Last week was a tough one for the markets. Oil rose over US$88 and the Dow got clobbered. It fell 366 points on Friday. The euro rose to almost US$1.43.
The Boston Globe gives us a quick update on the housing picture:
“‘You can see that it’s a crisis,’ said John L. O’Brien, registrar of deeds for southern Essex County, based in Salem [Massachusetts]. ‘It’s starting to take on a life of its own.’”
Foreclosures in the yankee state are running three times last year’s level. And losses are working their way up the socio-economic ladder. Goldman Sachs’ (NYSE:GS) Trust 2006-S3 is a sophisticated investment instrument containing 8,274 mortgages. One out of every six of those mortgages is in default – only 18 months after the thing was put together. When that many people stop paying, it wipes out the entire capital value of the derivative. And since speculators usually take leveraged positions, the losses can go much further.
We don’t know whose mortgage is going unpaid…or who invested in the trust…but according to former colleague Adrian Ash, after Goldman created the derivative and sold it to its customers, it then sold its own monster creation short in order to protect itself.
Goldman is a smart operator. The typical fellow has no obvious way to protect himself.
His house falls in value…his earnings go down in value…his living costs go up…and he’s out of luck. And not all the big players are as smart as Goldman. There always has to be someone on the other side of these trades. Also last week, two major financial companies – one in London, the other in Düsseldorf – defaulted on US$7 billion worth of debt.
What is going on? Time will tell.
“It’s funny because you can see it is a big problem,” said our cousin yesterday. “People have bought these huge houses. They don’t really need so much house, and they never intended to pay for it. They just figured that they’d stay in it for a few years…and then sell out at a big profit. The bigger the house, the more money they’d make. So they bought these McMansions, which really aren’t very well built. Everybody thought the same thing, so everyone was buying more house than he needed. That’s why the whole housing market went up…people were all pushing up to the next level.
“But now, no one is coming up. The pressure from the bottom has gone away. And these people are left with a lot more house than they can really afford, or that they even want. They have to keep it clean…and maintain it…and pay taxes on it. And property taxes are so high in Maryland now…especially for waterfront property…that you never really own your house; you just rent it from the government. I was going to build a house down on the bay…but the property taxes alone would have been between US$15,000 and US$20,000 per year. I said, ‘Forget it’.”
What will happen next? What happens when people say ‘forget it’ to new purchases? What happens when the bottom rung of the property ladder breaks? When happens to an economy that depends on consumer spending when consumers have no more money to spend?
We don’t know, dear reader, but we don’t think it’ll be pretty. For the moment, time is keeping its mouth shut. We have our opinions, of course. You can probably guess what they are. But we’ll keep our mouth shut too.
The Daily Reckoning Australia