In Home-Lending Push, Banks Misjudged Risk

[FRED]

For the duration of the Ka-Poom program, there are two main stories: the housing bubble and the U.S. trade deficit. These are as entwined as a central banker and his President, an Enron lawyer and his client, a drug addicted prostitute and his or her pimp... well, you get the idea. It kicks off with this from the Wall Street Journal.

In Home-Lending Push, Banks Misjudged Risk
February 8, 2007 (CARRICK MOLLENKAMP - WSJ)

When the U.S. housing market was booming, HSBC Holdings PLC raced to join the party. Sensing opportunity in the bottom end of the mortgage market, the giant British bank bet big on borrowers with sketchy credit records.

Such subprime customers have always been risky, but HSBC figured it could control that risk. In 2005 and 2006, it bought billions of dollars of subprime loans from other lenders, lured by the higher interest rates they carry.

Now, the party is over for HSBC -- and for lots of other bankers who aimed to cash in on the housing boom of the first half of this decade. When interest rates ticked up and the market cooled, HSBC reached a disconcerting conclusion: Its systems for screening subprime borrowers and for assessing the default risk they posed were flawed.

AntiSpin: "Systems for screening subprime borrowers and for assessing the default risk they posed were flawed"? Shocked, we are here at the Tulip. Shocked! Do they mean if mortgage originators encourage borrowers to lie about their income in order to qualify for a suicide or liar loan, so that the agent can make a commission, that the approved yet unqualified borrower may not be able to pay? That if lenders personally had no accountability in a loan process that, maybe, the loan might not turn out so well? Who could have known?

Another "surprise" today.

Home Lenders Plunge as More Subprime Mortgages Sour
February 8, 2007 (Bloomberg)

Shares of U.S. mortgage lenders plunged after New Century Financial Corp. and HSBC Holdings Plc said losses from bad home loans are piling up faster than they expected.

And another.

Toll's Orders Plunge, Forecasts Larger Land Writedown
February 8, 2007 (Bloomberg)

Toll Brothers Inc., the largest U.S. luxury home builder, reported a 33 percent plunge in first-quarter orders and said expenses to cut the value of its land may almost triple.

Orders declined to 1,027 units and homebuilding revenue slid 19 percent to $1.09 billion in the three months ended Jan. 31, Horsham, Pennsylvania-based Toll said today in a preliminary earnings statement.

The fact that two out of 100 employed humans in California in 2005 were real estate brokers was, at the time, no indication of a bubble. So now we're all treated to another surprise.

Plummeting commissions thin real estate's ranks
February 7, 2007 (JEFF COLLINS - The Orange County Register)

Agents and brokers earned a combined $1.16 billion in '06, or 20% less than in '05, research firm estimates. Lost income results in closed brokerages, career changes.

"There were payroll reductions. Offices closed. All kinds of things happened to … keep (offices) running with the total loss of commission revenue," said Rich Cosner, president of a chain of nine Prudential California Realty offices in Orange County and the Inland Empire.

Well, at least the resulting Risk Polution from all of these supposedly insured bad loans won't wreck the banks. They're all insured... ultimately by you and I, the tax-payer, that is... although I'm still sketchy on where my upside was on the deal... you know, my cut if the loans hadn't "mysteriously" defaulted.

Mounting debt defies theories
February 7, 2007 (EDWARD LOTTERMAN - Pioneer Press)

The president has delivered his budget to Congress. Though Congress can be expected to weigh in with much overblown rhetoric, the appropriation bills it passes probably won't differ much from the president's proposal.

Whatever the exact outcome, one thing is clear: No school of economic thought supports the current practice of increasing the national debt, year after year. Only history will tell whether it is economists or the U.S. government that is wrong.

Perhaps the economy is OK only because oil-exporting countries and Asian central banks are willing to lend us a lot of money cheaply, temporarily staving off the results of excess borrowing.

Our grandchildren will know the answer. Perhaps they will be grateful for our current profligacy. And perhaps they won't.

That's a big ask, Ed. Ken at The Guardian's got a take on it with less "one the hand this and the other that" equivocation.

Betting with the house's money
February 7, 2007 (Kenneth Rogoff - Guardian Unlimited)

The US has been running trade deficits for over a decade - so why hasn't the dollar crashed yet?

Many people have been asking why the dollar hasn't crashed yet. Will the United States ever face a bill for the string of massive trade deficits that it has been running for more than a decade? Including interest payments on past deficits, the tab for 2006 alone was over $800 billion dollars - roughly 6.5% of US gross national product. Even more staggeringly, US borrowing now soaks up more than two-thirds of the combined excess savings of all the surplus countries in the world, including China, Japan, Germany, and the OPEC states.

As long as the status quo persists, with strong global growth and stunning macroeconomic stability, the US can continue to borrow and run trade deficits without immediate consequence. Over time, the dollar will still decline, but perhaps by no more than a couple of percent a year. Nevertheless, it is not hard to imagine scenarios in which the dollar collapses. Nuclear terrorism, a slowdown in China, or a sharp escalation of violence in the Middle East could all blow the lid off the current economic dynamic.

What other "surprises" are in store for U.S. taxpayers? Read the site over for numerous not too subtle hints.

On the whole "Deflation/inflation/Ka-Poom" debate front, looks like EJ's made two additional converts to the Ka-Poom side.

Convert #2: Michael Shedlock

Mish pre-Janszen:
Monday, April 25, 2005
Deflation is in the Cards

Contrarian Debate: Janszen vs Mish
Saturday, December 16, 2006
Mish says Deflation, Janszen Inflation

Mish today:
Thursday, February 08, 2007
Counterfeiting Money - Crime or Good Economics?

Convert #2: Jim Paplava

January 19, 2007
Forecast 2007: Disinflation then Inflation

Reads like a combination of No Deflation! Disinflation then Lots of Inflation and Recession 2007: Part III.

The idea of a disinflation followed by an inflation had not been mentioned anywhere on Financial Sense before EJ's interview with Jim. In fact, you will not find the word "disinflation" anywhere on the Financial News site before Jim's November 18, 2006 article Don't Worry, Be Happy which appears... surprise!... two months after EJ's "No Deflation! Disinflation then Lots of Inflation" piece.

Two down, one to go! Rick Ackerman and EJ face off shortly in an intellectual duel to the death* on... deflation versus Ka-Poom. Coming to iTulip and Rick's sites soon!

* Not really. As Uncle Jack says, "It's all fun and games 'til someone loses an eye." Neither Rick nor EJ are Running with Scissors: A Memoir

[akrowne]

Re: In Home-Lending Push, Banks Misjudged Risk

Well, it sure seems a turning point has been reached in the press.

I'm feeling pretty down, though. Besides having SouthStar threaten to sue me today, I mean.

I had dinner with a friend who is more or less the typical twenty-something with obscene amounts of debt (largely from school, mind you), an exurban house that needs to be sold and which she and her steady bf will probably be underwater on, low and stagnant earnings, and who feels totally unfulfilled in life because this would essentially be the time to have kids but they can't afford them.

And what can I say? "Tough it out, hopefully it won't get too much worse."

[Jim Nickerson]

Re: In Home-Lending Push, Banks Misjudged Risk

EJ, exceedingly nice collection of good articles to support your thesis. Good work.

Reckon when SeanO is going to check back in with some real data regarding Kalee-fornee-ah?

[DemonD]

Re: In Home-Lending Push, Banks Misjudged Risk

EJ, I remember one of the items you layed out in your housing bubble crash scenario is systematic fraud, accounting irregularities, and other criminal behaviors. I think we can safely say the evidence points that this prediction was 100% on the money. I like giving credit where it is due, and you nailed that one. (Not that I didn't believe it, but now we can safely say that that part of the prediction is certified as "correct.")

p.s. still looking for signs of ka
p.p.s. maybe MSM or other economist phd's would be more open to discussing/acknowledging ka-poom theory if it were named something really banal like "disinflation-hyperinflation macroeconomic cycle theory" or something. just a thought that popped into my head.

[DanielLCharts]

Re: In Home-Lending Push, Banks Misjudged Risk

so what?

not affecting the economy. first ,show me the intial unemployment claims. really, show me. the unemployment claims numbers continue to defy itulip's dark thesis, and they are one of the defining tells of a recession's onset.

so far the reasoning for economic failure is succumbing to "dan wilkinson error". dan wilkinson was supposed to be a great d-lineman, picked first in his draft class by the bengals. problem was wilkinson was a huge bust as an nfl player. just as the scouts were right that wilkinson was huge, fast and strong, so has itulip been right about the appearance of events that characterize economic malaise, namely sub-prime bank failures and slumping house prices. so the properties leading to your outcome are all there, but the kicker - and the only thing that matters - is that the outcome of recession is not present and remains improbable.

i think the fact that a recession should have set in already in the last quarter, and the constant new highs in equity markets, which tend to discount (although not perfectly) a recession event about a half a year in advance, are two hugely irksome points that this community really has to struggle with. they are reality pills waiting to be swallowed.

another data point to gnaw on is that if unemployment claims did in fact bottom in the first quarter of 2006 and we are indeed heading for recession, then this is the LONGEST PERIOD EVER in which the 4 week moving average of unemployment claims has not spiked higher. a spike always tends to occur, but it's just not there, regardless of pending construction-related layoffs that every week is supposed to materialize but doesn't. even the non-recessionary slowdown of 1995 was more brutal on employment than this slowdown. this slow down is MILD, nothing like the horror show EJ has proposed.

members here might consider accepting that the probability of a recession occurring in 2007 is actually quite slim and getting slimmer. i didn't believe ECRI, who have a pretty good track record of using leading indicators to predict recessions, that a recession in 2007 was improbable, but i have to side with them now.

so the self-congratulatory tone of many of the contrubitors here is a little wierd. the assumption that the economy is going slip into an abyss like the titanic is not at all a foregone event. perhaps the set up is there, but right now it's only fair to assume right now that you guys are wrong. 4 weeks of unemployment rolls at 350K+ and we can talk. until then, i still propose a respite on the reporting of anything negative. the bengals management could high five and laud each other endlessley over how fast and strong wilkinson was, but at the end of the day, none of it mattered because he still sucked.

[DanielLCharts]

Re: In Home-Lending Push, Banks Misjudged Risk

btw, jim, i'm not addressing you directly, it's a general rant.

[DanielLCharts]

Re: In Home-Lending Push, Banks Misjudged Risk

EJ, You might reconsider writing that both Mish and Puplava are in agreement with you. I recently read some blog commentary on RGE that mentioned how a firm studied Puplava's picks and concluded that his stock market performance was just not good. i think they said he was poor timer who did not beat the market. I would wager that Mish is a terrible timer as well and almost certainly lags the market - probably in a big way. alas, I don't have data to back it up. (It's just that he's been a bear for about the past 4 years, during which it was about the worst time in the past 10 to be bearish)

Their recent conversion to ka-poom theory just might be the kiss of death. They are certainly quite accomplished directors of conspiracy theorist blogs and forums, but they're not guys i would want playing for my team when it comes down to being right.

[Uncle Jack]

Re: In Home-Lending Push, Banks Misjudged Risk

The main problem with Puplava's argument, aside from jumping on the iTulip bandwagon, is that he mislabels "deflation" as "dis-inflation." They're two separate things, which makes me think he really hasn't caught on.

From the iTulip Glossary:

D

deflation : n. negative rate of inflation, e.g., "CPI inflation averaged -1.3% in 2007."

disinflation : n. declining rate of inflation, e.g., "CPI inflation declined to 2.1% in Q4 2007 from 2.5% in Q3 2007."

Of course, I think there is a problem any time we use the official "CPI" number to measure what's really happening, but this sums it up as well as anything.

For anyone or Puplava himself to believe what Puplava is saying is to believe that we'll still have inflation but at a declining rate, essentially saying, "_________(s) have reached what appears to be a permanently high plateau" - Fill in the blank with your favorite asset, the rest of the quote is Irving Fisher.

[DanielLCharts]

Re: In Home-Lending Push, Banks Misjudged Risk

Yep. And to boot, that show of his is 1/3 finance, 1/3 x-files, 1/3 captain kangaroo.

The main problem with Puplava's argument, aside from jumping on the iTulip bandwagon, is that he mislabels "deflation" as "dis-inflation." They're two separate things, which makes me think he really hasn't caught on.

From the iTulip Glossary:

D

deflation : n. negative rate of inflation, e.g., "CPI inflation averaged -1.3% in 2007."

disinflation : n. declining rate of inflation, e.g., "CPI inflation declined to 2.1% in Q4 2007 from 2.5% in Q3 2007."

Of course, I think there is a problem any time we use the official "CPI" number to measure what's really happening, but this sums it up as well as anything.

For anyone or Puplava himself to believe what Puplava is saying is to believe that we'll still have inflation but at a declining rate, essentially saying, "_________(s) have reached what appears to be a permanently high plateau" - Fill in the blank with your favorite asset, the rest of the quote is Irving Fisher.

[art]

Re: In Home-Lending Push, Banks Misjudged Risk

I think DanielLCharts has an interesting idea buried in his (self proclaimed) rant.

>4 weeks of unemployment rolls at 350K+ and we can talk.

Can the forum members agree (maybe via EJ) on a set of metrics that we can all watch to decide when Ka-Poom milestones have been hit or missed?

[grapejelly]

Re: In Home-Lending Push, Banks Misjudged Risk

so what?

not affecting the economy. first ,show me the intial unemployment claims. really, show me. the unemployment claims numbers continue to defy itulip's dark thesis, and they are one of the defining tells of a recession's onset.

...

i think the fact that a recession should have set in already in the last quarter, and the constant new highs in equity markets, which tend to discount (although not perfectly) a recession event about a half a year in advance, are two hugely irksome points that this community really has to struggle with. they are reality pills waiting to be swallowed.

another data point to gnaw on is that if unemployment claims did in fact bottom in the first quarter of 2006 and we are indeed heading for recession, then this is the LONGEST PERIOD EVER in which the 4 week moving average of unemployment claims has not spiked higher. a spike always tends to occur, but it's just not there, regardless of pending construction-related layoffs that every week is supposed to materialize but doesn't. even the non-recessionary slowdown of 1995 was more brutal on employment than this slowdown. this slow down is MILD, nothing like the horror show EJ has proposed.

members here might consider accepting that the probability of a recession occurring in 2007 is actually quite slim and getting slimmer. i didn't believe ECRI, who have a pretty good track record of using leading indicators to predict recessions, that a recession in 2007 was improbable, but i have to side with them now.

Good points.

I think there are many stakeholders in the Great Asset Inflation and it could go on for years.

If we believe that M3 is really expanding 12% annually right now, that is big.

Of course the inflation is going to financial assets. But because of low *perceived* inflation of goods, investors don't perceive the inflation so they are happy.

The stock market keeps going up in nominal terms but in inflation-adjusted terms is actually below its 2000 peak. But investors don't notice or care because CPI inflation seems low.

And for much of the middle class and more affluent, the benefits of the Great Asset Inflation continue. People with houses don't feel poorer. Maybe in some areas they do in the abstract, but generally they do not. Sellers deny that their homes are worth less.

Okay, perhaps "social mood" is good with the more affluent segments.

Real wages have been declining. But there are plenty of jobs, both on the books and off the books, for poorer people, so they continue to get by.

And there is still the upward mobility in the US, where someone can work as a laborer and then buy a truck and become a self employed gardener. All to work for the more affluent segments still flush from the Great Asset Inflation.

Bears are eaten up every day from the seemingly illogical results of reflation and upbeat social mood that can continue far longer than we think. That's evidence for merit in Prechter's social mood theories. When social mood is in its cyclical high, anything bad can happen and it's all good. When social mood is negative, anything good can happen and it's all bad.

Of course its all timing, isn't it? We're all right in our stock picks, just not in their timing

You mentioned Greenspan's "irrational exhuberance" warning came in 1996 and then even he had capitulated several years later with "this time really is different" just in time for the crash.

When the last bear capitulates, we shall have the collapse. It could go on for some time because so many people are stakeholders in inflation. But that doesn't make us wrong. It may make us poor investors though

(I wouldn't trust Mish's investment recommendations or Puplava's or anyone elses anyway. I don't even trust my own )

[DanielLCharts]

Re: In Home-Lending Push, Banks Misjudged Risk

art, i think that's a great idea. much better than the draconian respite on negative news that i proposed. i think milestones are much more concrete than pointing to articles on bank failures while at the same time ignoring news about how jobless claims remain extremely healthy. this sort of activity could go on for years. i think it might also be positive for the collective psyche of the community. my guess is we don't want to turn itulip into the daily reckoning.

I think DanielLCharts has an interesting idea buried in his (self proclaimed) rant.

>4 weeks of unemployment rolls at 350K+ and we can talk.

Can the forum members agree (maybe via EJ) on a set of metrics that we can all watch to decide when Ka-Poom milestones have been hit or missed?

[Uncle Jack]

Re: In Home-Lending Push, Banks Misjudged Risk

Yep. And to boot, that show of his is 1/3 finance, 1/3 x-files, 1/3 captain kangaroo.

Hey, I really miss Captain Kangaroo, especially when all those ping pong balls dropped from above. That always generated a giggle.

Still does.

[WDCRob]

Re: In Home-Lending Push, Banks Misjudged Risk

It's not an article of faith that the deficits/imbalances will eventually cause serious trouble -- that's pretty well been proved by history.

And while I'm not well versed enough in global finance to hazard a guess as to when or exactly how the house of cards comes down, I know it will fall eventually absent meaninful policy changes to address the imbalances. More generally, I think the idea of "American Exceptionalism" (it won't happen in the United States because blah blah blah) is rotten to the core no matter what social/economic/political field it's applied to.

So I just don't pay a lot of attention to the daily this and that. Anyone got consumer confidence data from Summer of 1929?

Ultimately I have no idea if KaPoom is correct, but I respect that it's an internally consistent hypothesis and that EJ has made some fairly concrete predictions on both the path and the end result. And if his underlying theory is correct, it doesn't really matter to me if it all kicks off in September 2007, or January 2009. The important thing would be that it happened and that I would have taken steps to protect myself.

[ablevin]

Re: In Home-Lending Push, Banks Misjudged Risk

EJ, I love your site and I hope to contribute more as I gain the confidence that what I have to say is meaningful to your discussion.

I am a believer in the Ka-Poom hypothesis. I believe that timing is everything, and that timing the markets is incredibly difficult, and possibly even futile. That said, what fun would it be not to try? I mean, the point of all this is to maximize my purchasing power relative to the game's other players, is it not?

I think what myself and others are looking for is a suggestion as to what might be the catalyst for the "Ka". In Spring 2000, you claim it was the capital gains selling that tanked the stock market that caused the recession. I would argue that the hangover from Y2K CapEx spending also had something to do with it, but, that is somewhat irrelevant. My point is: what fundamental change in the current situation will cause people to spend less, or lend less, etc.?

I welcome everyone's ideas. Perhaps it is already happening with the mortgage lender failures. My personal opinion is that nothing really tanks until Japan increases interest rates further, causing the carry trade to unravel some. We saw a harbinger of that last Spring when Japan moved from 0% to 0.25%.