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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

The Brutal Truth About the Credit Crisis

Politics / Credit Crisis 2008 Nov 17, 2008 - 07:53 AM GMT

By: Money_and_Markets


Diamond Rated - Best Financial Markets Analysis ArticleMike Larson writes: I don't know about you. But I started keeping a mental “Outrage List” a while back. The idea: Chronicle all the ridiculous statistics, all the lies, all the questionable practices, and all the dubious “rescue packages” Wall Street and Washington keep shoveling onto the public's lap.

And boy oh boy, is it getting long these days!

Heck, it's getting to the point where I need to pop a Valium before reading the headlines or watching the tube — because if I don't, I might just put my shoe through the TV screen!

Just Consider What Has Happened in Only the Past Few Days and Weeks …

American Express manages to get approval (from the Federal Reserve) to become a bank holding company in the blink of an eye. This kind of thing usually takes weeks or even months. And within 24 hours, the reason they did so leaks — they want to reach into your wallet and pull out some bailout money, too! Amex is reportedly seeking $3.5 billion in taxpayer funds.

General Motors operates for years churning out gas-guzzling SUVs and Hummers. Ford also stakes its future on big trucks like the F-150 — instead of choosing the same prudent path as competitors like Honda and Toyota, who focus on fuel-conscious sedans and compacts.

GM (via its financing arm GMAC) even goes a step further. Not content to stick to car loans, it decides to branch out and make billions and billions of dollars of crappy mortgage loans.

Then, when the utterly predictable consequences of this foolish corporate strategy come home to roost, GM and the other automakers come back to the trough like pigs looking for slop. Only in this case, we're talking real money — $25 billion or more.

Paulson and Bernanke cajole Congress into forking over $700 BILLION to create TARP.
Paulson and Bernanke cajole Congress into forking over $700 BILLION to create TARP.

Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke urge Congress to create the Troubled Asset Relief Program — with as little debate and oversight as possible and a price tag of $700 billion. They warn of financial cataclysm if the government doesn't start buying up mortgages and mortgage related assets from banks.

Yet just a few short weeks later, they totally change course. They say “Never mind — we're not going to buy up assets after all. We're going to buy up stakes in small banks, big banks, insurers, and God knows who else, with the money. We know the last 20 or so 'solutions' to the credit crunch didn't work. But this one will. Really. We mean it.”

Fannie Mae and Freddie Mac make a huge deal about a new program to modify more mortgages. We get the mid-afternoon press conference, the intraday ramp in the stock market, the usual stuff.

Citigroup, JPMorgan and other lenders get in on the action too, issuing glowing press releases about foreclosure moratoriums and other plans to keep borrowers in their homes.

But in reality, many lenders and mortgage servicers have ALREADY been trying all kinds of loss mitigation strategies and loan modifications (loan term extensions, temporary interest rate reductions, and so on).

Yet …

They Haven't Managed to Stop the Nation's Foreclosure Rate From Rising.
Why? It's Simple …

  1. All those modification efforts can't overcome the negative impact of surging unemployment.
  2. Many borrowers lied about their income and their assets in the first place, meaning they can't even make the reduced payments their lenders are offering.
  3. Others were speculators and second-home owners, who don't qualify for relief.
  4. Home prices are falling so far, so fast, that millions of borrowers are underwater — owing $20,000, $50,000, even $100,000 more than their homes are worth. They have little financial incentive to stay in their houses — even at a lower monthly payment — because they know they won't breakeven for years, if ever. And many of them know darn well they can rent for less … sometimes much less … at a house or apartment down the street or across town.
  5. Still others have loans that were ultimately sliced, diced, and repackaged into complex securities — now owned by various Ferrari-driving hedge fund managers who leveraged up to buy junky paper just a few months after they got out of B-school.
  6. Because of the “miracle” of this financial alchemy … which made Wall Street rich beyond measure … these borrowers are stuck. Their loan “servicers” WON'T modify their loans because they're afraid of getting their pants sued off by the investors who own securities derived from those underlying loans, securities that in some cases can lose value if the loan terms are changed.

The Hole Keeps Getting Deeper … And Deeper … and DEEPER …

How about the bottomless pit known as AIG?

The company made a bunch of stupid decisions to insure crummy mortgage-related securities against default. It clearly had no idea what the heck it was doing, and managed to lose a whopping $24.5 billion in the most recent quarter. But instead of going broke, they get thrown a helping hand courtesy of, well, you and me. The tab for that bailout keeps on rising — approximately $150 billion at last count!

Then there's Fannie Mae and Freddie Mac. They take on hundreds and hundreds of billions of dollars of mortgage and interest rate risk. They pile headlong into the derivatives market, dig deeper into the riskier subprime and Alt-A part of the mortgage business, and continually operate on relatively small capital cushions.

Furthermore, they keep carrying billions and billions of dollars of dubious tax-related “assets” on their balance sheets and claim that means they're in decent shape.

But soon after, the two companies are essentially nationalized.

And those tax assets? Fannie Mae just slashed their value by 78% to $4.6 billion.

Why Can't the Government Just Cut The Crap and Level With Us?

Sometimes I just can't help but ask myself that question. I mean, I know it makes for bad politics. But like the old saying goes, honesty is the best policy. And we're just not getting it from Washington and Wall Street.

Instead, policymakers and industry officials have been offering up a steady diet of B.S. about this credit crisis and the housing bust for the greater part of two years now …

  • “It's just a subprime mortgage problem.”
  • “There's nothing to worry about, the problem is ‘well-contained'.”
  • “Major banks and brokers will never fail. It'll just be a few small institutions.”
  • “Home prices never go down.”
  • “It's a great time to buy or sell a house.”

That's what you've been told by officialdom. And all of it — every last bit of it — has proven to be dead wrong.

On the other hand, we've been doing our best to give it to you straight the entire time, no matter the consequences. This morning, I'm going to do it again …

I'm Going to Tell You the Brutal Truth You Won't Hear From Washington or Wall Street …

You can't just wave a magic wand in Washington and wish all this stuff away.

You can't reverse years and years of reckless overspending, overborrowing, and overlending — even with hundreds of billions of dollars of taxpayer money.

You can't keep borrowers in homes they should have never bought in the first place.

You can give banks and consumers billions and billions of dollars … but you can't make them lend and spend it. If they know the economy stinks, they're going to lose their jobs, or that there's just too much risk out there, they aren't going to do what you want them to do. Instead, they'll do what is PRUDENT — repair their balance sheets, hunker down, and rebuild their capital base over time.

The harsh reality is that the economy is cyclical. Busts follow booms. They have for hundreds of years. And those busts are healthy over the longer term, even if they're painful in the short-term. They set the stage for healthy, productive growth.

Greenspan's policies drove the cost of money into the gutter.
Greenspan's policies drove the cost of money into the gutter.

Unfortunately, the Fed has consistently gotten in the way of that curative process in recent years.

It went totally overboard under Alan Greenspan after the dot-com bust, driving the cost of money into the gutter. Thanks to that reckless monetary policy, and the reckless disregard for prudence throughout the lending industry, we experienced the biggest housing and mortgage bubble in the history of the U.S. We also saw too much dumb lending and asset inflation in the leveraged buyout business, in the commercial real estate arena, and in the emerging markets.

Now, we have to suffer the consequences. They're baked in the cake.

The government can try to ease the pain of that process. That's what all these bailouts are about. But in case you haven't noticed, they really haven't worked. We've gotten brief bounces in stocks, brief periods of economic expansion, temporary improvements in the credit markets.

But they don't stick. They fail.

What to Do Now …

I know this is a sobering big-picture view. But it has the added benefit of being true — unlike a lot of the garbage you're hearing from your elected and unelected leaders.

Someday, we'll see the depths of the recession's eyes. Someday, we'll get to the point where enough companies have failed, enough homes have fallen into foreclosure, enough lenders have gone under, and enough debt has been crunched to get a real bottom in the markets and the economy. Then we'll be ready for our country to grow in a healthy, sustainable fashion for the long term.

But we're not there yet. And judging from what I'm seeing, my outrage list appears doomed to grow.

The best way for you and me to avoid ripping our hair out? Tune out the B.S. Focus on reality. And invest accordingly — with heaps of cash, inverse ETFs, put options, and other protective positions.

Until next time,


This investment news is brought to you by Money and Markets . Money and Markets is a free daily investment newsletter from Martin D. Weiss and Weiss Research analysts offering the latest investing news and financial insights for the stock market, including tips and advice on investing in gold, energy and oil. Dr. Weiss is a leader in the fields of investing, interest rates, financial safety and economic forecasting. To view archives or subscribe, visit .

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