Forgive me, I’m still catching up on my reading.

This one jumped out at me:  The Wall Street Journal reports U.S. Consumers Reduce Debt for Fifth Month in a Row

That headline taken in a vacuum should be good news right? Well… sorta. It was consumer debt that both drove the economy for the last 30 years and yet at the same time contributed to it’s implosion.

People drastically reducing spending and (hopefully) living within their means don’t help an economy that depends on consumer spending for 70% of it’s activity.  These people (including myself) are putting as much of their resources into reducing their debt and freeing themselves from the usurious practices of the banks.  But this is a case where we have too much of a good thing. If debt reduction happens too fast, the corresponding consumer spending reduction could extend this recession far longer than normal.

About the only good thing I can see coming from this either way is that if enough people relieve themselves of credit card debt, it will hurt the banks since they will no longer be able to make money from their usury. They might actually have to compete a little and put their interest rates at a reasonable level.

Anything that hurts the banks makes me smile a little inside. It’s not like they don’t deserve it.

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There was much talk earlier this spring about so called “green shoots” in the economy by talking heads trying to coin a phrase that would stick. Unfortunately for us, they had very little evidence to back up such statements. Housing was still tanking, unemployment was still skyrocketing, and GM and Chrysler were swirling down the toilet of bankruptcy.

I’ve been rather pessimistic on the economy for a while now. As recently as April I was predicting a long drawn out recovery. I also predicted that a second wave of foreclosures coming from a type of mortgage called Option ARMs would start carpet bombing the economy all over again. Well, unlike a certain ex-President of ours, I’m willing to chart a new course when provided with new information.

Here is why I am cautiously optimistic for a near term recovery. I’ll go out on a limb and say that the bottom was sometime in June 2009.

Option ARMs

First, my biggest reason for originally predicting a long, drawn out, recovery was the Option ARMs. In a previous blog post, I explained how Option ARMs are one of the most dangerous mortgage types out there. The cliff notes version of this is: You can pay less than the amortised amount each month and whatever you don’t pay gets tacked onto the principle, up to 125% of loan value, and thus charged interest. After about 5 years or once the principle reaches 125% of loan value, the monthly payment “recasts” and now the owner has to pay the entire amortized payment on 125% of the loan value and now they only have 25 years amortization… just as sugar on top. A large batch of these mortgages were due to start recasting at the end of 2009.

My reason for course change? Many of these mortgages aren’t even making it that far. 42% of Option ARMs originated in 2006 and 35% of Option ARMs originated in 2007 are more than 60 days late today. These mortgages are never going to make it to the 5 year mark for recasting. Now, I’m not saying that these people aren’t going to be foreclosed on, they are. It’s unlikely that ANY of these mortgages will qualify for loan modification since one of the requirements is a principle balance lower than the value of the home.

Here is the good part, by going into foreclosure sooner, it softens the overall impact on the economy. So while it’s still bad, it hurts less. Would you rather be hit by 18 inches of snow over a period of 3 days or get hit by an 18 inch diameter snowball?

Ford posts profit

Ford Motor Company had two pieces of good news. First, Ford posted an overall profit for 2^nd quarter 2009. Their operating cash still took a $1 billion hit, but clearly progress is being made. The proof of that is in the next item.

Ford posts positive sales numbers

Ford posted their first sales gain in 19 months. Now I’m sure that a good portion of this can be attributed to the government’s Cash for Clunkers program, however Ford’s current model lineup easily stands on it’s own without help from the government. If their new Taurus had been in showrooms already, I’m sure they would have done even better.

This comes on the heals of Toyota’s statement that they are no longer profitable in North America.

Anecdotal

I do I.T. consulting work on the side. One of my clients is a real estate appraiser. Just three months ago he was talking about closing up shop. Now he’s having me refurbish older computers that haven’t been used in a while so he can bring in more help for all the work he has.

A guy who does painting and drywall work for me was talking about how he is closing on a house on Thursday but he doesn’t have time to work on it because of all the work he has coming in suddenly.

GDP only at -1%

This is where the caution part of “cautiously optimistic” comes in. That number, in a vacuum, doesn’t look too good. Taken with the numbers of the previous quarters it signals a huge turnaround. However, much of that regrowth has come from the government’s stimulus projects. Sure the bill was passed in the late winter, but it took till April and May before any sizeable amount of money was dispersed. In my area alone there are no less than four major bridge building/refurb projects that have started or resumed.

Unemployment

The unemployment numbers still don’t look too great but they tend to be a lagging indicator simply because they aren’t reported till after someone gets or loses a job. Watch the unemployment stats over the next few months.

Green Shoots?

Not really. But the seeds have been planted and watered.

Watch this space.

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Fox New Business is reporting that Wells Fargo is suing itself.

In a condo foreclosure case in Florida, Wells Fargo holds the first mortgage and is suing all other lien holder, one of which is itself, the holder of the second mortgage.

Demonstrating that there is no such thing as “Too big to FAIL“, Wells Fargo hired Tampa lawfirm Florida Default Group of Tampa Florida to file suit against itself. WF then hired Kass, Shuler, Soloman, Spector, Foyle & Singer to defend itself from itself.

At this point, no matter the outcome, it seems as if the lawywers are the only winners in this case.

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How could they think this was sustainable?

via Council on Foriegn Relations

edit: updating formating.

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We’re arguing about AIG v. GM on the Cheers and Gears site. The argument started over an article by the Baltimore Examiner that compares the situation of the two companies.

One member posted this:

In the interest of “keeping it real”:

1) The AIG money has given the US partial ownership. So if you want to pretend the auto loans aren’t a bailout, then I suppose you could do the same thing for the AIG buyout.
2) AIG used to make money and has a good chance of making money again. GM hasn’t made money for a long time and likely will never get out from under their debt.
3) A failure by AIG by all accounts that I have heard would be catastrophic. GM’s failure will be hard but is a much less substantial affair.
4) The eventual cost to save GM will likely be in the 100 Billion range. I have trouble keeping up, but I believe they have already received 14 Billion + 6 Billion to GMAC + future 16 Billion + future retooling money + EREV subsidies. Also they are worth -86 Billion as of the end of 2008. Given the cost/risk as compared to AIG, AIG is where the money should go.

I will agree that the union being blamed for GM’s problems is just silly and the AIG bonuses are horrible. But that is US-capitalism for you.

My response here:

1) We paid $180b to own 80% of a company with a market cap of $3.3b and that has outstanding liabilities of $807b. For comparison, with $180b, the Feds could have purchased the entire liabilities side of GM’s balance sheet and had about $3b in change.

2 a.) AIG has a poor chance at making money again. Their name is permanently tarnished. They’ve had to take down their sign on their NYC headquarters. They have about as much chance of making money again as Enron does. BTW, I also use the term “making money” very loosely. AIG never “made” money……. they “made up” money sure… but most of the money “made” by them was imaginary.
2 b.) If by a “long time” you mean two years… then sure. GM had a quarterly profit of $891 million dollars in 2Q 2007. Net income, excluding one-time items, was $1.4 billion.

3 a.) Catastrophic to whom? DeutcheBank? Royal Bank of Scotland? Barclays UK? That’s where the bailout money went. Of the 15 banks that AIG made payouts to, only 4 were US based. All of which already received TARP funds.
3 b.)General Motors, it’s dealers, suppliers, and affiliates employ millions of people. The hit on employment in this country and others would be catastrophic. Not even Toyota wants to see GM liquidated because in the process it would take out suppliers that Toyota relies on. The quickest way to kill Ford and Chrysler would be through an uncontrolled G.M. bankruptcy. You don’t think that would be catastrophic?

4.) If $180b were to be extended to GM as a long term, low interest loan. The government would get it’s money back, with interest, Iaccoca style. We are getting a grand total of $0 back from AIG… because they weren’t loans.

So sure…. I’m all for “keeping it real”

What I don’t understand is this attitude of “Yeah the AIG bonuses piss me off, but we had to bail out AIG. Let GM die.”

Someone care to explain?

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Why are we still calling this a recession?

From the Wikipedia and Economic Depression is: A depression is a sustained, long downturn in one or more economies. Considered a rare but extreme form of recession, a depression is characterized by abnormal increases in unemployment, restriction of credit, shrinking output and investment, numerous bankruptcies, reduced amounts of trade and commerce, as well as highly volatile relative currency value fluctuations, mostly devaluations. Price deflation or hyperinflation are also common elements of a depression.

1. The Commerce department releases that in Q4 2008 the economy contracted at 6.2 percent. Predictions that in 2009 the economy will be the worst since 1946.
2. The horribly underestimated jobless rate is 7.6 percent. Likely to hit 9 percent.
3. California’s jobless rate is 10.1 percent in January.
4. The Dow is at it’s lowest point since 1997 and dropping.
5. 40% of all subprime mortgages issued from 2005 – 2007 are expected to default
6. Indicators of price deflation are showing.
7. Mortgages, credit cards, lines of credit all slashed.
8. Bankruptcies surge 40%
9. US exports fall 20%. Japanese exports fall 46%.

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AIG posted a nearly $62 billion fourth quarter loss. So far, AIG has received $150 billion in taxpayer money and as of a plan announced today will receive and additional $30 billion of your dollars.

But these aren’t loans. These are gifts to AIG meant to help free up lending and spur the financial system. Here’s why it won’t: AIG’s total liabilities as of September 30 2008 were $951 billion. They can’t write new insurance policies because they don’t have the capital to back them up. No more streams of income, no way of paying that debt. The only way to pay their debts is to sell pieces of themselves off at decidedly above market prices.

Watch those dollars swirl round and round as they go down the drain.

To put the size of this in perspective. The government could have purchased 98% of General Motor’s liabilities for the same amount it has given to AIG. At least GM has a chance of surviving.

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Here is the difference between what has happened and what is about to happen.

In the past 12 months, most of what has failed has been fairly standard, though sub-prime, adjustable rate mortgages. You get a $180k mortgage for a $200k home and get an adjustable interest rate that resets every year after 5 years or so. You paid the standard principle + interest + escrow. What has happened is the first bunch of homeowners who’s mortgages reset could no longer afford the new payments. Some refinanced, but a good many went into foreclosure. The foreclosures put downward pressure on home prices. When this happened, even fewer people could refinance their homes because the values of the home often fell below the amount of the first mortgage. The vicious cycle started and that’s how we got where we are today.

Keep in mind that 12 months of that have brought down the largest investment banks in the country, put Bank of America, CitiGroup, and Wells Fargo on the ropes, and forced mergers of banks that never would have happened in a normal climate.

Here is the fun part.

With an Option ARM loan you have the option to make partial principle and partial interest payments. What you don’t pay gets amortized back into the principle of the loan up to a maximum of 115% or 125% of the original loan value or once 5 years has been reached. Many people pick these types of loans because it was the only way they could afford the monthly payments on their McMansion. In the meantime, property values have fallen across the board making refinancing out of these loans virtually impossible. Once these loans are recast (similar to the resetting of the interest rate in an ARM), the home owner goes from making a minimum payment that doesn’t even cover interest to a fully amortizing payment that covers all interest AND principal. And remember, principal is 15-25% higher than the original loan balance. Most people with these types of loans also put no money down or got a second mortgage to pay for their money down. They owe 25% more than their home was valued at way back at peak housing prices. The payments jump to full amortization anywhere between 80% to 200% of the old house payment.

Now, with all that in mind. Lets look at the numbers.

The end of 2008 was the time period where the highest dollar value of standard ARM loans was due to reset. At the peak, about 36 billion dollars per month in loans reset. There is a lag with standard ARMs because the payment shock is anywhere between 0% and 20% increase in monthly payment. Many families can handle it for a short while before they start falling behind.

May/June 2009 is when the Option ARMs begin to reset. This wave has 3 small dips. The peak of the first wave hits us in December 2009 and reaches $25b per month in recasts. It drops off for a bit then shoots up to $30b a month in recasts around June 2010. Drops back to $20b per month in December 2010 and then surges to $40 billion per month in June 2011. Now when these loans recast, there will be a lot less lag time because the monthly payment will jump anywhere from 80% to 200% of what the homeowner is used to paying. With no way to pay and no ability to refinance, homeowners will throw in the towel much faster.

Are you ready for the punchline brought to us by Dr. Housing Bubble?

As of December of 2008, a stunning 28% of option ARMs were delinquent or in some stage of foreclosure. This is before any recasts have even kicked in!

Remember, the banks have already failed and consolidated from just the first mess. Bank of America, Wells Fargo, and Citigroup are already dangling on the cliff.

Who’s next?

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