Credit Tsunami Approaches Shore.....

Credit Tsunami Approaches Shore…](http://market-ticker.denninger.net/archives/530-Credit-Tsunami-Approaches-Shore…html)
The Market Ticker| Monday, August 4. 2008 | Karl Denninger

… while politicians ignore.

The economic news of the day is that personal income and spending were quite weak - better than expected, but weak. Real income, measured with price inflation counted, fell.

“And the band played on” in political circles.

It won’t for long.

Folks, everyone has said this is a “subprime” problem, then a “housing problem.” People have assumed that prime loans would be “ok.”

For 30 year fixed mortgages with 20% down payments and 36% DTIs, where no HELOC has taken place, this is almost certainly true. They will not default in serious numbers.

But to think that this is just a housing issue is horribly naive, and yet this is what the Capital Markets are thinking.

They are “conveniently” forgetting that this credit problem was not limited to either subprime or housing.

The markets will not ignore this for long. So-called “prime” mortgages are going to default in significant numbers as well, and “ALT-A”, or liar loans and “exotic” mortgages made to people with high FICO scores, are defaulting at rates that rival “subprime” - but they are a much larger portion of the marketplace!

Furthermore, we are going into this economic difficulty with a very high degree of leverage in corporate debt. Whether it be LBO loans or other forms of financing, the credit “bubble” made it “not worth it” for corporations to spend (or restrain themselves) to keep leverage reasonable and thus debt ratings high.

The claim has been, up until now, that “defaults are historically low.” True.
The danger is that with more debt rated “junk” than ever before going into a recession, defaults are unlikely to remain low - or even reasonable - for very long.

This bad lending has already crunched auto leases, with Chrysler withdrawing the option entirely. Ford and GM are likely to follow suit.

Even firms like BMW are realizing that having 60% of their sales volume made on lease is likely a really, really bad idea when you have to place bets on residual values when you write the paper - and eat the cost of being wrong.

This foolishness in lending literally extends to everything. Credit cards, LBOs, student loans, automobile loans, C&I, all of it. None of these areas are immune.

The government has totally botched managing this crisis with their incessant attempts to bail people out and continue to allow people to lie.

$1.3 trillion has been thrown on the table - none of it money that we already have - in an errant attempt to bail out people who made bad bets along with Fannie and Freddie, who are in effect giant hedge funds operating at insane leverage levels.

The proper response is to withdraw the excess liquidity and support and force prices in all of these areas to correct. This is especially critical in both housing and education, with the latter being incredibly sad.

College costs have grown at an unreasonable and unsustainable rate, fueled by - you guessed it - cheap credit. As a consequence our young people come out of college with levels of debt never before seen - an especially cruel bit of exploitation by the “ivory tower jackoffs” who are, of course, those who do their damndest to indoctrinate those very same young people - and their employers.

I guess this should be expected - after all, that’s what politicians and ivory-tower idiots ***do ***(lie and spend money they don’t have), right? But in this case, all they’ve managed to do is further damage confidence, and trust is crucial to properly-functioning markets.

When - not if - the Capital Markets get their arms around this, you are likely to see the Mother and Father of all flushes in equities.

At the beginning of the year I predicted we would hit 1220 in the SPX before the end of the year. We got down to 1200.

I now expect a three digit handle on the SPX within the next six to twelve months, with a 75% probability (three out of four) that we see it before the election.

Folks, 80% of America did not benefit from this credit bubble in any material way, but the prudent are now being told that we must pay the price.
That’s backwards.

The underlying fallacy here is that the government (or anyone for that matter) can prevent these defaults and damage. This is false, because the damage to the economy and the losses have already happened.

They occurred when the bad loans were made; we are now arguing over when they will be recognized and upon whom they will fall, not whether or not the loss will take place.

Get your arms around that folks, because it is reality.

Oh, the first major homebuilder went down today. WCI filed Chapter 11.

The first of many.

Good post. But here is the kicker… those who default on their high balance unsecured credit lines (credit cards, student loans, etc)… will be better off financially than those who keep paying their bills on time.

It will not be worth $20K, $30K, $40K or whatever in cash payments to the lender in return for blemish free credit as no one will care soon. What they will care about is down payment and for that it is better to have your money than a 720 credit score. People are starting to realize this and defaulting intentionally (note: intentionally running up credit card debt with intent to default is a criminal act), figuring all will be forgiven for those who have a little down payment in the future… and they might be figuring right.

I was stunned to find out about WCI’s insolvency. More bad news on the European Front, it seems the same bad credit decisions that were made on the micro level regarding home mortgage lending was practiced on the macro level with regards to whole countries.

**Morgan Stanley issues alert on Spanish banks **](http://www.telegraph.co.uk/money/main.jhtml?xml=/money/2008/08/05/ccspain105.xml)
**The Telegraph **8/4/2008 | Ambrose Evans-Pritchard

Morgan Stanley, the investment bank, has issued a major alert on the health of Spanish banks, warning that a replay of the ERM crisis in the early 1990s could wipe out the capital base of weak lenders exposed to the property crash.

“A momentous economic slowdown is now under way. We believe the deterioration in Spain is just in the beginning stages. The bulk of the pain will be suffered in 2009,” said the report. “The probability of a crisis scenario similar to the early 1990s is increasing. If the ERM (Exchange Rate Mechanism) scenario were to become reality the main concern would not be earnings, but capital,” it said.

“We estimate that a non-performing loan ratio of 10pc to 15pc for developers’ loans would fully erase earnings in 2009 and would represent between 20pc to 30pc of the current tangible capital base of Banco Popular, Sabadell and Banesto,” they said.

The grim report comes amid a fresh flurry of horrendous data from Spain. The ICO consumer confidence index has plunged to a record low of 46.3. Lay-offs continued to surge in July as the building industry - 13pc of Spain’s workforce - stepped up its job purge. Unemployment has risen by 457,000 over the last year, pushing the rate to 10.4pc.

“These figures are very disturbing”, said employment chief Maravillas Rojo. The root cause of the bubble was the extremely lax monetary policy imported by Spain after it joined Europe’s monetary union.

Interest rates were slashed on EMU entry, and then fell to 2pc until late 2005 - far below Spain’s inflation rate. However, Mr Solbes has been reluctant to link the crisis to Spain’s euro membership.

As Europe’s economics commissioner at the launch of the euro, his career is inextricably tied up with the whole EMU experiment.

(Excerpt) Read more at telegraph.co.uk