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.
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.