Falling House Prices and Mass Housing Foreclosures Were Warning Signs of Things to Come


No one will deny that last week was one of the most tumultuous in history. The streets red with blood…the bodies of the dead and dying strewn about where they fell.

You already know the names: Lehman, Merrill, AIG. Fannie and Freddie.

But none of this happened by accident.

The warning signs have been all around us for years.

Bud Conrad, chief economist at Casey Research, wrote about the beginnings of our current problems back in March of 2007…before most people were even aware of the storms brewing just over the horizon.

“Faced with historic levels of debt, falling house prices, and weaker economy, the pressure on housing would gain momentum as desperate homeowners either hand their keys back to the banks, or simply hit the bid on the best (low) offer they can get. A vicious cycle would set in, threatening to shove the economy into uncharted and unpredictable waters.

“The impending calamity – mass housing foreclosures, failing banks, Fannie Mae and Freddie Mac in ashes, millions of personal bankruptcies – is so dire…most people can’t even conceive of it. And indeed, it may not hit us this year, or next, but the market always corrects itself, and this time will be no exception – sooner or later… That’s why the coming crisis is so predictable: there’s no way to avoid it.”

I actually wish that his analysis had been flawed.

I also wish that the government officials had been right who have consistently claimed since then that the subprime crisis was contained and the markets would rebound in the second half of the year.

Unfortunately, this is not the case.

The Fed’s recent attempts at quick fixes have not worked, and current events are reinforcing what Bud Conrad prognosticated almost two years ago: that this is much more than a normal cyclical correction. This is a disaster of biblical proportions.

As the Fed and the Treasury continue to intervene in the market, they continue to lose ground and credibility, caught between a sharp recession and strong inflationary pressures. In an effort to bail out the financial sector, they have no choice but to start injecting hundreds of billions in liquidity into a contracting market place.

This will contribute to the creation of a stagflation period that will make the ’70s look like a tea party.

The Fed’s never-ending injection of liquidity into the market has, and will continue to, devalue the dollar.

Ordinarily, a country threatened with currency collapse would lean toward tight money, perhaps contracting its domestic money supply. That would push interest rates upward and compensate foreigners for holding on to the currency despite the depreciation risk. And it would soften that risk.

But this time, things aren’t ordinary…there is a difference that has turned what might otherwise be a disturbance into a disaster: the U.S. economy’s inability to endure high interest rates.

Because of the corrections taking place now in the grossly distorted U.S. housing, commercial real estate, and personal credit markets, raising interest rates to protect the dollar would prove as calamitous as not raising interest rates.

The housing bubble fueled a blockbuster business in first mortgages, and then home equity loans. Homeowners drew down their equity to splurge on consumer goods, including shiploads of imports.

The relative attractiveness of U.S. financial instruments kept the game going into overtime. The foreigners who received all those U.S. dollars put them back into U.S. Treasury bills and other dollar-denominated instruments, thereby underwriting low interest rates for all U.S. borrowers.

The net result? Foreigners funded our housing boom. The amount of mortgage growth annually matched the amount of trade deficit, which foreigners dutifully invested back into the U.S.

And subprime lending was no mere sideshow. It was big business. In 2005, it accounted for 25% of all new mortgages – about $600 billion of high-risk paper, most of it with adjustable interest rates.

The collapse of the subprime market soon spread into other mortgage sectors…and the derivatives created on top of all those subprime mortgages made everything much worse. Given that the annual GDP of the U.S. economy is just $13 trillion, the $250 trillion in derivatives should have been seen as an accident waiting to happen.

Foreign reinvestment is part of the system of U.S. debt, and we are already seeing a significant impact.

As foreign investors watched the collapse of the U.S. housing markets, and the relative values of their debts began to sink, they quickly moved out of U.S. debt, particularly Fannie/Freddie obligations.

This massive exodus of foreign cash out of the debt of Fannie/Freddie prompted the biggest stock market fall since the days just after 9/11. On September 15, 2008, Treasury Secretary Paulson injected the biggest amount of daily liquidity since 2001, a whopping $70 billion in just one day.

And now the government is proposing an additional infusion of approximately $1 trillion. More than the total cost of the Iraq War.

To put this amount into perspective: if you had spent $1,000,000 a day, from the birth of Christ until today, you would have only spent about 732 billion dollars.

It’s going to be interesting to see what happens to our markets if that proposal goes through.


Oliver Garret
for The Daily Reckoning Australia



  1. The boom ahead

    3rd Quarter Stock Report With Sam Stovall, Chief Investment Strategist at Standard & Poor’s, pbs.org/nbr, Tuesday, September 30, 2008

    PAUL KANGAS: The third quarter has come to an end on Wall Street, and it was an ugly one. Joining me now to talk about the quarter and what’s to come for stocks is Sam Stovall, chief investment strategist at Standard & Poor’s. And, Sam, good to see you, as always.


    KANGAS: Let’s cut right to the chase. The major indices were down sharply, the Dow fell 4.4 percent, Standard & Poor’s 500 tumbled 9 percent during the quarter, and the NASDAQ 100 got clobbered, falling almost 14 percent. What are these performances telling you about what’s to come for the market?

    STOVALL: Well, first off, Paul, it reminds me that September is the worst month for the S&P 500, whether you look back to 1990, 1970, ’45 or ’29, but it does tend to set us up for a pretty nice October, that since 1990 October has actually been the best-performing month for the S&P 500, gaining about 2 percent versus 0.7 for all 12 months combined, and the second- and third-best months are November and December. So yes, it gives me pause to think that maybe we could experience that end- of-year rally.

    KANGAS: Was yesterday’s 778-point drop on the Dow a capitulation indicating we’re near a bottom?

    STOVALL: I think it certainly was. I believe that in order for us to experience a pure 62 percent retracement of the prior bull market, which is typically what we experience in bear markets since World War II, we would have to tumble to about 1,075 on the S&P 500, which is pretty close to where we ended up just the other day at 1,106, so I think we’re close. Also, if we look at the investor sentiment figures, whether it’s the VIX on volatility, put-call ratios or investment newsletter writers, we’re experiencing bearish sentiment levels that have not been seen since 2002.

    KANGAS: How about today’s rally? Was that fairly convincing for you? Impressive at all?

    STOVALL: Well, it was. Early on, I thought it was simply a snap-back from having lost so many points yesterday and then also thinking that Congress would probably get together, put something out either by the end of this week or beginning of next week, but then when I saw the strength build as the day progressed, that implied to me that there is more strength and we broke above the prior low which served as resistance, 1,156 on the S&P, so that was encouraging.

    KANGAS: What sectors do you see taking leadership here?

    STOVALL: Well, if this is a bear market bottom, and there is no guarantee it is, typically we gravitate toward the early-cycle performers, consumer discretionary, industrials, as well as technology stocks. So companies such as Stanley Works (SWK) in consumer discretionary, which is also part of our dividend aristocrats group. In the industrials category, a company like Carlisle Companies (CSL). And then in technology either Hewlett-Packard (HPQ) or salesforce.com (CRM) could be companies that perform well.

    KANGAS: We just have a minute left, Sam, but what is your year-end target for the major averages? Or is that kind of a moving target?

    STOVALL: No. We believe that the S&P will close the year at about 1,250. Interestingly enough, in the first year of a bull market we gain about 38 percent. If you slice that up into four quarters, that’s about a 9 percent advance which is pretty much what would be the bounce that we would experience from tonight’s close. Also, if we’re looking toward 2009, I think we’re likely to see a low-teens improvement in earnings which would make investors feel a little better.

    KANGAS: Sam, do you personally own or have other disclosures about those stocks you mentioned?

    STOVALL: No, Paul, neither I nor S&P owns any of the stocks that I mentioned.

    KANGAS: All right. Sam, I want to thank you for your insights once again.

    STOVALL: I’m happy to be with you, Paul, as always.

    KANGAS: My guest, Sam Stovall, chief investment strategist at Standard & Poor’s.

  2. We’re going to see a bull market before long

    * “Street Critique” Hilary Kramer, Chief Market Analyst at GreenTech Research, pbs.org/nbr, October 01, 2008:

    PAUL KANGAS: Tonight “Street Critique” guest says bailout or not, these are treacherous times. She’s Hilary Kramer, chief market analyst at GreenTech Research… In early July, you told us a major capitulation was coming in the fall and that cash is king. So was Monday’s massive sell-off that capitulation or is there another shoe to drop?

    KRAMER: That was the major crash that we’ve experienced, but we may see other very bumpy days, rocky days, days where we start to pull ahead and then suddenly we pull back. So it’s not yet the time to get too aggressive in the market.

    KANGAS: So you’re on the sidelines for the moment.

    KRAMER: Absolutely. And waiting.

    KANGAS: Are you seeing any good news here coming down the pike, so to speak?

    KRAMER: Absolutely. We’re going to see a bull market before long because so many institutional funds have raised huge amounts of cash because they’ve been expecting redemptions. They’ve been nervous and all at once, all that money is going to return into the market especially in November and December.

  3. Watcher7, just about every guest on the NBR show is a blatant Wall St cheerleader, always ready to talk up the markets and talk down interest rates. Out and out spin. The presenters always seek disclosure, which is good. But I’ve only ever seen one guest who wasn’t trying to spin the markets, about 12 months ago, Brian Westbury was his name, I think. He didn’t get much of a go once the presenter got his drift, trying to talk over the top of him, cutting him off, and he hasn’t been back on the show since.

  4. What is your point?

    Are you saying that Stowell and Kramer will be wrong about their speculation?

    I quote them as they bolster my speculation that the Dow Jones is going to rally to a new nominal high before the real bust.

    The only newsletter that I have a paid subscription to has this observation in the September 19 issue:

    “Note that in 5 of the past 6 recessions (2002, 1990, 1982, 1974, and 1970) ALL conditions were fulfilled, and in the remaining
    buying opportunities most of them were met. Today, in the current recession, all bearish extremes are again in place
    for one of those “best buy” opportunities that typically comes around every 3-7 years.”

    On the newsletter website it has this promotion:

    “Jim Stack of InvesTech Research was the only panelist
    to correctly predict both a recession and bear market in 2001.”

    – Paul Kangas, Nightly Business Report, January 1, 2002 –


Leave a Reply

Letters will be edited for clarity, punctuation, spelling and length. Abusive or off-topic comments will not be posted. We will not post all comments.
If you would prefer to email the editor, you can do so by sending an email to letters@dailyreckoning.com.au