Subprime Crisis: US Economy Needs a Correction

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We were at a dinner party last night. Among the guests were three bankers – two French bankers…and an investment banker with Lehman Bros. (NYSE:LEH) in London.

“This credit crunch is hitting harder than most people realise,” said the man from Lehman Bros. “It’s not just a subprime problem any more. You can put together a great deal…you still won’t be able to get financing for it.

“But so far, only people in the financial industry are affected. And, let’s be honest, none of us are really hurting. We made so much money in the last few years…we could all retire if we wanted to. And I don’t think the crunch will last too much longer or go much deeper. There’s just too much going on.”

Bob Diamond, president of Barclay’s Bank, is quoted in the Financial Times:

“We have a ‘real cracking of the liquidity bubble,’ he said.”

The question is whether the crack can be mended with a little central bank epoxy. Most people think so…all hope so. And all are working on it. Goldman (NYSE:GS) put US$2 billion of its own money into its troubled hedge fund. The Bank of America (NYSE:BAC) bought US$2 billion worth of Countrywide Financial (NYSE:CFC), America’s biggest mortgage lender. And central bankers all over the world are providing as much liquidity as the market is willing to take.

What separates us from the rest of the financial commentators is not our knowledge; we don’t know what will happen any more than anyone else. It is our desires. While others desire a speedy recovery on Wall Street, we’re rather hoping for a long, dreadful illness…punctuated by periodic reports that the patient has died. A correction is what the US economy needs, because Americans are not making any real financial gains. Corrections are painful. But no pain, no real gain…that is, unless you are positioned properly.

And our old friend Rick Ackerman writes:

“Here’s a front-page headline from the New York Times that gave us a chuckle the other day: ‘Few Heard Ticking Credit Time Bomb.’ Few who are not deaf, dumb and blind, perhaps. However, for the millions of sentient humans who live outside the warp in which the Times evidently is fabricated each day, the ticking of the credit time bomb was about as hard to detect as a giant asteroid bearing down on Cleveland. It seems no one at the Gray Lady thought to Google the words ‘credit crisis’ in recent years, since that would have turned up millions of leads that some enterprising reporter could have checked out.

“Both the Times and The Wall Street Journal have been doing some heavy catching up recently in the wake of revelations concerning the true condition of the US real estate market. It took the bankruptcies of some big mortgage lenders, as well as subprime leverageur Bear Stearns’ narrow scrape with death, to call attention to potentially disastrous problems that the financial-newsletter world has been heralding for years.

“The Times, the Journal and other status quo purveyors of news must surely regard the mortgage crisis as something to be resolved in due time, presumably by an inevitable upswing in home prices and a little help from the central bank. But such thinking only confirms that they are as clueless now as they were when the real estate crisis reached critical mass nearly two years ago. And, we are certain, they will be equally clueless when the expected upswing in home prices fails to materialise and deflation tightens its death-grip on the US and global economies.

“By then, the praise and respect the news media have mindlessly heaped on former Fed Chairman Alan Greenspan will be under reconsideration. For the record, let us say that he has already been tried and convicted by the vast newsletter world as the main instigator of a credit blowout that could only have ended as this one is about to: In a global bust. Three generations after the start of the Great Depression, the eggheads, pundits and wonks are still looking for a culprit. Was it the Smoot-Hawley tariff? Too-tight credit after the market crashed? The next time around, when the saga of the Second Great Depression is told, they need look no further than a Federal Reserve that succeeded in turning the concept of ‘free lunch’ into America’s only mainstream religion.”

Americans must have been wearing some heavy-duty earplugs to miss out on the ticking of the credit time bomb – especially the subprime bomb.

The Survival Report ’s Mish Shedlock reports: “More than 1.3 million borrowers took out over US$389 billion worth of pay-option adjustable mortgages in 2004 and 2005. Many of these started to reset in 2006, just as the property market started to tank. Many more are set to reset this year, in 2007.

“As much, in fact, as US$1 trillion in pay-option loans and other creative ARMs over the next 12 months alone – sending an atomic shockwave across the US economy between now and January 2008!”

And apparently, it’s not just America that has been affected by the subprime debacle…today, the Bank of China announced they hold nearly US$10 billion in US subprime backed mortgages.

Yikes.

Bill Bonner
The Daily Reckoning Australia

Bill Bonner

Bill Bonner

Best-selling investment author Bill Bonner is the founder and president of Agora Publishing, one of the world's most successful consumer newsletter companies. Owner of both Fleet Street Publications and MoneyWeek magazine in the UK, he is also author of the free daily e-mail The Daily Reckoning.
Bill Bonner

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