What is occurring right now is reminiscent of what occurred after the subprime worries of February of 2007 dissipated for a few months. During this time, a few high profile companies such as New Century Financial started showing problems in their subprime portfolios and caused the DOW to drop 415 points. In this timeframe we also had Countrywide come out and state that 40 to 50 subprime units were failing on a daily basis (who would of thought that less than one year later they would be saved by Bank of America, a luxury the smaller outfits didn’t have). It seemed like we were heading much lower. Yet the market bottomed and started up once again nearly unabated until August of 2007. Let us look at the DOW since 2007:

As you can see, from February until August the market rallied. In this period we had many subprime outfits failing and the press on housing was finally starting to get a bit more realistic. Yet the market still rallied. Ben Bernanke issued a statement saying that subprime problems were “contained” and confidence once again was boosted. That is until the credit markets seized up in August. You have to love some of the quotes being said at this time and during the bubble euphoria. The reason I bring this up is that technically it looks like we are having a bear market rally like the one we saw after the February news abated. The only difference this time is that people on the street are having a hard time reconciling good news on Wall Street with their own bottom line. If they are to watch CNBC they must feel like they live in an alternate reality. Is energy not at all time highs? Housing prices are still going down. Food prices are still increasing. What reality are they living in? Before the credit crunch of August, the minor downturn in February of 2007 seemed like a temporary dip for Joe and Susie Public.

Let us now look at some history of previous U.S. recessions:

Recession	Duration	Worst Quarter
Jan – July 1980	6 months	-7.8
July 81 – Nov 82	16 months	-6.4
July 90 – March 91	8 months	-3
March 2001 – Nov 2001	8 months	-1.4

The reality is that we are in a recession that most likely started in December or January. Of course we won’t know officially until we have quarterly GDP data but I think if you ask any person on the street, they can easily tell you that the economy is contracting in some form. Just look at state budgets. If you look at the above, it seems that the pattern for quarterly downturns has diminished as time goes by. We also see this effect with CPI information. My take on this is that so much of the government data unfortunately does not reflect the expectations of what the average American is living. For example, how is it possible not to include actual energy and food costs in the CPI? Or what about using owners equivalent of rent instead of mortgage payments? You also get the unbelievable data spinning regarding not counting those not looking for work in unemployment data because they’ve given up. Pretty soon, we’ll have zero percent inflation and no unemployment yet people won’t be working and everything will cost more. And you wonder why there is so much confusion out there.

Let us look at one indicator that reflects market distress, monthly foreclosure filings:

*Click to enlarge.

The trend is clearly moving up and we are still hovering around record rates. And this in light of every imaginable concoction of bailouts including the Hope Now Alliance and others that are now waiting in the pipeline. Advance talks are now on their way about the government purchasing bad mortgages; interesting how the government isn’t looking to purchase good mortgages. We also know that the market’s current rally isn’t based on economic fundamentals but on recent historical rate cuts and the bailing out of a Wall Street Investment firm, Bear Stearns.

It seems like everyone is wiping the sweat from their forehead and saying, “that was a close one! If it weren’t for the government we’d be running around in leotards like cavemen.” How ironic that a firm like JP Morgan and Chase took on a $30 billion non-recourse loan from the Fed to bailout Bear Stearns. Let me ask you this, a company such as JP Morgan with a market capitalization of $161 billion, why in the world did they need that non-recourse loan? In fact, they have $123 billion in equity on their balance sheet. So tell me again why they “needed” the $30 billion from the Fed? Many that are bellowing out a sigh of relief fail to realize that the main culprit of this mess, the housing market, is still fundamentally in a major correction. All that has been done is a prolonging of the inevitable correction. Except now, the government is taking ownership of more and more of the toxic mortgages. The more time that goes by, the more shoveling of bad debt will the public be eating. Let us take a look at the jumbo market for the 1^st half of 2007 before caps were raised:

As you can see, the purpose of raising caps was to shift risk from one side of the private balance sheet onto the public domain, most likely by Fannie Mae and Freddie Mac. Given, that most of these new conforming jumbo products that started this month are not interest only or Option ARMs, but how risky will these new loan products be? We keep hearing how well conforming loans have done in this housing crisis and how poorly large toxic jumbo products have done so now instead of stopping these horrible products cold, we have now institutionalized them? Forget about all this temporary rhetoric. When has anything been temporary with government? Also, the reason the conforming loan portfolios have done better is because they, uh conformed to standards! Now, we’ll just arbitrarily lift caps to $729,500 and come what may.

If you want proof of this parallel universe, today’s home sales number says it all:

“Home sales rise on biggest-ever price drop

NEW YORK (CNNMoney.com) — A record plunge in prices of existing homes produced only a modest increase in sales in February, according to the latest reading on the battered housing market by an industry trade group released Monday.

The National Association of Realtors reported that sales by homeowners rose 2.9% in February to a seasonally adjusted annual pace of 5.03 million, up from January’s reading of 4.89 million. It was the first month-over-month rise of the annualized pace since July.

The median price of a home sold during the month fell 8.2% to $195,900 from $213,500 a year earlier – the largest year-over-year price drop on record. Before the start of the current housing slump, it had been 11 years since prices declined, when compared with the same period a year earlier.”

Of course the market is taking this as good news but a drop in prices will again hurt the bottom line of builders and sellers. This is good news however for future home buyers. The issue was never about whether owning a home is a good investment. It was about prices becoming dislocated from local area economic fundamentals. The fact that sales rose because prices dropped tells you something. People need to drop prices and sales will come! Is it really that hard to understand? No need for bazooka loan products or Wizard of Oz bailouts since all that is needed is for home prices to reflect market fundamentals. Yes I know, too big to fail right? The fear of plunging into the Alice in Wonderland debt rabbit hole. Many are still in withdrawal and are hoping that the credit dope of interest only and Option ARM mortgages will once again rear their ugly heads. Not likely. Prices will continue to come down and as they do, sales will slowly start to pick up. Eventually both universes will cross and stay on one single path.

Update:  The Case-Shiller 20-City Index shows a year over year drop in housing of a record 10.7 percent.  Also, Consumer Confidence dropped from 76.4 in February to 64.5 in March.  Again, this simply points to the major disconnect from Wall Street to Main Street.

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