What's up with gold?

As regular readers know, I think that the price of “stuff” will go up long term as the dollar continues to fall – and the dollar will continue to fall long term, as our governemnt prints more pretty green pieces of paper.   So why have commodities (gold, silver, oil, wheat, etc.) dropped so much over the past 2 days?

The short answer is that I don’t know.  How’s that for sticking my neck out?  🙂

From what I’ve read and heard, it’s a combination of two distinct factors:

1) The market had priced in a 1% drop in interest rates, and the Fed only dropped 3/4%.  So traders think that the Fed is now hawkish on inflation.  (Yup, I think it’s weird too.)

2) The US is definitely going into a recession.  That means that demand for commodities will drop as consumers spend less. 

Of the two reason given for the drop, I’m inclined to think that #2 has more validity than #1.   Not that I think that’s a bad thing!  The US needs to spend less.  The average US consumer is in over their head with debt.  Collectively we need to stop spending more than we earn – and the same goes for the US Government.  If the dollar is to rise long term, we need to stop spending more than we make.

We need to pay off old debt and stop taking on new debt for awhile.  We need to accumulate capital so that our banks don’t have to drop their trousers and bend over for money from Sovereign Wealth Funds in order to stay in business.  A little actual capital would have prevented Bear Stearns from being bought out for $2/share.  Of course, that was us (the US) doing the “buying”, but now we’re all on the hook for $30 billion of Bear Stearns’ over-valued mortgages.

I don’t know what the next shoe to drop will be – or how the markets will react to it.  In spite of the fact that CIT Group (not to be confused with CitiGroup as I did at first!) today announced that they didn’t have any money on hand and needed to borrow $7.3 billion to stay afloat, the US stock markets all went up today.  And the commodities all dropped. 

Side note:  I like the headline on the CNN article I linked to – “CIT Borrows $7.3 Billion to Repay Debt”  I’m still trying to figure out how borrowing money to repay debt works….

Anyway, despite the news of yet another financial company having problems, the stock market shrugged it off and the DJIA soared 261 points.  XLF (an ETF that tracks all the financial stocks in the S&P 500) was up an astounding 6%!  But I think that we’ll see this sector plumet at some point as this mortgage inspired credit crisis unfolds.

Remember that very few of the ARM’s and Option ARM’s that were handed out at the peak of the housing bubble (2005 through 2007) have reset to higher rates yet.  A lot of those mortgage holders are making minimum payments on their interest only loans.  This is far from over, and I’m hanging on to my gold ETF.  I’m also buying silver when I find it cheap on eBay.

In other words, I’m using this drop in commodities as a buying opportunity.  I don’t know about oil, wheat, or corn (they depend too much on the economy) but I expect to see a big rebound in precious metals sometime soon.  And when that happens, I’m betting that the rebound in precious metals will coincide with a drop in the financials.

gk

The running of the bulls

From the 400 point rally today in the stock market, you’d think that the bulls are running rampant in Pamplona.  And you may be right, however….

Stocks are still down over 10% for the year.  The highly leveraged banks and Wall Street firms are still highly leveraged.  Massive amounts of mortgage backed securities – and their higher default rates coming this year and next – are looming.  When a CDO takes a 10% loss because the home owners can’t make the payments, that translates to a 300% loss on a 30 to 1 leveraged portfolio such as Bear Stearns and Lehman Brothers.  (Citigroup is also highly leveraged.)  The $2/share Fed “take it or leave it” financed JPM buyout of Bear Stearns still needs to be approved by shareholders.  Hmmm…. How would you vote if you owned BSC?

As I’ve written before, this unwinding of the leverage in the financial markets will take quite awhile.  The longer the Fed props up failing companies, the longer it will take to hit bottom.   JP Morgan is getting a deal only because the Fed is guaranteeing $30 billion of BSC’s “assets.”  They’re not really worth $30 billion, but the Fed took that much risk away from JP Morgan.   That’s $30 billion that US taxpayers will end up spending to finance this bailout – because the underlying securities are “riskier assets.”

 A couple of weeks ago, I thought we were headed for a repeat of the Carter years and stagflation, but it’s beginning to look more and more like we’re repeating Japan’s mistakes of the 1990’s.  Low interest rates, keeping bad debt on the books (instead of recognizing the loss and getting it over with) propping up banks with fake assets on their books, etc. 

Japan still hasn’t fully recovered from the 1990’s.  I sincerely hope that we don’t continue making the same mistakes, but today’s 3/4% drop in both the discount and Fed funds rates isn’t helping.  That only serves to drive up long term inflation, and that (rather than deflation that I’m reading about) is my long term worry.

As regular readers know, I don’t try to predict short term market swings, I simply try to stay on the right side of the market during long term trends.  I don’t know if today’s action signals a turnaround or not; my gut says no – because of the reasons listed above – but my gut doesn’t make the market move.

Regardless, I don’t see any fundamental change in the long term trends of the dollar going down, commodities (especially gold, silver, corn, and oil) going up, and the broad market (especially financials) going lower.

My feeling is that the majority on the street think that the worst news is behind us; that most people are looking for a reason to buy.  They’ve discounted all the bad news and they’re ready for another bull market.  I don’t think they’ll get it just yet.

Too many firms have too much debt.  Too many firms are leveraged enough so that a small change in the base assets (mortgages in most cases) results in a huge change to their balance sheets.  One little piece of unexpected bad news will be enough to cause a dramatic sell off.  I’m talking about a sell off big enough to trigger a halt to trading. 

I think the coming upswing in the foreclosure rate (because of all the ARM’s taken out in 2005 through 2007) hasn’t been fully factored in to the stock prices of the companies that are using these mortgages as collateral on their loans. 

When people realize how little capital is propping up these companies, share prices will drop.  The dollar will drop, and commodities will rise.  Again, I have no clue what the market will be at in a week or a month.  I don’t know if commodities will be higher a month from now or not.  But I’m betting that 10 years from now, you’ll be glad you bought gold at $1000/oz, silver at $20/oz, oil at $105/barrel, etc. 

If we really are following the deflationary path Japan took in the 90’s, the Dow may well be at 7000 10 years from now.  As it stands, buy and hold investors are down from where they were 8 years ago….  How much longer do we need to prolong the agony? Take the losses now, write off the sub prime and alt-a loans, get it over with!

Of course that’s just my opinion, I could be wrong.  🙂 

gk

To keep and bear Arms

I’m going to change pace a bit from my usual financial topics in order to put a little reason into the 2nd Amendment  debate.  Today the US Supreme Court heard arguments regarding a District of Columbia gun ban.  In 1975 the District of Columbia banned all handguns within the District boundries, and they also prohibit anyone from owning any firearm (or ammunition) unless it was registered.

In all the articles I read concerning the case tonight, not once was the Second Amendment quoted in the story.  I think it’s important, so here it is for some perspective.  All punctuation and capitalization is as written: 

A well regulated Militia, being necessary to the security of a free State, the right of the people to keep and bear Arms, shall not be infringed.

Seems pretty clear cut to me, but then again, I can’t find a “right to privacy” anywhere in the Fourth Amendment….    And if the Founders meant for it to only apply to state militia’s, they wouldn’t have included the part that specifies “the right of the people”.   They would have left it out so only state militia’s would have that guaranteed right. 

Time for  a brief (or maybe not so brief!) civics lesson….

The US Constitution is the basis of the United States.  Everything the government is permitted to do by the people is in it.  Just in case anything is ambiguous, it also includes some things that the US Government is expressly prohibited from doing. 

The US Constitution is fairly short, and most of it is very straightforward and easy to read.  Read it!  Go ahead and do it now.  I’ll wait….

Back?  Ok, here’s the deal:  The Constitution only has seven Articles, each of which has a purpose.  The Preamble explains WHY the Constitution is being written.  It says:

We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.

Pretty simple – no explanation is needed.  If you need one, you shouldn’t be reading this.  Go away because you won’t understand the rest.

The seven Articles delegate certain powers to the government, and also give some rules for how to do things.  Article I creates the House of Representatives and the Senate – the legislative branch of our government.  There are sections that dictate terms of office, who is responsible for what, etc. 

Of particular interest to this discussion Section 8.  It lays out – in quite a bit of detail – everything the US House of Representatives and the Senate are ALLOWED to do.

I capitalized ALLOWED because this is a very important concept – the purpose of the Constitution is to lay down the rules which WE THE PEOPLE choose to delegate to our government.  The Founders took it for granted that we, as the people who make up this country, have all our natural (I would say God given to make the point, but that’s not in keeping with the spirit of the document) rights, but in order to secure these rights (see the Preamble) we delegated some of them to the government.  

Some things, such as providing for the common defense, simply cannot be done effectively by individual citizens, so we formed a government to take care of them for us.  We gave the government the right to do these things – the government doesn’t have any power or authority unless we grant them to it.  So many people I talk to don’t get this very fundamental concept – yet without understanding it, the document makes no sense.

I’m not going to get into a discussion of the entire Constitution here, but if you understand that the entire reason it exists is to tell the government what we’re allowing them to do, you get it.  If you don’t “get” that concept, try reading the Constitution again.  And again.  And again.  Maybe eventually (one can only hope) it’ll sink in. 

For those of you who may be a little slow, read this: THE Conventions of a number of the States, having at the time of their adopting the Constitution, expressed a desire, in order to prevent misconstruction or abuse of its powers, that further declaratory and restrictive clauses should be added: (emphasis mine) And as extending the ground of public confidence in the Government, will best ensure the beneficent ends of its institution.

It’s the preamble to the first 10 amendments – otherwise known as the Bill of Rights.  In other words, people at the time thought there was too much ambiguity in the original document, and they decided to amend (hence the term amendment) the original Constitution to clarify things.  They thought that those things which were super important to them should be elaborated upon so no one could possibly misunderstand what they were doing.

Thankfully, the Bill of Rights was ratified by the states in 1791.  Just imagine how different our country would be today without them!  Do you think we’d still have the right to a free press, free speech, trial by jury, etc. if they wouldn’t be expressly  spelled out in the Bill of Rights?  Crap, GW Bush has figured out a way to deny access to lawyers, to be charged with a crime, (and a bunch more) in just the last few years!  And many of his plans have been ruled unconstitutional – thanks to the free press exposing them.  Imagine if he didn’t have these limitations….  I doubt that I’d be able to write this!  But that’s a whole ‘nother subject….

One other VERY important concept – the Constitution GUARANTEES certain rights to the people – it does not GRANT any rights to the people.  A grant “implies giving to a claimant or petitioner something that could be withheld” whereas a GUARANTEE is “an assurance for the fulfillment of a condition.”

Guaranteeing a right is MUCH different than granting a right.  In fact, I would argue that that basic guarantee is what separates us (the US) from the rest of the world.

Anyway, end of rant. 

Now that you understand the purpose of the Constitution, read that Second Amendment again.  For that matter, read the whole Constitution again.  Now tell me exactly where we delegated the “the right of the people to keep and bear arms” to the government.  Go ahead – I’ll wait….

Found it yet?  No?  That’s cool, because I can’t find it either. 

On the other hand “shall not be infringed” seems pretty clear to me – how about you? 

So what should we do?  Should ordinary people like you and me be permitted to own and carry guns?  Damn straight!  There’s not even anything in the Constitution which permits the government to prevent us from carrying machine guns if we choose to do so.  It’s currently the law, but hopefully the case which was heard today will overturn ALL gun control laws. (Note: I don’t think that’ll happen, but it’s a happy thought!)

Does that mean I think everyone should be allowed to carry machine guns on the streets?  Yup.  If you don’t agree with my (admittedly rather extreme) view, that doesn’t mean you can’t ban machine guns, or handguns, or canons (yes, they should also be legal in my opinion) or even 155mm howitzers. 

The way to do it legally is to pass an amendment.  My brother and I discussed this a few years ago, and he called it the “no big boom” amendment .  Just like we prohibited people from owning other people (slavery) with the 13th Amendment; allowed income taxes with the 16th Amendment; allowed women to vote with the 19th Amendment; banned the manufacture, sale, or transportation of intoxicating liquors with the 18th Amendment – then changed our mind with the 21st Amendment (thankfully!) 14 years later.

You may have heard the the Constitution is a “living” document.  That’s so true!  But it’s “living” in the sense that we have the ability to change any part of it at any time.  The Founders weren’t stupid – they knew that things would change, and that they were creating an entirely new form of government – a form which had never been tried before.

There were bound to be problems and conflicts and things that needed to be changed.  That’s why the Constitution itself contains the rules for changing stuff that needs to be changed – or that the people deem need to be changed.  Read Article 5 – that’s how we are able to make changes to the document.  Those dead white guys did a damn good job!

We had to fight to keep (and/or extend) some of these rights in the civil war.   Hmmm…  How could that war (or the Revolutionary War) have been fought without private arms?  And I’m tired of the NRA (among others) claiming the the right to keep and bear arms has anything to do with hunting.  It doesn’t.  It doesn’t even have much to do with self defense – at least as we refer to self defense today. 

The 2nd Amendment was written to guarantee the right of the people to defend themselves against a tyrannical government.  The Revolutionary War is the first and best example of what an armed citizenry can accomplish.  True, you don’t stand much chance of holding out (at least for long!) against tanks and smart bombs.  But you can make imposing tyranny – either a military dictatorship or (much worse in my mind) a religious theocracy – much more difficult to implement if you can shoot back at those who attempt to impose their ideas on you or your family. 

Waco comes to mind….  As does the “insurgency” in Iraq.   In another time, fighting against a different occupying force, the “insurgents” would be called “freedom fighters.”  Look at Afghanistan in the 1980’s if you don’t understand what I mean.

Anyway, the 2nd Amendment is there to protect us from our government.  I could say it 100 different ways and never make my point as clear as I’d like, so I’ll let someone else say it for me.  Towards the end of the Civil War, Lincoln said it in the Gettysburg Address.  At the end he says “that government of the people, by the people, for the people, shall not perish from the earth.” 

Screw it – since it’s my blog, I’ll include the whole speech.  It encapsulates the ideals and goals of our country better than any words I could ever type.  Read it.  Remember it.  Understand what he said – and most importantly – understand why he said it.  I’ve put a few sections relevent to this discussion in bold to highlight them.

Four score and seven years ago our fathers brought forth on this continent, a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.

Now we are engaged in a great civil war, testing whether that nation, or any nation so conceived and so dedicated, can long endure. We are met on a great battle-field of that war. We have come to dedicate a portion of that field, as a final resting place for those who here gave their lives that that nation might live. It is altogether fitting and proper that we should do this.

But, in a larger sense, we can not dedicate — we can not consecrate — we can not hallow — this ground.  The brave men, living and dead, who struggled here, have consecrated it, far above our poor power to add or detract.

The world will little note, nor long remember what we say here, but it can never forget what they did here. It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us — that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion — that we here highly resolve that these dead shall not have died in vain — that this nation, under God, shall have a new birth of freedom — and that government of the people, by the people, for the people, shall not perish from the earth.

I fear that if we continue down our current path, the “government of the people, by the people, for the people” will perish from the earth.  And the earth – and all its’ citizens – will be the poorer for it.

gk

More on Bear Stearns

According to CNN, it appears that the deal bailing out Bear Stearns is costing JP Morgan a lot more than the $236.2 million that the $2 per share announcement would lead you to believe.   According to CNN:

The Fed also approved the financing arrangement announced Sunday in which JPMorgan Chase & Co. will acquire rival Bear Stearns Cos. The deal valued at $236.2 million, a stunning collapse for one of the world’s largest and most venerable investment banks. The Fed will provide special financing to JPMorgan Chase for the deal, JPMorgan Chase said. The central bank has agreed to fund up to $30 billion of Bear Stearns’ less liquid assets.

In other words, the Fed just printed another $30 billion in fresh money to loan to JP Morgan.  JP Morgan will use that money to buy up the Bear Stearns “assets” – and I use that term loosely – and give them to the Fed.  In other words, the US taxpayers are now on the hook for the defaults looming in Bear Stearns portfolio.

Hmmm….  How is JP Morgan going to make the payments on that $30 billion loan?  Think that has anything to do with the discount rate cut from 3.5% to 3.25%?  I wonder what interest rate that $30 billion loan carries…. 

Of course it doesn’t really matter, as when you always lose in the long run when you borrow money short term to pay back long term debt. 

Now the question is who’s next?  There’s a lot of chatter about Lehman, but there’s going to be bigger fish to fry soon.  JP Morgan may be safe for now, but I think we’re going to see some chinks in the venerable Goldman Sachs’ armor soon. 

I’m going to try to total up the amount of money the Fed has injected into the markets over the past 6 months or so;  regardless of the amount, it dwarfs the $160 billion stimulus package to taxpayers coming in a few months. 

If the hundreds of billions (it’s got to be over $500 billion) that the Fed has put into the economy hasn’t solved the crisis, do you really think another $160 billion is going to do it?

gk

Bear Stearns sold for $2/share

CNBC is saying Bear Stearns is selling itself to JP Morgan for $2 per share!  BSC was trading in the $60’s last week before dropping by half on Friday. 

That shows you just how fast these highly leveraged firms can disappear.  Keep that in mind when you listen to the financial firms all say that everything is just fine when they announce earnings next week.

gk

Good Ol Rocky Top

The Tennessee basketball team is ranked high in all the polls, but how are they gonna celebrate when they win?  Check out this story.

“The arrest is aimed at drying up the sale of untaxed liquor and putting one of the best in the field out of business.”

It all comes down to the fact that the government isn’t getting its’ cut.  There’s really no difference between local thugs and gangs who demand “protection” money and our federal government – except the feds have more guns and can do it legally.

Corn won’t grow at all on rocky top

dirt’s too rocky by far.

That’s why all the folks on rocky top

get their corn from a jar.

Be sure to read the comments  on the WBIR story I linked to above.  Along with the normal stupidity, there are some good points being made.

gk

What liquidity crunch?

Just two days ago on Wednesday, March 12th, Bear Stearns CEO Alan Schwartz said (I’m quoting from a Reuters story) “We don’t see any pressure on our liquidity, let alone a liquidity crisis.”

He also said “We have $17 billion or so excess cash on the balance sheet.”

Today he said “Our liquidity position in the last 24 hours had significantly deteriorated.  We took this important step to restore confidence in us in the marketplace, strengthen our liquidity and allow us to continue normal operations.”

Bullshit.  Rumours about Bear Stearns and their problems have been circulating for quite awhile.  I even mentioned it here on Monday in a post titled “Who is this guy Margin – and why does he keep calling?” 

To put it bluntly, Schwartz lied.  He knew he was lying when he said it.  He should be fired immediately and prosecuted for fraud.

The bailout of Bear Stearns by the Fed today is the tip of the iceberg.  This will get worse, and the Fed has now set a precedent of bailing out non-banks.  Here’s a quote from a CNN story today. 

“The crisis, however, is not isolated to Bear Stearns, said Christopher Whalen, managing director of Institutional Risk Analytics, who predicts that the liquidity crunch will only get worse. The heart of the problem is that no one knows how to value the assets these Wall Street firms are carrying so noone wants them.  A lot of firms are right behind Bear,” he said”

gk

Dollar vs Euro

Despite the news about Bear Stearns, this may be the news that is the most significant in the long run.  The EEC economy is now larger than the US economy. 

According to the story “Taking the gross domestic product of both economies in 2007, the combined GDP of the 15 countries which use the euro overtook that of the United States when the European currency surged to a record high of more than $1.56 per euro.”

It’s not that Europe is growing faster than the US, it’s that our government is inflating the dollar faster than the Europeans are inflating the Euro.  And with all the billions the Fed has created out of thin air in the past few months, I don’t see that trend reversing anytime soon.

gk

Here's the whole thing

Thanks to The Daily Reckoning Australia for permission to repost this great article by Dan Denning.  I posted an excerpt a few minutes ago, but here’s the whole thing.  Enjoy!

gk

Any Port in a Storm
Geneva, Switzerland – Melbourne, Australia
Tuesday, 11 March 2008

From Dan Denning at the Old Hat Factory:

–Oil is going up faster than gold. Both are leaving the dollar in the dust. Oil set its 9th new high in the last ten trading sessions. The front-month futures contract traded at US$108.21 in New York.

–Why is oil sprinting past gold? Both are hedges against inflation and U.S. dollar weakness. But in simple terms, it’s easier for large players to be long oil than long gold. Crude oil futures are the most actively traded contracts in the commodities market. If you want a quick trade, that’s where you go.

–Any port in a storm, goes the old saying. Oil and gold make a nice port. Keep an eye on the trade, though. It’s getting crowded. There are three phases to any bull market. The first stage is the undervalued stage, when an asset class bottoms and nobody notices. That is the best time to buy. It has long since passed.

–The next stage sees the price go up to where future earnings are fully valued in the current price. The stock is neither cheap nor dear. This was probably 2004-2006.

–Then comes the insanity, where a stock keeps going up because it keeps going it. People buy it simply because it’s rising. We are getting close to that stage with oil and gold. A big factor in how they go from here is how much lower the dollar can go. Between now and next Tuesday, it may go even lower.

–The Fed meets next Tuesday to decide on rates. Judging by the futures markets, investors expect the Fed to cut rates 50 or 70 basis points. You’re probably seeing the oil market price that in. We’d expect the oil price to come back a bit when, in fact, the Fed does cut rates. However these blow-off phases in bull markets can overshoot massively. That would leave oil… well… we’d put a number out there like $150, but you’d just laugh.

–There is not much to laugh about if you’re Ben Bernanke though. It’s not clear another rate cute will slow down the deterioration in the banking sector. The value of collateral keeps falling. Banks want their money back. Leveraged speculators have to sell to raise cash.

–And as we mentioned yesterday, there is one extremely worrisome development that could rock the global financial markets to their foundations. Yes, it’s been pretty bad up to now. But the government sponsored enterprises (GSEs) in the U.S., Fannie Mae and Freddie Mac, together guarantee over US$4.2 trillion in mortgages.

–Incredibly, and by that we mean “not credibly”, the GSEs have not sustained the same level of losses in their mortgage portfolios as the banks have. Fannie lost US$3.6 billion in the fourth quarter and Freddie $2.5. Both had to raise more capital. But compared to the banks, these losses are remarkably small.

–But here’s the thing… the first wave of bad subprime debt came from mortgages originated in 2004. The delinquencies and defaults on those loans have been enough to cost the financial sector over $150 billion in losses. It’s brought the credit market to its knees.

–The horrible news for investors is that loans originated in 2005 and 2006 already have much higher delinquency rates. They will have higher default rates, too. The last in to the boom will be some of the first out.

–Over US$600 billion in lower-credit quality loans were originated in 2005 and 2006. Already about 5% of loans made in 2006 are more than 90-days delinquent on payments. It’s not a shocker when you think about it. At the height of the boom, anyone could get a mortgage. But what this means is that the loans made in 2005 and 2006 at the peak of America’s housing boom could be the worst performing of the whole subprime lot.

–The shocking performance of these 2005 and 2006 loans hasn’t been factored into stock prices yet. We would also suggest that no one yet know how the mortgage portfolio of the GSEs is going to hold up this year. The idea that asset quality at the GSEs may become an issue this year is simply too scary for most investors to contemplate.

–GSEs sell bonds to finance purchases of mortgages in the secondary market. The GSE bond market was larger, for a period, than the U.S. Treasury market. Central banks, pension funds, banks… everyone owns agency-backed bonds (as GSE bonds are called.) If those bonds continue to fall in value, this whole mess reaches a new, truly scary phase.

–Where is it all headed? Eventually the Fed is going to have quit selling money cheap and start buying mortgages. We reckon the Fed will have to directly buy GSE debt in the near future. The liquidity issues in the financial sector will only finally be solved when all the suspect, infected, and putrid mortgage debt is either written off or finds a permanent home. The Fed is likely to be that home, fulfilling its mission of buyer of last resort (along with lender of last resort.)

–Naturally, loading up America’s national balance sheet with the accumulated mal-investments from the housing bubble is not going to be a good thing for the U.S. dollar. While the oil price looks a little frothy on its own, when you account for the potential damage to the dollar from the “nationalization” of the mortgage market, well… you ain’t seen nothing yet.

One more straw

Dan Denning nailed it!  Here’s part of what he had to say in today’s Daily Reckoning email.  I looked for the article on their site (check it out – it’s good stuff!) but I didn’t find it in order to be able to provide a link.  I’ll repost the entire article here if I receive permission, but for now, this is the main part that I think most people don’t yet understand:

–But here’s the thing… the first wave of bad subprime debt came from mortgages originated in 2004. The delinquencies and defaults on those loans have been enough to cost the financial sector over $150 billion in losses. It’s brought the credit market to its knees.

–The horrible news for investors is that loans originated in 2005 and 2006 already have much higher delinquency rates. They will have higher default rates, too. The last in to the boom will be some of the first out.

—Over US$600 billion in lower-credit quality loans were originated in 2005 and 2006.Already about 5% of loans made in 2006 are more than 90-days delinquent on payments. It’s not a shocker when you think about it. At the height of the boom, anyone could get a mortgage. But what this means is that the loans made in 2005 and 2006 at the peak of America’s housing boom could be the worst performing of the whole subprime lot.

—The shocking performance of these 2005 and 2006 loans hasn’t been factored into stock prices yet.We would also suggest that no one yet know how the mortgage portfolio of the GSEs is going to hold up this year. The idea that asset quality at the GSEs may become an issue this year is simply too scary for most investors to contemplate.

The emphasis above is mine.  Think about how much leverage there is in the financial system.  Now imagine what happens when a good portion of that $600 billion in collateral is in default.  Not a pretty picture is it?

gk