Subprime writedowns, “More pain looks inevitable”

"I'd wait for him to get home. Then, I'd listen for the car in the garage...and stand by the door until he came out."

My wife's grandmother was explaining what it was like during the Great Depression. Her husband, a stockbroker, had lost almost all his clients... and maybe all his money. Some men couldn't take it. They sat in their cars with the motor running until the stock market disappeared forever.

It is hard for us to imagine what it was like. Hardly anyone alive today remembers. Instead, what we remember is a long period in which nothing went wrong. Credit default swaps - insurance against non- payment - grew like mushrooms, up nine times in the last three years... to more than $45 trillion.

And why shouldn't they grow? It cost almost nothing to insure against default... because nothing ever defaulted. Even if you wanted to default - whether on a commercial loan or a mortgage - it was hard to do; there was always someone waiting to lend you more money.

But now... things have changed:

"Suddenly the mood has darkened," reports the London Times. "Just when bankers and investors were hoping the worst was over, a second devastating wave of subprime writedowns from major banks has rocked confidence. In recent weeks, Citi announced it would writedown a further $6.4 billion in losses related to the subprime mortgage crisis. Merrill has also revealed more subprime writedowns, while HSBC last week said it would take $45 billion back onto its balance sheet by rescuing two structured- investment vehicles. Last month Barclays wrote off $1.3 billion.

"More pain looks inevitable. Analysts expect Citi to be hit with a further $15 billion of subprime writedowns. Investors will be nervously scrutinising a Royal Bank of Scotland trading statement this Thursday when the bank is expected to reveal subprime related losses of more than £1 billion. Goldman Sachs analysts have estimated that the total subprime linked losses could reach a whopping $500 billion - far higher than Federal Reserve chairman Ben Bernanke's initial estimate of $50 billion, later revised to $150 billion.

"To add to the gloom there are mounting fears that the problems could engulf other types of American debt - credit cards, car finance and unsecured loans.

"'What has happened is that the risk has been spread so far and wide that no-one really knows where the pain is being taken. The financial bombs just keep going off,' said one senior investment banker."

Last week, none of our milestones were hit.

Gold didn't rise above $850. The euro (EUR) didn't go above $1.50. Oil didn't hit $100.

Well, there's always next week!

We are watching a titanic traffic accident. The unstoppable force of inflation is running smack dab into the immoveable object of falling prices.

We don't yet know how it is going to turn out... but we're sure of one thing: sparks will fly when these two collide.

Last week, the European Central Bank announced that it "fears inflation more than a slowdown," according to the Financial Times. But most of the news points to an increasing danger from falling prices, not rising ones.

Commodities were down on Friday. Gold fell $13. It could go as low as $700 in this correction. Buy the dips, dear reader. Take advantage of a correction in the yellow metal - and it could turn out to be a golden Christmas for you.

"Foreclosures are piling up," says the Associated Press. And now comes this shocker from the Commerce Department: the median house price in the United States fell 13% over the 12 months ending in October. The median house now sells for US$217,800. Hmmm... that's about US$2.6 trillion in disappeared value from the national balance sheet.

But we have a long way to go. Wives are not listening to their husband's automobiles; not yet.

Bill Bonner
The Daily Reckoning Australia

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