Alt-A's: the next shoe to drop??

Are Alt-A's the next shoe to drop? We at the Daily Bear think so... Alt-A mortgages represent over $1 trillion of outstanding mortgages or ~12%. Combine this with the $1.5 trillion sub-prime market and approximately 30% of the market is under stress.


Recent signs point to stress in the Alt-A market. While payments continue to be made, there a strong signs of credit deterioration. According to S&P, Alt-A loans which are 90 or more days delinquent are 2.5 times higher than 2005. This rate has begun to accelerate in 2007, 4% vs 2% 12/06.

Scary ? About 33 percent of adjustable-rate loans in the Alt-A sector were originated with reduced documentation and a combined loan to value (CLTV) ratio of greater than 95 percent last year. (S&P) These are investors with over 700 Fico scores... just a sub-prime problem, think again. Stayed Tuned.........

Shadow Statistics By Doug Hornig

Shadow StatisticsBy Doug Hornig
(originally published on 3/21/06)
You're bombarded with all those statistics that pour out of Washington, the ones that appear to show how unemployment and inflation are low, GDP is expanding, and so on. They may not square with your personal experience, but after all, the government pays a lot of people with fancy degrees a lot of money to carefully track economic statistics. So you figure the numbers must be somewhat accurate. But now a man has come out of the woodwork who's done the real math and properly crunched all the numbers. His conclusion: "If the numbers don't seem real to the man in the street--they probably aren't."

Our new friend is Walter J. (John) Williams, with a B.A. in Economics and an M.B.A., both from Dartmouth. He serves as an economic consultant, both to private individuals and Fortune 500 companies."For more than 20 years," he writes on his website (www.shadowstats.com), "I have been a private consulting economist and, out of necessity, had to become a specialist in government economic reporting."Has he ever. What Williams does (and few others bother to do) is read the fine print. The government, he notes in a recent interview with Kathryn Welling of the welling@weeden investment newsletter, "is very honest in terms of disclosing what it does. It always footnotes the changes and provides all the fine details." It is in those details--no surprise--that the devil lies."What has happened over time," Williams says, "is that the methodologies employed to create the widely followed series, such as [...] the GDP, the CPI, the employment numbers, all have had biases built into them that result in overstating economic growth and understating inflation.""Real unemployment right now--figured the way that the average person thinks of unemployment, meaning figured the way it was estimated back during the Great Depression--is running about 12%. Real CPI right now is running at about 8%. And the real GDP is probably in contraction.

I venture that if you talked about those numbers now with the average person, they would say that they seem reasonable [...] my work shows that the economic perceptions of non-professionals actually have some real validity; there are in fact reasons for the disconnect between official statistics and what the populace is feeling."According to Williams, government realized as long ago as the Kennedy administration that Americans would rather hear good news even if it's false, and so the manipulation of data began.

Unemployment was easy. First they created the "discouraged worker" category (those who've given up on finding a job) and counted them separately. Then, under Clinton, they quit counting them at all. Upwards of five million out-of-work people were suddenly no longer "unemployed."Consumer Price Index? Since Jimmy Carter, every administration has messed with it. In order to make it look decent, Alan Greenspan and Michael Boskin, former head of the Council of Economic Advisors, came up with the "substitution" concept. Williams: "The whole purpose of the CPI [was] to measure the change in the cost of a fixed basket of goods over time [...] What Boskin and Greenspan argued was, 'We should allow for substitution because people can buy hamburger instead of steak when steak goes up.' The problem is that if you allow substitutions, you aren't measuring a constant standard of living. You're measuring the cost of survival."Who gets squeezed by this? Fixed-income people. "The difference that it makes is significant: if the same CPI were used today as [under Carter], Social Security checks would be 70% higher."An adjunct to substitution is "weighting," adopted under Clinton, whereby the Bureau of Labor Statistics changed from a straightforward arithmetic to a reality-challenged geometric method, a move Williams calls "a pure mathematical game." The gist of the change is this: now, if something goes up in price, it gets a lower weighting in the CPI, and vice versa. Voilà. Down comes inflation.There's also hedonics, which we covered in an earlier WWNK article. Simply summarized, this means that if a product is "improved," then it is deemed to have come down in price, even if you're paying more for it.Gross Domestic Product? "If you adjust the real GDP numbers that the government releases for the myriad revisions and redefinitions that have been applied to the measure with increasing frequency since the mid-1980s, you find that there's a happy overstatement of growth of about 3% on a year-over-year basis [...] it's important to realize that if inflation is understated, then reported 'real' growth will be overstated."Yet "manipulations of the CPI [...] pale next to the impact of imputations in the GDP." Talk about insidious. To the government, "[any] benefit a person receives has an imputed income component." Thus, for example, if you're a homeowner, forget that backbreaking monthly mortgage payment, you're considered to be paying yourself rental income on your home! No kidding. It's called "imputed interest income," and it's the fastest-growing segment of citizens' personal income. Not only does this phantom cash jack up GDP, it also inflates average household income, which is actually dropping. This we can all see in the explosion of personal debt because, as Williams says, "without growth in income you just can't support growth in personal consumption on a healthy basis, so you do it on an unhealthy basis. You borrow money."Just like the government. And while the amount the government admits it is borrowing may look horrifying enough, the reality is far, far worse. What follows is not for the faint of heart.Williams says that the feds take a stab at reporting their accounts according to "generally accepted accounting principles," or GAAP. Although the numbers include "all sorts of disclaimers," and exclude Social Security, Medicare, Medicaid and similar accounts, "They at least do put out a financial statement. It's the best they can come up with."However, "The budget deficit numbers you hear announced at White House press conferences are from accounts kept on a cash basis, with no accruals made for monies owed by or due to the government in the future.

"What's the difference? A lot. In 2004, the deficit was reported at $412 billion. The official GAAP-based number published by the Treasury Dept. was $616 billion. Add in the net present value of the underfunding of Social Security and Medicare, and what you get is $3.4 trillion. Yes, trillion. And that's if you ignore a one-time spike from the setting up of the new, utterly unfunded Medicare drug benefit.The true GAAP-based deficit has been holding steady in that range. $3.7 trillion in 2003, $3.4 in 2004, $3.5 in 2005. "[T]otal federal obligations at the end of September were $51 trillion," says Williams, "over four times the level of GDP. It is unprecedented for a major country to have its actual obligations so far out of whack."Williams' conclusions about what comes next are grim.

"The Fed will back the system with every dollar it can print. But of course that would go on top of what is already an uncontrolled federal deficit. The end result, when it does all come together, will be something akin to a hyperinflation, but at the same time you'll have also a very depressed economy. So there'll be an inflationary recession, which I think we're already beginning to get into."Despite his dire research findings, "I am an optimist at heart," Williams admits, and he echoes Doug Casey's own words when he says, "If you're able to somehow protect your assets and liquidity through the very rough times ahead, you're going to have some of the greatest investment opportunities that anyone has ever seen."(The full interview with John Williams is available here:http://www.weedenco.com/welling/Downloads/2006/0804welling022106.pdf)

Bill Gross Investment Outlook

Investment Outlook
Bill Gross July 2007
Looking for Contagion in All the Wrong Places
Whew, that was a close one! Ugly for a few days I guess, but it could have been much worse! No, I refer not to Paris Hilton upon her initial release from the LA County pokey after serving three days of hard time, but to the Bear Stearns/subprime crisis. Shame on you Mr. Stearns, or whoever you were, for scaring us investors like that and moving the Blackstone IPO to the second page of the WSJ. We should have had a week of revelry and celebration of levered risk taking. Instead you forced us to remember Long Term Capital Management and acknowledge once again (although infrequently) that genius, when combined with borrowed money, can fail. But (as the Street would have you believe), this was just a close one. Sure Bear itself had to come up with a $3 billion bailout, but folks, most of these assets are worth 100 cents on the dollar. At least that’s how they have ‘em marked! Didn’t wanna sell any so that someone would think otherwise…no need to yell “fire” in a crowded theater ‘ya know. After all, hasn’t Ben Bernanke repeated in endless drones that financial derivatives are a healthy influence on the financial markets and the economy? And aren’t these assets well…financial derivatives? Besides, I direct you to the investment grade, nay, in many cases AAA ratings of these RMBS (Residential Mortgage-Backed Securities) and CDOs (Collateralized Debt Obligations) and
defy you to tell me that these architects were not prudent men. (Sorry ladies, they are still mostly men!)

Well prudence and rating agency standards change with the times, I suppose. What was chaste and AAA years ago may no longer be the case today. Our prim remembrance of Gidget going to Hawaii and hanging out with the beach boys seems to have been replaced in this case with an image of Heidi Fleiss setting up a floating brothel in Beverly Hills. AAA? You were wooed Mr. Moody’s and Mr. Poor’s by the makeup, those six-inch hooker heels, and a “tramp stamp.” Many of these good looking girls are not high-class assets worth 100 cents on the dollar. And sorry Ben, but derivatives are a two-edged sword. Yes, they diversify risk and direct it away from the banking system into the eventual hands of unknown buyers, but they multiply leverage like the Andromeda strain. When interest rates go up, the Petri dish turns from a benign experiment in financial engineering to a destructive virus because the cost of that leverage ultimately reduces the price of assets. Houses anyone?
Oh, I kid the Fed Chairman – and I should stop because this is no laughing matter, and somehow I have a suspicion that this “close one,” this Paris Hilton charade of a crisis, is really so much more than just a 3 or 27 day lockup in the LA County jail. Those that point to a crisis averted and a return to normalcy are really looking for contagion in all the wrong places. Because the problem lies not in a Bear Stearns hedge fund that can be papered over with 100 cents on the dollar marks. The flaw resides in the Summerlin suburbs of Las Vegas, Nevada, in the extended city limits of Chicago headed west towards Rockford, and yes, the naked (and empty) rows of multistoried condos in Miami, Florida. The flaw, dear readers, lies in the homes that were financed with cheap and in some cases gratuitous money in 2004, 2005, and 2006. Because while the Bear hedge funds are now primarily history, those millions and millions of homes are not. They’re not going anywhere…except for their mortgages that is. Mortgage payments are going up, up, and up…and so are delinquencies and defaults. A recent research piece by Bank of America estimates that approximately $500 billion of adjustable rate mortgages are scheduled to reset skyward in 2007 by an average of over 200
basis points. 2008 holds even more surprises with nearly $700 billion ARMS subject to reset, nearly ¾ of which are subprimes.

It was not supposed to be this way. 1% teasers or 3% 2/28’s were supposed to be rolled with no
points into something resembling…well…1% teasers and 3% 2/28’s. Instead today we have nearly 7% fixed rate mortgages and not a teaser to be found. Congress, regulators, even Fed officials are stepping in and warning mortgage originators (even mortgage buyers!) that they’d better be careful and only make good loans. Those nasty capitalists! They must have gotten carried away a few years

PIMCO Bonds - Investment Outlook-July 2007 "Looking for Contagion in All the Wrong Places"

Page 1 of 3
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+July+2007.htm 6/26/2007
ago. Somehow all those BMWs in the New Century parking lot in Irvine, California didn’t attract much
notice in 2006. Now, well, there’s nary a Prius to be found there, but lots of outraged politicians in
Washington, that’s for sure.
The right places to look for contagion are therefore not in the white-washed Bear Stearns
hedge funds, but in the subprime resets to come and the ultimate effect they will have on the
prices of homes – the collateral that’s so critical in this asset-backed, and therefore interestsensitive
financed-based economy of 2007 and beyond. If delinquencies lead to defaults and
then to lower home prices, then we have problems and the potential for an extended – not a 27-day
Paris Hilton sentence. Take a look at Chart 1, which graphically points out the deterioration in
subprime ARM delinquencies. Escalating delinquencies of course ultimately lead to escalating defaults. Currently 7% of subprime loans are in default. The percentage will grow and grow like a weed in your backyard tomato patch.

Now I, the curmudgeon of credit, am as sure of this as I am that the sun will set in the west. The
uncertain part is by how much. But look at it this way: using the current default rate of 7% (3-4% total losses), the holders of some BBB investment grade subprime-based CDOs will lose all of their moolah because of the significant leverage. No need to worry about fictitious 100 cents on the dollar marks here. One hundred percent of nothing equals nothing. If subprime total losses hit 10% then even some single-A tranches face the grim reaper. AAA’s? Folks the point is that there are hundreds of billions of dollars of this toxic waste and whether or not they’re in CDOs or Bear Stearns hedge funds matters only to the extent of the timing of the unwind. To death and taxes you can add this to your list of inevitabilities: the subprime crisis is not an isolated event and it won’t be contained by a few days of headlines in The New York Times. And it will not remain confined to a neat little Petri dish in some mad financial derivative scientist’s laboratory. Ultimately through capital market arbitrage it will affect risk spreads in markets completely divorced from U.S. housing. What has the Brazilian Real to do with U.S. subprimes?

Nothing except many of the same bets are held in hedge funds that by prudence or necessity will reduce their risk budgets to stay afloat. And the U.S. economy? Of course it will be affected. Consumption will be reduced to say nothing of new home construction over the next 12-18 months.

After all, attractive subprime pricing has been key to the housing market’s success in recent years. Now that has disappeared. Importantly, as well, and this point is neglected by most pundits, the willingness to extend credit in other areas – high yield, bank loans, and even certain segments of the AAA asset-backed commercial paper market should feel the cooling Arctic winds of a liquidity constriction. If not taken too far – and there is no hint yet of a true “crisis” – these developments may be just what the Fed has been looking for: easy credit becoming less easy; excessive liquidity returning to more rational levels.

Still, PIMCO looks for the Fed to issue an insurance policy in the
PIMCO Bonds - Investment Outlook-July 2007 "Looking for Contagion in All the Wrong Places" Page 2 of 3
http://www.pimco.com/LeftNav/Featured+Market+Commentary/IO/2007/IO+July+2007.htm 6/26/2007

form of lower Fed Funds at some point over the next 6 months. And what happened to our glass
half-full secular thesis of last month? We still believe in strong global growth, but…as we also
suggested…that the U.S. housing downturn will affect growth and short-term yields over the next year or so.

We remain consistent and resolute. Contagion? Maybe, but you won’t be finding it at
“99.9%” pure Bear Stearns. Look for it instead, in the subprimely financed homes of Las Vegas,
Rockford, Illinois, and Miami, Florida. This problem – aided and abetted by Wall Street – ultimately resides in America’s heartland, with millions and millions of overpriced homes and asset-backed collateral with a different address – Main Street.

William H. Gross
Managing Director

A Note from our Friends at Lennar

Remember when the housing market was supposed to rebound in 2H07

The Daily Bear never believed it, now it appears neither did the industry

The U.S. housing market "has continued to deteriorate throughout the second quarter," noted CEO Stuart Miller. Analysts, on average, had been looking for a quarterly profit of 5 cents a share. New orders amounted to 8,056 homes in the latest quarter, down 31%, while the cancellation rate was 29% and backlog value plunged 56% to $2.8 billion. Lennar's second-quarter revenue dropped to $2.88 billion from $4.58 billion a year earlier, as house deliveries fell to 9,568 from 13,225. "As we look to our third quarter and the remainder of 2007, we continue to see weak, and perhaps deteriorating, market conditions," Miller said,

Scary Bear Housing Stats

-34% of homeowners do not know what kind of mortgage they have (Bankrate.com)
-$1.3 trillion in mortgage resets likely to hit the US in 2007
-$800 million of resets expected in July alone
-monthly mortgages payments likely to go up 10%-50%
-a $200,000 note taken out in 2004 at 4.5% would likely rise to 7.5% this year raising monthly payment from $750 to $1,440. no impact on consumer spending, think again....


First shoe (slight impact to overall economy)
late 2006/early 2007
- many sub prime lenders went bankrupt or were forced to sell portfolios (at a deep discount) after delinquencies skyrocketed
- Wall Street firms to cut off funding of these risky notes
- ~90 sub prime lenders have shut their doors
-lending standards and access to capital have tightened

Second Shoe

From the Fed
Since reaching a cyclical low of 0.70 percent at the middle of
last year, the percent of insured institutions’ loans that are
non current (90 days or more past due or in non accrual status)
has risen in each succeeding quarter. At the end of March,
the non current rate stood at 0.83 percent, its highest level in
two and a half years. During the quarter, non current loans
increased by $4.0 billion (7.0 percent). Non current levels
increased in most loan categories during the first quarter, with
the largest increases occurring in real estate loans. Non current
residential mortgage loans increased by $1.7 billion (7.3
percent), while non current construction and development
loans rose by $1.5 billion (36.1 percent). The rising trend in
non current loans was fairly widespread; almost half of all
institutions (45.7 percent) saw their non current loans
increase in the first quarter. The percentage of 1-4 family residential
mortgage loans that were non current rose from 1.05
percent to 1.13 percent during the quarter. This is the highest
non current rate for residential mortgage loans since
midyear 1994.

Additionally, provisions for loan losses increased 54% y/y, as delinquencies and charge offs increased 48%.

Source:
http://www2.fdic.gov/qbp/2007mar/qbp.pdf


Third Shoe
-1. increased consumer and mortgage debt driven by rising interest rates and increasing resets
-2. access to credit becoming tighter as Wall Street lessens tolerance for collateralized pain and legislation pressures lax rules
-3.consumer spending likely to fall as increased mortgage payments, higher gas prices and quickly rising health care costs crimp the consumer who is already 300% levered.
4. Recession 2008?

Young Master Bernanke - Article from our DC Division

Granddad, Did You Believe in Central Banks Once?: Mark Gilbert 2007-06-20 19:14 (New York)


Commentary by Mark Gilbert
June 21 (Bloomberg) -- ``Granddad Benny, is it true that central bankers used to believe they could steer the global economy with quarter-point twitches in overnight rates?''
Granddad looked up from his GoogleSoft iSpreadsheet, where a flashing red ``health care'' box was blocking 2027's planned expenditure from matching the income cell. ``Yes, Joel. For about a decade we all believed central banks could ensure people had jobs, and could afford food and housing and such. That all changed after the Gigantic Global Bubble Burst of 2008.''
Joel put down his Mandarin dictionary. ``That's what my socio-economics teacher says we'll learn about next week. She called it the Giglobubu. What happened in 2008, Granddad?''
``We're still not sure, Joel,'' Granddad said. ``At the time, some accused the New Zealand central bank, some said it was the bond market, while others blamed the aftershocks of a slump in the U.S. housing market. If she's smart, your teacher will probably spend a lot of time talking about China.''
``Did China cause the Giglobubu, Granddad?''
``It played a big part, Joel. At the start of the century, China started to engage with the global economy. We were able to buy stuff like clothes and televisions really cheaply from China's factories, making everyone feel wealthy enough to spend and borrow instead of putting something aside for a rainy day.
``All of that borrowed money had to come from somewhere, and most of it came from Asia. When China stopped turning up at bond auctions in
2007 and started investing directly in companies instead, alarm bells should have rung. They didn't.

Billions of Spenders

``What everyone failed to realize was that the billions of people in China, Vietnam and other Asian countries didn't want to spend the rest of their lives living in huts in the countryside and working in factories for a pittance. They started to demand and get higher wages and a better standard of living, and went on a spending spree of their own. Their governments, meantime, built roads and hospitals and schools to keep people happy.
``Even though central bankers in the West had been puzzled by low bond yields and wage increases, they still took the credit for slow inflation! So when prices started to surge at the beginning of 2008, they were surprised when raising rates turned out to be powerless in the global economy. They were even more shocked when energy costs soared and they realized China controlled most of the world's power-producing capacity.''

Three Strikes and Out

Joel whispered ``2008 Giglobubu Causes'' into his Apple iWatch, and watched as the holographic multimedia display scrolled into life six inches above his wrist. ``Granddad, it says here that the New Zealand central bank made things worse?''
Granddad rubbed his beard as Joel's watch beamed graphs and charts into the air. ``Well, that's a bit unfair. They were quick to spot that prices were rising, and tried to curb inflation by driving up borrowing costs. Their mistake was trying to stop their currency, the New Zealand dollar, from rising. After the first two attempts failed, they should have given up. When the third attempt went wrong, people panicked because they started to realize how impotent the financial authorities were.''
``Granddad, it also says here that hedge funds and the derivatives market made things worse. What are hedge funds and the derivatives market?''
``Well, they are illegal now, Joel. As the global economy started to crumble under the weight of soaring raw material costs, financial markets melted down, with prices of stocks and bonds whipsawing. Hedge funds were supposed to be clever investors; it turned out that they had all made the same bet on the global economy staying wonderful for ever.

Tangled Webs

``Companies thought they'd borrowed money from their bankers.
Instead, hedge funds had bought up all of the IOUs. When companies started struggling to make their debt payments, instead of having a friendly chat with their bank managers, they found themselves eyeball-to-eyeball with the hedge funds' lawyers, who weren't interested in the survival of the companies and just wanted their money back.
``Lots of the banks had sold insurance on those IOUs and on a bunch of other stuff that they bundled together into derivatives called collateralized debt obligations. When those investments started to blow up, we all realized that nobody knew who owed what to whom. And banks and hedge funds had become such a big part of the global economy that they dragged everything else down with them.''
``I've been meaning to ask you, Granddad; what are all those funny little rectangles of green paper in that big frame on the wall next to your desk?''
``They're called dollars,'' Granddad said. ``We used them to buy things in the olden days. In 2015, a group called the Single Global Currency Association convinced the Bank for International Settlements, which by then was running the world's financial systems, that everyone should switch to one type of money.''
``And they didn't choose the dollar, Granddad?''
``No, Joel. There was a global referendum to make the decision on which currency people wanted. Which is why we now use the yuan all around the world. Anyway, it's getting late. Back to your Mandarin homework, young Master Bernanke.''

(Mark Gilbert is a Bloomberg News columnist. The opinions expressed are his own.)

Street Support for the DB's LBO View

From Dow Jones:

=DJ STREET SAVVY: LBO Funds Get Warning Shot From Bear's Fund

Thursday, June 21, 2007 7:37:15 AM (GMT-04:00)
Provided by: Dow JonesDJ
By Spencer Jakab
A Dow Jones Newswires Column
(This article was originally published Wednesday)
NEW YORK (Dow Jones)--Consider the similarities and linkages between the housing and the private equity booms. Now let's extrapolate from that the possible implications for the equity markets from Bear Stearns Cos.'s (BSC) distressed mortgage hedge funds, whose assets were being auctioned off Wednesday by creditor Merrill Lynch (MER).

One doesn't need to know the minutiae of collateralized debt obligations to grasp that losses in one category of lending vehicle could affect confidence in others that have been eager buyers of loans used to fund leveraged buyouts. In fact, an analyst who sits on the trading floor of a New York brokerage said there are rumblings in the credit markets Wednesday afternoon that the liquidation in mortgage bonds are sparking a sell-off in other assets outside mortgages.
Could the liquidation of the Bear Stearns fund force other mortgage funds to realize losses on opaque securities that they must now mark-to-market? More importantly, could this ripple through the larger financial sphere and ultimately impact the private equity industry's borrowing ability?

The analyst noted that "the Bear Stearns news is resulting in selling in all credit markets, particularly loans and corporate bonds."
While he didn't say it was likely, seemingly small problems in loan markets could turn into large ones for equities.
"Because of the size and leverage, a contagion/blow-up is always possible, and because many structured products recently introduced have never been stress-tested in real life, fireworks could occur if they unwind," said the analyst.
The two funds run by Bear Stearns held about $21.2 billion in long and $8.5 billion in short bets on mortgages as of March 31 on $638 million in equity capital, according to The Wall Street Journal. Unlike earlier asset sales by the fund, Wednesday's auction of opaque, illiquid securities may force other players in the mortgage arena such as collateralized debt obligation funds to reprice their securities and possibly realize paper losses. Collateralized loan obligations, big buyers of LBO debt, are a subset of CDOs that might be affected if losses were to cascade.
CDOs contain significant leverage but are able to attract copious funding by bringing in investors who can only buy high-quality paper. They achieve this by finding investors willing to take on the first losses in what are called equity tranches and derisively referred to as "toxic waste."
Other buyers of loans are hedge funds or proprietary trading desks using huge leverage. They depend on the cheapness of credit default swaps, or CDS, to hedge against repayment risk and can arbitrage the slight difference between the cost of protection and yields to make money. If the cost of protection rises, they would be unwilling to buy more loans, and liquidity could suffer in the private-equity arena.
At the moment, the implied cost of protecting against defaults in the leveraged loan market is almost as low as it has ever been, in sharp contrast to riskier parts of the mortgage market. A hedge fund manager involved in merger arbitrage says that the cost of CDS remains extremely cheap, allowing funds to snap up such loans at record-low yield spreads and still eke out healthy, low-risk returns with 1000% or more leverage.
"Implied default rates have never been so low," he said.
Unlike subprime borrowers, companies taken private in recent years have proven to be excellent credit risks so far, so this makes sense, and extrapolating this into the future might even be sensible. But this could be a moot point if investors throw the proverbial baby out with the bathwater, choking off funding to hedge funds and newly planned CDOs that are an integral part of the future funding plans of private equity. Unlike earlier LBO booms, commercial banks are on the hook for relatively little of this debt, selling it off to these institutions.
"Now banks have incredible ability to syndicate loans," said the hedge fund manager, who noted that the debt for the $10.3 billion purchase of Home Depot Inc.'s (HD) wholesale business will be several times oversubscribed by CLO and other leveraged funds. "What these banks do is write a check for $10 billion and sell the loan in a few days to CLOs," he said, noting that he isn't overly worried about future deal flow.
The collateral liquidation may be a blip that has no impact on LBO financing, or it may be a sign of things to come for the private equity juggernaut that has been boosting stock prices. A drop in confidence or new funding would hit stock prices if an aggressive buyout firm like KKR or Blackstone begins to face the same sort of scrutiny as a potential subprime mortgage borrower does today.

Volcker

In the words of Paul Volcker

The United States is importing 7 percent more goods than it exports, personal debt is soaring and the national debt Ð while "not terribly large" compared with the total economy Ð is mostly financed by investors in Japan, China and other countries.

"You can't expect this great country to live forever off other people's money," said Volcker..

The Daily Bear could not agree more with this statement. At some point, the f/x investment will slow and interest rates must rise.

Foreign investment now represents over 50% of us debt holdings up from 20% in 1994.

What does this mean to the Bear and you?

Given our weakened ability to service our debt, foreign countries are going to be less apt to buy our debt (mainly China and Japan). This will soon cause the long bond to drop and interest rates to rise. Of course the dollar will likely fall as a result. Couple this with excess demand for commodities such as oil and oil and oil, and you get a nice recipe for inflation. Last time the Bear checked high interest rates, inflation and a weak dollar will likely add extra risk premium in long term bonds

If foreign countries stop buying (or lessen demand) our debt, long-term bond prices will drop, interest rates will rise and the dollar will fall. Excess demand for energy and natural resources from China and India will likely spur a rise in U.S. inflation rates. Higher interest rates and inflation coupled with a weak dollar make long-term bonds a risky investment with very little upside. And again more pressure on rates to rise. As shown so brilliantly in the chart below, a drop off in foreign purchase or US debt since 2004 has led to a gradual rise in long term rates. What makes us believe this will turn around, our massive budget deficit, healthy dollar or out of control current account deficit.














And to those of you who think the global economy is strong enough to brush off a serious recession and fall in the US dollar, think again. A 10%-20% decline in the dollar will lay a severe blow to European imports. For example, over the past 3 years the average dollar cost to buy a European made car costs the US consumer $6500 extra. To say this will not impact demand and the Euro economy will be uninformed. Similar effects likely in Latin America and Africa. While fixed rate cheaters in Asia will likely escape the immediate impacts of the falling dollar, the America's and Euro region makes up greater than 50% of all imports from the APAC region. US GDP alone represents on order of 33% of the world output.

Did we mention the effect of higher interest rates on housing. commerical real estate and corporate profit? 100 times before..

The average 30 year fixed rate mortgage has risen to 6.75 from 6.18 in January.. ouch. In the spirit of Jerry Marks, "It's Freeee" the ride is coming to a halt sometime in 2007.

See you at the bottom of the correction.

DB

A Prime Example

Thanks to member 005 (Haggerty) for this article.

These two articles represent the same unit for sale separated by 8 mths.

Article 1
Monday, October 30, 2006

Million-dollar St. Pete townhome plan betting on Old Northeast allure
Tampa Bay Business Journal - October 27, 2006by Michael HinmanStaff WriterST. PETERSBURG -- . But he believes absorption of existing inventory will be more rapid than some think."I lose a lot of sleep over it, but I have to believe the fact that all of the studies are saying people are moving to Florida and that they are going to need houses," Bennett said. "The marketplace is just going to be back to what it used to be a few years ago before it was inflated by investors."

Samter is hedging its bets on a few other multifamily projects as well, including the mostly complete 175-unit Villas of Carillon in North Pinellas County, a $70 million project offering 2,000-square-foot units beginning at $400,000.


Article 2.
June 18th 2007 - The same exact unit

$300000 Brand new 3/2.5 Townhomes in St Petersburg
2000 sq ft.
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Any questions????????

DB

US Consumer: How Much More can we Borrow?


The US consumer seems to borrow and spend borrow and spend and yes you guessed it borrow and spend yet again. Now the bulls will say, never underestimate the US consumer's ability to borrow more money as evidenced by the recent surge in retail data. And yes its true, wage and job growth have given some dollars back to the consumer. That said, many data points suggest these trends are not and can not be sustainable.


Now the bear will say, wait a minute, consider the following:
- personal debt as a percentage of GNP is at 300%
- debt service levels as a percent of disposable income are at record highs at 15%
- personal savings rates are near record lows in negative territory (see chart below)
- equity extraction posted significant moderation to $84 billion in 1Q from $109 billion in 4Q-consider what happens when exisitng home prices experience significant price declines.
- home equity loans slowed to $23 billion (annually) from a peak level of $200 billion
- housing prices have begun to fall (existing and new homes)
- mortgage resets of a 1-1.5 trillion dollars are set to reset this yearup from $400 billion in 2006














To top this off foreclosures are starting to rise at a rapid rate as evidenced by yesterdays report. Mortgages starting the foreclosure process in the first quarter rose to a record high of 0.58 per cent. Specifically looking at the sub-prime market late payments (greater than 30 days) of sub prime mortgages increased 15.75% in 1Q up from 14.44% in Q4. You guessed correctly, this represents yet another record high. And the pain is not just felt in Florida or California. Blue collar markets in the mid west are feeling the pain as well. Ohio, Michigan and Indiana represent 20% of total foreclosures despite only representing 9% of loans outstanding.

To make matters worth, we must ask, are banks prepared for an onslaught of foreclosures. The following chart gives the bear pause to believe so.

Stayed tuned
DB

China: Inflation out of control?

Alarming statistics coming out of China

Prices led by food have caused inflation rates to leap to a two year high
May inflation results suggest inflation grew at an annual rate of 3.4%, ahead of analysts expectations and up from 3% in April.

Food prices up 8.3% vs. last year
-Pork prices up 26%

The higher than expected inflation is causing investors to take their money from 2.5%-3% deposits and put into the market for bigger returns. House of cards to say the least.

Interest rates in real terms are now negative.


The Central Bank of China looks is expected to move quickly (for the 3rd time this year) to raise rates to fight back inflationary pressures. The magnitude of the increase might spook Shanghai investors and ultimately US markets.

On the positive side, prices remained muted excluding food items.

DB

Daily Bear Coming Out Party

In repsonse to hundreds of requests the "Daily Bear" blog has arrived.

The blog will be a collection of articles and thoughts on why the stock market and overall economy is in far worse shape than the "experts" and media portray. The Daily Bear welcomes your emails every day for posting.

Todays thoughts:

The Private market seems to be garnering attention of late as billion dollar public organizations get swallowed up by the booming private equity market. We at the Daily Bear believe this party will run its course in time as the highly leveraged market is facing rising interest rates coupled with increasing investor return requirements. We believe this scenario will ultimately lead to a moderation in deal flow and shock to the stock market. As the ten year continues to climb and interest coverage ratios decline, we are becoming increasingly concerned. Stay tuned..

Recent troubles at LBO plays Linens and Things, Freescale and Realogy point to the emerging problem.

1. Private company's interest coverage ratio

-3.5x 2004
-2.4x - 2005
-1.7 x- 2006

source: S&P

2. 10 year treasury's hit 5.25%