Off On A Tangent

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ABC censors it’s on-line polls and comment threads to exclude Ron Paul and Dennis Kucinich, who typically win these polls.  Yes, that’s right, the candidates who “can’t win” are winning on-line polls.  This “can’t win” moniker looks more and more like a fabrication of the media - the media which has a grand total of 4 different owners.  You get your news from 4 choices, and they all don’t want non-centrists like Kucinich or Paul to win.  But, if you sat most Americans down and asked them to pick which candidates they agreed with the most, these two are at the top.

Story about Kucinich

But not really.  Yesterday, the market bounced about 150-200 pts in the last 30 minutes.  This morning, it’s up 300 on news the fed cut it’s discount rate from 6.25 to 5.75.  The discount rate is the rate the fed is willing to loan to a very select few institutions - like around 10 banks.  Typically, only millions of dollars are loaned through this window.  But, the market jumps up by 300 pts, 450 if you count yesterday’s late activity.

Is this rational?  Does this rate cut mean Countrywide and other mortgage lenders and mortgage security holders aren’t facing massive defaults on their loans and subsequent insolvency?  You decide.  I’m off to take advantage of a selling opportunity.

If you have money in the markets, get it out.  The short story of why the market is falling now is that money loaned out as mortgages is not being repaid due to people defaulting on the loans.  Real Estate values and long term mortgage securities are slowly being revalued (they don’t sell as often as stocks, so you don’t know, minute to minute how much such things are really worth, you only find out now and then).  This re-evaluation has bankrupted a few hedge funds, American Home Mortgage, and soon Countrywide - the nation’s largest mortgage lender.  One big reason why a lot of mortgages are defaulting is ARM mortgages reseting at higher interest rates.  People can easily see their monthly mortgage rates jump $300+, and many many people bought houses beyond their means already.

So, the market is tanking - that usually means that bad news has come out, the market has taken it into consideration, and we’re off to the races on the upside again.  But hold up.  Here is the schedule of past and upcoming ARM resets, by dollar amount:

(source JP Morgan)
March 07 = 6 billion $
April 07 = 7 billion $
May 07 = 9.8 billion $
June 07 = 10 billion $
July 07 = 12 billion $
Aug 07 = 17.5 billion $
Sept 07 = 18 billion $
Oct 07 = 20 billion $
Nov 07 = 23 billion $
Dec 07 = 22.5 billion $
Jan 08 = 25 billion $
Feb 08 = 25 billion $
March 08 = 23 billion $
April 08 = 22.5 billion $
May 08 = 24 billion $
June 08 = 18 billion $
July 08 = 20 billion $
Aug 08 = 25 billion $
Sept 08 = 23 billion $
Oct 08 = 23 billion $
Nov 08 = 23 billion $
Dec 08 = 20 billion $

As you can see, this doesn’t top out until Jan-Feb of ‘08.  A big reason why the relatively small number of defaults so far has hit so hard is because of hedge funds being leveraged 90+% in their investments.  Ie, they took $1, used it to buy $10 worth of risky investments on margin.  When that investment drops 10% in value, the fund loses $1 - ie 100% of it’s actual monies.  When the lender of the other $9 comes by and demands his money back, you wind up with $0 after paying it back.  Less with interest.  This is how a “piddly” $100 billion problem turns into a crisis of mega proportions.
So, the market wasn’t expecting problems in August when ARM resets jumped from $12 billion to $17.5 billion.  This seems a rather late reaction since Bear Stearns funds went out of commission more than a month ago.  Didn’t that foretell coming problems?  No, it would be contained.  Then American Home Mortgage fell, but the market thought that would be contained.  Now Countrywide is being rumored to fall, and the market is finally reacting.  But what do you think the market thinks about Sept’s $18 billion in ARM resets, and Oct’s $20 billion, and Nov’s $23 billion?  And with lending practices really tightening up, at what rate are those ARMs going to reset?  No, the market still thinks the fed is going to lower the fed funds rate soon and that that will allow mortgage companies to keep their mortgage rates down, but that seems like wishful thinking.  There is nothing tying mortgage rates to the fed funds rate - already the fed is having to force-feed money into the system to keep its own rate at 5.25%.  And yet mortgage rates are going up anyway, because banks can no longer afford risky and unprofitable loans.  These ARMs, I predict, will be reset at higher rates than the market currently thinks, and many many financial institutions are going to come up dry.

The slow unwinding of the market in the next few months is going to be horribly depressing and is going to fool a lot of people.  But, it’s also a chance to get out now while you’ve only lost 10% from the highs.  Do so.

Our baby is healthy and thriving and …