stubbornness does have its helpful features. You always know what you're going to be thinking tomorrow.

 Glen Beaman