Tonight (Thursday) CBNC will air a documentary entitled "House of Cards", a summary as to what went wrong with the economy and credit system. In our view it would have been far more useful to have warned about the calamity a few years ago, as we at Comstock have consistently done in our weekly commentaries. In fact, on two occasions--February 10, 2004 and August 16, 2007--we called the economy a "House of Cards". Don't get us wrong--we're not singling out CNBC. The immense problems now facing us were missed by almost all of the media as well the vast majority of economists and strategists, including Alan Greenspan, Ben Bernanke and some 250 Ph.d economists working at the Federal Reserve. We note that everything we knew came from publically available sources, and it still puzzles us that so many were oblivious to what was happening.
In particular, how could Greenspan not know the dire consequences of the massive housing bubble together with the lethal combination of subprime mortgages, complex structured products, a huge trade imbalance, record household debt and near-zero household savings? He was Chairman of the Federal Reserve Board since 1987, and a successful private economic consultant before that. Furthermore, he headed an organization employing some 250 economists, the largest economics department in the world.
For that matter, how could so many others be so wrong as well? Where were the regulators, the White House, Congress, the nation's vast number of economists, the brilliant minds on Wall Street and the large number of financial journalists working in the media? Why does there now have to be an investigation as to where everything went wrong? After all, the facts were out there for all to see. Here at Comstock we have been writing about the potential dire consequences of the housing bubble for many years with no access to any information that wasn't publically available. It is absolutely ludicrous that the vast majority are saying even now that the events leading to the current crisis were not foreseeable.
Following is a brief summary of what we wrote, all gleaned from public sources. On February 10, 2004, in a comment titled "House of Cards" we wrote: "They (the Fed) know the economy is not self-sustaining, so are trying to keep the equities and real estate markets pumped up in order to give consumers the illusion of paper wealth in the absence of jobs and income. In our view this is a house of cards that is doomed to come tumbling down."
On February 26, 2004 (What's Going on at the Fed?) we noted Greenspan's odd recommendation that residential mortgage holders switch from fixed rates to adjustable rate mortgages (ARMs). We wrote ".this would be another way to induce massive refinancing with hundreds of billion dollars more in cash- outs and their highly favorable effects on consumer spending. In our view, however, the Fed blew it in the late 1990s when they failed to stop the bubble, and the resulting imbalance will, most likely, be impossible to correct without severe disturbance to the economic and financial system."
On March 4, 2004 (Criticism of the Fed from a Central Banker) we noted that Otmar Issing, Chief Economist of the ECB, indirectly criticized the Fed for not taking asset values into account in setting monetary policy. He asked whether central banks can just ignore bubbles and reject any responsibility. He stated that prevention of asset bubbles was the best way to minimize costs for society from a longer-term perspective. According to the promos for tonight's documentary, Greenspan took the exact opposite approach, and now we all know the consequences.
On April 14, 2005 ("And Then, Alas, It's Too Late") we referred to an article written by Paul Volcker, in which he stated, ".under the placid surface there are disturbing trends; huge imbalances, disequilibria, risks-call them what you will. Altogether the circumstances seem to me as dangerous and intractable as any I can remember, and I can remember quite a lot. What really concerns me is that there seems to be so little willingness or capacity to do much about it. A wise man once said that 'what can be left to later usually is-and then it's too late'."
On April 7, 2005, (Is Anybody Listening?) we cited a warning by the IMF that the huge and growing market for credit derivatives and other complex securities could suffer a serious and "disorderly" decline if conditions turned negative. They stated, "If market conditions turn negative, many investors in these products could rush to exit at the same time, causing market liquidity shortages that could amplify price movements. Furthermore, elements of risk management systems designed to deal with these complex products have not been through a live test, particularly to see, if in time of need, counterparties stand ready to absorb the additional market and credit risks from those who would like to shed them."
On June 23, 2005, we cited reports by the FDIC and Fannie Mae indicating that they were indeed aware of the possibility of a housing bust. The FDIC Chief Economist, Richard Brown, said that the 22 major housing markets with the fastest growing prices accounted for 35% of the nation's housing values. He stated, "It's a widespread boom and has macro implications. A slowdown would not only hurt these markets, but the US. as a whole." The FDIC found that 55 of 362 local markets were experiencing a boom and that they accounted for 40% of national residential values. In addition a report from Fannie Mae concluded that the probability of regional housing busts had "risen sharply in certain parts of the country." They found large increases in the number of riskier loans, interest-only loans, or loans not backed by documentation of the borrower's income and assets. They found that about 24% of the subprime loans included in private label securities were adjustable rate mortgages with an interest-only payment provision. Alarmingly, more than 30% of subprime loans were topped with a home equity loan granted at the same time.
So far we have only referred to potential warnings and dangers. But the amazing thing is that even after the potential turned into reality, the stock market continued to rise and the regulators, economists, strategists and media continued to minimize the situation. On August 6, 2006 (The Dangers Ahead) we noted that various mortgage lenders began to go public with their dire problems. H&R Block's subprime lending facility had to set aside $60 million due to borrowers falling behind in payments. Countrywide financial stated that customers were slow in paying their loans. Similar statements were made by Impac Mortgage and Accredited Home Lenders. Washington Mutual revealed that as a result of improper calculations it had made loans to borrowers at lower rates than their personal financial situation justified. The unpaid balance of these borrowers was $30 billion. It didn't take much imagination to realize that these revelations were only the tip of the iceberg and that there was much more to come.
Now remember, the above revelations occurred in August 2006. The stock market kept rising for another 14 months to October 9, 2007. During these 14 months new revelations came out almost daily detailing the full implications of the crisis that was enveloping us. We learned how mortgages were sold and packaged, sliced and diced, and sold all over the world. We learned about an alphabet soup group of securities few had ever heard of before. On February 8, 2007 we cited a Wall Street Journal article stating that "The mortgage market in the U.S. is a complicated web of mutually dependent businesses. Mortgages are bought and sold several times over, and the default risk often lands far from the institution that originated a mortgage." The press was full of announcements of mortgage companies taking huge write-down's and going out of business.
Things got even worse in June 2007 when two big Bear Stearns hedge funds came close to collapse. Despite all this, Wall Street still didn't get it. In August 2007 a guest on financial TV casually referred to all the market turmoil as "financial gamesmanship" as opposed to what he termed "solid economic fundamentals." He was not alone in his thinking as the market rallied for another two months before peaking.
Looking back, the market not only ignored the solid warnings of some very prominent people and institutions, but, even when faced with the reality of events, continued to operate in a state of denial. Now the people who never saw the debacle coming when it was staring them in the face are going to tell us how it happened--but we already know. The major problem now is how we ever get out of it--and nobody knows the answer to that one either. That is why the stock market and housing market (see ISI chart customized for Comstock) has not yet seen a bottom.