Testing The Assumptions
(Looking for love [financial market truth] in all of the wrong places?)

I speculated in my “Through the Looking Glass, and Down the Rabbit Hole” paper
http://www.nakedcapitalism.com/2008/03/covert-nationalization-of-banking.html
(Scroll down the page), a few “What if”, and/or, “Bigger than a bread basket” business man’s conclusions. Over the last few days I’ve been pounding on these conclusion trying my best to prove myself wrong, while waiting for someone, (Where are you?), to come back and explain to me why I’m just full of #%&*. So far not a peep in reply. In the rapidly developing meantime, I’ve had moments of “Uh-Oh, I didn’t know that”, “Wonder if that makes my conclusions off base?”, “How in the hell do you factor that in?”, and then ending with, for the moment, “Uh-Oh, again, these numbers look more on the mark than I had ever imagined they would be”, not that that is any comfort to me. It isn’t!

I started with a report that there were presently “900,000 in foreclosure” which led to my saying in the above paper:

“It is reported in the last few days that there are 900,000 homes presently in foreclosure. Taking businessman’s approach, lacking any “for certain” data, I’ve assumed a $200,000 to $400,000 per home amount for those homes in foreclosure. So…current non-performing mortgages industry wide could be in the range of $180 billion to $360 billion.”

But wait! As they say in the TV steak knives ads, it was “reported” in the financial news this week that “2.2%” of the total numbers of US homes were “in foreclosure”. Earlier this week Moody’s, Economy.com “…estimates 8.8 million homeowners, or about 10 percent of homes, will have zero or negative equity by the end of the month.”
So if 8.8 million equals 10% of the total homes, then 2.2% would equal 1.936 million homes presently in foreclosure. Now that’s quite a spread, 900,000 over 1,963,000 or more than twice, or 100%, of the original number I used. If we quickly apply the above “what if” per house values then this becomes an estimated range of $392 billion to $785 billion of loans in foreclosure right now, as we speak. Forget about what might be coming in the short term for the moment.

Then to make things even more interesting S&P had this to say today:

“NEW YORK (Reuters) – Standard & Poor’s said on Thursday write-downs for large financial institutions on subprime debt are likely past the halfway mark, but could still hit $285 billion. S&P’s estimate of write-downs was up from the $265 billion figure it published in January, but the credit ratings agency said an end to subprime write-downs was in sight.” (March 13, 2008)

Now the fun really begins. If you divide 1.936 million homes into $285 billion you get an average “loan” amount of roughly $132,000 per house. Can it be true? Not on either of the “coasts” for sure which were referred to today as being the “major areas where loans were in default”, and I think the “coast areas” probably mean somewhere East of the Mississippi and then East again, and the Rockies West. This leads to another number crunching exercise. It’s been quoted all over the place in the last ten days that the total US Mortgage market is $11 trillion dollars. So if you divide 88 million homes (see above) into $11 trillion you come up with an average mortgage amount of $125,000 per home in the whole wide USA. Now this begins to smell. Did someone at S&P do what I just did, and apply a “national average” to come up with their “$285 billion” quoted above. It sure as hell looks like it. Or you can try a backdoor approach, and multiply $11 trillion by 2.2% which yields $242 billion or $121,000 per home for another very “smelly” “national average”.

Let’s digress for a moment and see how these present “total foreclosure” numbers above stack up against what the Fed has been doing regarding bailout funds. A report today stated that the Fed has dumped in $900 billion so far “going back to the summer of 2007”. Already in 2008 they have put up a total of $140 billion in TAF’s in January and February, 2008, (I think) announced an additional $100 billion in TAF funds and another $100 billion “for related financial institutions” for March 2008, and then topped things off yesterday with another $200 billion for “who knows what”. That’s $540 billion so far in 2008 which means they put out $360 billion in the last half of 2007. That’s quite an acceleration of funding. And the first March announcement did say that they, the Fed, were committed to keeping up this funding for the “next six months” if necessary. So if you add up the already spend, or committed funds, of $900 billion, and you then add on another $200 billion times 6 months, with no further accelerations of funding, the total comes out to $2.1 trillion. It would seem that even the “$900 billion” already spent is an over kill to S&P’s “$285 billion sub-prime markdowns” much less the stated commitment by the Fed for an additional $1.20 trillion in 2008. What could the Fed and the financial market be possibly thinking? I’ll tell you what.

The “Moody’s Economy.com” report, quoted part above, said in total:

“Economy.com estimates 8.8 million homeowners, or about 10 percent of homes, will have zero or negative equity by the end of the month. Even more disturbing, about 13.8 million households will be “upside down” if prices fall 20 percent from their peak. The latest Standard & Poor’s/Case-Shiller index showed U.S. home prices plunging 8.9 percent in the final quarter of 2007 compared with a year earlier”.

And since this quote from last week there have been recent estimates that housing market values were going to drop as much as 30% to 40%. If you again apply my “what if” numbers from above, the potential default amounts then rocket up to, for the “10%, 8.8 million homes” is $1.76 Trillion to $3.52 trillion, and up to, for the “20% ,13.8 million homes, $2.76 trillion to $5.52 trillion.

Then I’ll reverse course and go back to S&P’s “estimate of write-downs”i.e. “$285 billion”. Hmmm…”write downs” says S&P, which seem to point to their meaning not “gross loan” amounts. So… using all of my circa 1962 “Money, Credit, & Banking” class skills, I am beginning to see that we have two, not one, financial mortgage market “default” distinctions being thrown around, “net loss”, “write down”, numbers that banks experience once a default property is sold, and/or have been traded into the Fed for shiny, (well maybe not so shiny) bars of gold (AAA Treasuries), and then the second being the gross initial loan amounts that default. So…As I remember, once a mortgage becomes “non-performing” it has to be taken out of the bank’s Fed mandated balance sheet requirements, and placed over in a “not to be used” loan multiplier, say 10 to 1 (my guess), category. With this said, one thing finally seems to be making sense, and that is Bernanke’s very smart move to allow banks to quickly “trade in” these toxic “non-performing” loans for “bars of gold”. And this then leads to a very poignant, and pointed, question of S&P’s statement “…write-downs for large financial institutions on subprime debt are likely past the halfway mark…” made on March 13, 2008. And then finally, once again, the Fed commitment of $2.1 trillion total amount, so far, of announced bail out funds beginning from last summer, as stated above, begin to also make some sense. And I would also quickly, and seriously, suggest that someone run over to S&P and give their gear head financial analysis guys and gals, a strong slap in the face to wake them up.

So back to some more number crunching for the 0.0001% of you still with me.
If you take S&P’s “$285 billion” number for presently forecasted “write-downs” yielding a $132,000 average per house number, it seems that one should ask, “What does that amount then yield in gross mortgage per house value of the present number of houses reported to have been to be “sold”, and “resolved”, since the beginning of the melt down last summer of 2007?.” The only number that I’m able to come up with to “test” this “assumption”, at the moment, is the reported “8% to 10% home price, year on year, drop” of “national home prices” that was recorded, and reported, for the last quarter 2007”. To make things easy I’ll use the 10% number which should mean that the average total home mortgage would be $1,320,000. While that number would be a “non brainer” for someone like me sitting in the high rent district of California, I would question that value when being applied nationwide, and that assumption, re: question, then leads to even more questions. One way to “think about it” might be that the percent of the total amount of mortgage “write downs” might be greater than 10%, say 30% to 40%, or that circling back to my “California” interpretation, you might concluded the “biggest” were first to fall. What can be said at the moment is that “We don’t know”, and I will stretch the point by saying that I’m not sure that any one else “knows”.

What might be at play here is the dusty old accounting inventory distinctions of LIFO-FIFO (Last In First Out-First In First Out). Well…If you were to take a 30 year total market assumption of the “total mortgage market”, pretty safe I would say, and then extrapolate, and apply, that which has gone on since the advent of the sub-prime loan market it does seem reasonable to me, to assume that it is a FIFO (First In-First Out) number that is now coming back to bite us in the ass with vengeance. And then, and then again, what is the total of these, about to be, toxic sub-prime loans when compared to the currently quoted total $11 trillion mortgage market in value, and in per house, numbers? The list of questions then goes on and on, but let’s try to give it a whack. And if you haven’t already figured it out, I’m now “Way Out There” in the California surfer vernacular. A number, “1995”, keeps rolling around in my brain. It is the year that “Derivatives’ were invented in a similar manner to the totally bogus (sorry) Big Bang” “Ex Nihilo”, i.e. “from, our out of, nothing, re: Webster”, creation story. So is the front loading “13 over 30” re: a 1995 start of “sub-prime lending” or is it safer to assume a “7 over 30” number starting in 1980. Again who knows? And then the “$64 trillion dollar question” is (My haven’t the times changed?) how much, and what percentage of the “total $11 trillion mortgage market” gets factored into “being at risk” in the front loaded estimated amount, right now, and as of, today? My WAG (you do what that means) would be in the $5.5 to $6.6 trillion dollar range. Now we’re talking serious money, and even though it just may be a coincident these numbers are within shouting distance to the “13.8 million homes [yielding] $2.76 trillion to $5.52 trillion [in zero or upside down mortgage debt equity]” as stated above.

Now that I’ve got “that all figured out” what is to say about the following?

“We are becoming increasingly concerned that the authorities in the world do not get it,” said Bernard Connolly, global strategist at Banque AIG. “The extent of de-leveraging involves a wholesale destruction of credit. The risk is that the ’shadow banking system’ completely collapses,” (Circa March 10, 2008.)

Well, again, who knows? It does seem like that we’re all standing in front of the big “Wizard of Oz” screen trying to find some truth through all of the smoke and mirrors of this “Shadow banking”, read derivatives, system.” I suspect that it is the “Varmint in the Wood Pile”. We can smell it, we can hear it, and we can see all of the dead chickens spread around the barn yard, and we still don’t know what it is, and/or how to do anything about it. Not a very happy ending, but that is the best I’ve got for the moment, like it, or not. And if you happening to be wondering, I don’t like it one bit.

MONDAY MORNING 8:00 AM, MARCH 17, 2008, POP QUIZ.
For all of Standard & Poor’s Home Market Analysts.
(99% of Final Grade)
(Weighed questions. 10% total #I.0 through #3.0. 90% for #4.0)
(Sorry no multiple choice questions. Essay only.)
(Please write clearly in ink only on your bluebooks.)
(Be cautioned that what you write today may not be valid tomorrow.)
(You may freely consult the sum total of all of the World’s information systems during testing)
(After the workday week has ended you may take your bluebooks home, and continue to write over the weekend. You may also consult with your family members if you choose, and please be cautious. No need to worry the innocent.)

S&P Pop Quiz Essay Questions:

1.0 What is the gross home market mortgage debt numbers underlying your last week quoted $285 billion mortgage “write down” numbers?
2.0 What is the actual number of homes that you have in these calculations?
3.0 Have all of your “homes in foreclosure” leading to your “write down” number that you have quoted actually been resolved i.e., sold and done with, our have you extrapolated the numbers. If so what are those two categories of numbers in gross and net values, as well as per home numbers in each class.?
4.0 Do you ever, or have you ever, (sounds familiar doesn’t it) looked ahead to April 15, 2008 to see where your numbers might be after all of the first quarter 2008 Stats are in? (Probably a question for Moody’s, but what the hell, I might as well ask S&P.)

End.

Best regards,

Earl L. Crockett
March 15. 2008

Though the risks of an unpleasant outcome are worrisome, the effects of Fed interest-rate cuts and fiscal stimulus have yet to be fully felt by the U.S. economy.

This passage comes from the reporters (as opposed to a person interviewed or cited). And, too typical of the Journal, it is poorly reported/written.

Think about it. Basically, the sentence structure communicates: “Not to worry”.

And the reason for ‘not to worry’ is that the ‘effects of Fed action are not yet fully felt’.

But, if those of us who follow Yves think for just a second, the effects of Fed actions are negative, not positive. When they get fully felt, we’ll all be witnessing a greater disaster.

Remarks by Governor Ben S. Bernanke
Before the National Economists Club, Washington, D.C.
November 21, 2002
Deflation: Making Sure “It” Doesn’t Happen Here

But the U.S. government has a technology, called a printing press (or, today, its electronic equivalent), that allows it to produce as many U.S. dollars as it wishes at essentially no cost. By increasing the number of U.S. dollars in circulation, or even by credibly threatening to do so, the U.S. government can also reduce the value of a dollar in terms of goods and services, which is equivalent to raising the prices in dollars of those goods and services. We conclude that, under a paper-money system, a determined government can always generate higher spending and hence positive inflation.

Of course, the U.S. government is not going to print money and distribute it willy-nilly (although as we will see later, there are practical policies that approximate this behavior).8

Thus, as I have stressed already, prevention of deflation remains preferable to having to cure it. If we do fall into deflation, however, we can take comfort that the logic of the printing press example must assert itself, and sufficient injections of money will ultimately always reverse a deflation.

8:Keynes, however, once semi-seriously proposed, as an anti-deflationary measure, that the government fill bottles with currency and bury them in mine shafts to be dug up by the public.

Oh My God!