I find the following article relevant in advocating why there is only ONE solution to get the whole world out of the mess created by the US sub-prime collapse, and it's not whether the Fed should cut the rate, or provide a life boat for the mortgagees, or whatever.
That one thing is certain: for these sub-prime mortgagees (especially those who opted for the "2-year low fixed interest rate followed by variable rates thereafter), the rates will rise between now and 2008 (since the peak of these mortgages happened in 2006). So, things will only get worse in 2008.
What happens when mortgage rates double? Even assuming a steady job and moderate wage rise, the repayments will balloon, putting a strain on disposable income.
But with all the outsourcing (especially the high value-added jobs to "cheaper-cost" countries like Singapore (where I come from), China, India and numerous South-East Asian countries, as the attached article shows), more Americans face ever gloomier job cuts.
Therefore, there is only one way out: ensure more Americans are gainfully employed (the US government should create more high value-added jobs for its own citizens).
With jobs => disposable income => consumer spending => vibrant economy
And Americans are in a very good position to let their votes decide how the Democrats or Republicans should go about doing it this coming presidential elections.
During the Asian financial crisis of 1997, American consumers came to our (Asia's) rescue.
Now, 10 years later, the Americans are in trouble with China assuming greater economic power and capacity to help the Americans. But will they?
Being a Chinese living in Singapore, I am doubtful - for the simple reason the Chinese (whether in China or Singapore or Taiwan) by nature are very self-centred (generally, although there are many altruistic Chinese around). And they are also very materialistic, so to get them to "help", their response will likely be, "What's in it for me?".
Therefore, don't count on China to come to the Americans' rescue: the Americans will have to help themselves.
Will we see the end of globalization with protectionism rearing its ugly head again? In Singapore, the deprived citizens keep saying, "Jobs (benefits) for foreigners, national service or draft (sacrifices) for citizens". Any government worth its salt will ensure its citizens are gainfully employed.
To ensure survival (of country and presidency), the next US president may well do that if there's no other choice or way out!
What about us in Singapore? Of course, our government will push for globalization and not protectionism, but we are too small to make any difference. We need the USA and China more than they need us.
Singapore, 8 August 2007 (eve of our "Independence Day")
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http://globaleconomicanalysis.blogspot.com/2007/08/will-rate-cuts-save-economy.htmlMonday, August 06, 2007
Read the July 2007 Sitka Pacific letter to clients.Will Rate Cuts Save The Economy?The question of the day is "Will interests rate cut by the Fed save housing and the economy?"Jim Cramer Says "Yes"Jim Cramer's opinion can be seen in
Financial TV host flips out over the state of the economy.
(click on the above link to see Cramer in action)But the answer is "No".So we've seen what Cramer has to say, let's take a serious look at whether Fed rate cuts will save the economy and why I believe the answer must be "no".The first reason is that long term rates (the 10 year treasury), simply may not decline when the Fed starts cutting. Does anyone remember "Greenspan's Conundrum"? If not, Greenspan was perplexed as to why long term rates did not rise much as a series of 17 consecutive rate hikes by the Fed were made. On that basis it is therefore entirely possible that when the Fed starts cutting (and they will), that long term treasury rates may not follow. Clever readers will now be asking "Wait a second Mish, you said may and now you are presuming will. What gives?"That brings up reason number two. Everyone knows Mortgage rates are directly tied to the 10 year treasury note. Or are they? I have been stating for well over a year that mortgage rates would disconnect from the 10 year treasury note. Some have laughed at me for that viewpoint. But my reason was simple: increasing default risk would eventually force it.While the "Reverse Conundrum Hypothesis" is indeed just that (it may or may not happen and now I think that it won't but it could), the 10 yr vs. mortgage rate disconnect is no longer a theory. Eventually has arrived. The disconnect is now well underway. It started in June and has blown wide open in the last two weeks. Yes, I have proof.Consider the following chart of treasury yields for the past 12 months.$TNX - Treasury Yields
(click on any chart for a crisper view)The above chart shows all the major rallies and declines in the 10 yr treasury over the past year in basis points.Bankrate.com 30 year fixed mortgage rates
(basis points are approximate given chart scales)Major Moves: Treasuries vs. 30 yr Fixed Mortgages32 basis points vs. 20 basis points44 basis points vs. 37 basis points43 basis points vs. 22 basis points84 basis points vs. 74 basis points60 basis points vs. 13 basis pointsLook at those last two data points closely.An 84 basis point rally in the 10 year led to a 74 basis point hike in mortgage rates.On the subsequent decline of 60 basis points only 13 were picked up in mortgage rates.But it's not even that good. Not even close.Bankrate.com 30 year fixed mortgage rate Jumbos
Jumbo rates went UP even with that substantial rally in treasuries.Bankrate.com 5/1 ARMs
5/1 Arms are similar to 30 year fixed but.... for all the additional risk, the consumer is saving a mere 25 basis points.All of the above charts are for Prime Loans, with good credit scores, and a down payment. Inquiring minds are no doubt wondering what happens in other conditions.Major Disconnect in SubprimeLate last Friday I gave a call to Dave Donhoff at
No Bull Mortgage and was wondering about subprime and Alt-A, and how they were affected by these treasury gyrations. Before I go further, let me say that Dave is one of the good guys. He has not had a single returned loan or foreclosure on one of his customers in the last 6 years. Although Dave has not been tracking exactly what I wanted he did offer this:
Almost all stated income loans everywhere vanished last Friday.
Almost all 2/28 ARMs vanished last Friday.
While this was eventually expected it was not expected by everyone overnight.As we were talking I was fortunate that a representative of major mortgage lender who had a scheduled appointment stopped by to see Dave. That person agreed to talk to me on condition anonymity so I will honor the request. But here is what I found out from that major lending insider.
Subprime rates have risen by as much as 190 basis points at his organization in just the last 2 weeks!
Many other lending institutions have done the same thing.
The definition of prime has tightened considerably, everywhere.
Any variance from prime raises the mortgage rate.
Small differences in FICO score now matter (sometimes by a lot).
Every little thing adds up.
90% LTV rates are higher than 85% LTV rates which are higher than 80% LTV rates.
100% LTV rates are very difficult to come for subprime and even Alt-A.
Condos vs. homes matters significantly.
There were 3 rate increases in the last 2 weeks even as 10 year treasury rates rallied.
Second mortgages have nearly vanished - no market.
2/28 arms - gone.
Someone who is "really clean" but is not prime (but close) and is putting down 20% has had a 70-80 basis point hike in the last 2 weeks.
The bankrate charts might not show it, but in the last two weeks nearly every loan rate went up even as treasuries rallied significantly. The primest of prime was perhaps flat.A 190 basis point hike in two weeks was so shocking that I asked for a repeat. "90?" I asked. "No. that's 190 basis points" came the reply. For those not familiar with the term basis points, 100 basis points is a 1% rise in the loan rate. For example, 190 basis points would send a mortgage loan from 7% to 8.9%. The bigger the loan the bigger the increase in monthly payments (ouch!)Virtually any subprime borrower whose arm is due to reset later this year or early next year and has not yet rolled over the loan is obviously in deep trouble regardless of what the Fed does or does not do. Not only is the teaser rate itself going to rise dramatically because of the rising treasury rates, the risk component has risen as much as 190 basis points in addition to that.Furthermore, anyone in a stated income loan, anyone with a second mortgage, anyone in a pay option arm, or anyone in a 2/28 is now locked out of all those options. (Please see
Locked Out for more on what's happening through the eyes of Bankrate.com). And finally, as Dave Donhoff put it to me, "Many buyers are discovering there is a difference between quoted rates and actual availability of funding at those rates".Let's Assume A MiracleBut let's assume a miracle. Let's assume that the Fed cuts rates 100 basis points in a surprise move on the advice of Cramer, interest rate spreads plunge, there is no treasury/mortgage rate disconnect, the 10 year treasury rate drops significantly, mortgage rates follow the 10 year rate lower, fixed rate mortgages at reasonable rates are offered to everyone regardless of credit risk, and the US dollar does not blow up in response. Wow. Nonetheless, let's assume that Miracles R Us grants all that as a single miracle request. Unfortunately there are still two sticky questions to resolve.Sticky Questions1) Is the consumer out of the woods?2) Is the economy out of the woods?The answer to both questions is still no. Remember that foreclosures are massively rising even though the bulk of interest rates resets is still upcoming. Many of those teaser rates were put in place as the Fed slashed rates to 1%. Cramer simply did not ask for enough.Consumers need not only lower rates, but the initial teaser rates they had (if not even lower). So let's assume still another miracle: mortgage rates reset at the prior teaser rate lows regardless of risk, negative amortization, or worsening FICO scores of the applicants. That's asking a hell of a lot more of Miracles R Us but the Miracle Fairy heard my telepathic plea and returned my call on the Miracles R Us Miracle Hotline. I was told that both miracles would be granted if I could honestly assure them that it would solve all the problems.Sadly, I had to inform Miracles R Us the honest truth: Still more miracles on top of those miracles would be needed. With that, Miracles R Us issued me an MDT (Miracle Denied Ticket) and told me I could apply again in six to twelve months.The Miracle Fairy went on to explain the reason for denial: "We are swamped with requests but the Ministry of Miracle's Magic Miracle Bucket (MMMMB) is severely depleted and massively underfunded at this time. Even we Miracle Fairies at Miracles R Us are affected by liquidity issues, and it's the worst possible time too, with so many miracle requests pouring in. We suspect there was a leak in our Miracle Bucket raining unwarranted miracles over the populace for the last four years. We are now officially in MRM (Miracle Rationing Mode)" and your request is simply too big.With that explanation, the Miracle Hotline was abruptly terminated. I had more questions to ask the Miracle Fairy but they remain unanswered. Given how busy the Miracle Fairy is I am rather pleased she took the initial call.Inquiring minds are no doubt asking why I told the Miracle Fairy that more miracles would be needed. The reasons center around debt servicing and jobs. There is simply no pent up demand for housing, no growth in wages, and no way cash strapped consumers can service current debt loads. There is also no source of jobs that an overheated housing market created. There is no need for more Home Depots, Lowes, Pizza Huts, Applebees, nail salons, strip malls, Walmarts, etc etc. In fact there is a need for less stores not more and the coming consumer led recession will prove it. Overcapacity is simply rampant. It would take even more miracles to correct all of that.Is there pent up consumer demand in anything? If there is, why is Walmart slashing prices on 16,000 items smack in the face of rising energy prices? (Please see
Price Wars for an explanation). July had the worst decline in US auto sales in years. Is a rate cut supposed to cure that?The jobs picture is weak and hiring is not even keeping up with the birth rate plus immigration as explained in
Martian Economists and BLS Moonbats. And unless more miracles are granted, this is the end of the line for unnecessary corporate expansion. But please don't blame me, I'm just the messenger. Take it up with Miracles R Us.Oh sure, Starbucks will add another 15,000 stores or whatever (perhaps) but will they be in the US or China or India? So where is the replacement for US jobs that housing provided supposed to come from?Corporate Profits Have PeakedThe merger mania, buyout bingo, CDO, and LBO parties each went on longer than anyone expected. But the parties are now clearly over. And all of those parties added enormous up-front profits to the pockets of broker dealers like Merrill Lynch, Goldman Sachs, Lehman, and scores of hedge funds.It took about a year longer than expected for subprime to blow up. But Lenders are now blowing up in a magnificent display of fireworks. The
Mortgage Lender Implode-O-Meter is at 109 as I type, and more implosions are added every week. By the way, Implode-O-Meter is being sued and a summary judgment to dismiss the lawsuit was tossed. For more information please see
Judge Franklin R. Taft Denies Ml-Implode Motion To Strike via Anti-SLAPP.Expect far fewer stock buybacks on borrowed money, far fewer leveraged buyouts and tighter lending conditions all across the board regardless of what the Fed does or does not do. And we still have not seen enough write downs related to subprime slime. Of $565 billion in subprime loans made in 2005-2006 (the worst years), a mere 2-3% of that has been downgraded by the chickens and sheep at Moody's, Fitch, and the S&P. See
Thoughts on Moody's "Tough Stance" for how Moody's is attempting to play the victim in this mess when in fact they are a big part of the problem.Although the asset side of the balance sheet seems pretty good, it is a complete illusion. The debt side of the balance sheet has never been greater. When assets take a hit (and they will), the debt will still be there acting like an anchor for years to come and/or until massive bankruptcies wipe that debt off the face of the earth.No matter how one twists and turns, logic dictates that several major miracles as well as massive positive assumptions about those miracles would still not be enough to revive either housing or this economy.The problems we are facing now are a direct result of too loose a monetary policy at the Fed. Slashing interest rates to 1% cannot be the cure if slashing interest rates to 1% was the problem. Careful analysis thus shows that Cramer is making the same basic mistake as Greenspan and Bernanke.Some are slower than others, but by now everyone (including Cramer and the Fed) should be realizing that it was the Fed's miracle financing that caused the corporate malinvestments, overcapacity, and consumer debt hangover problems we now face. Miracle financing caused the problems, so miracle financing sure won't be the cure. The miracles have now run out and the party is over regardless of what the Fed does or does not do. It's as simple as that.Mike Shedlock / Mishhttp://globaleconomicanalysis.blogspot.com/
Posted by Michael Shedlock at 10:16 AM
Will Rate Cuts Save The Economy? digg_url = 'http://globaleconomicanalysis.blogspot.com/2007/08/will-rate-cuts-save-economy.html';
