If you haven’t noticed, Wall Street is having a bad week.  It would seem that the reality on Main Street is finally catching up to the Wall Street casino.  Many Americans are only starting to pay attention to the economy.  Why is this happening?  What went wrong?  To be honest, the current financial system is a mixture of loan sharking and legitimizing a Ponzi scheme as a true and stable system.  Think how idiotic some of the new financial innovations are.  If you are wondering why A.I.G. was bailed out it is because it would expose the world to a balance sheet that is completely exposed with these new products.  You can add Bears Stears, Fannie Mae and Freddie Mac, and AIG to the now growing list of bailouts.

Let us simplify one aspect of this economic mess.  You sell an insurance policy to your friend that should Generic X company go into default, he will receive $1 million.  Your friend fearful of shady Generic X corporation decides to invest in the place (moral hazard time!) and would have not ventured to do so if he did not have insurance.  Feeling confident he invests and, life goes on.  Well as it turns out, Generic X is a very funny institution.  It turns out they were giving loans to burger flippers for nice $500,000 McMansions.  Generic X suddenly goes into a tailspin and defaults since those housing loans are defaulting in massive numbers.  Your friend gives you a ring to redeem his policy and the conversation goes as follows:

“Hey buddy.  It looks like I’m going to need that $1 million since Generic X just bit the dust.”

“Really?  Wow.  Didn’t see that coming.  Funny story.  Remember when I sold you that insurance?  Well, as it turns out we weren’t really betting on Generic X failing so we never really had the money.”

“Say what?  But isn’t that why we bought insurance?  To protect against a loss?”

“Yeah.  We sort of thought the same thing and bought insurance from Crapco Insurance and as it turns out, they were betting that Generic X wouldn’t fail either.”

“So what are you telling me?”

“We don’t have the money.”

“So what am I suppose to do with this policy?”

“I don’t know.  But I heard the Fed is exchanging all kinds of things for Treasuries so you might want to give the head guy over there a call.  I think his name is Ben Bernanke.”

Call it what you want but this is a Ponzi scheme.  Ponzi schemes pay old members with new member money acting as if they were really investing.  Things go well so long as you can keep finding new members (i.e., housing prices keep going up).  But once your momentum catches up with you (i.e., prices reveres) the entire system comes crashing down imploding on itself.

In this article we are going to talk about 3 major economic stories.  Given the massive amount of news, anyone trying to make sense of the current economy and attempting to follow all the headlines must feel like drinking water out of a financial fire hydrant.  We are going to examine WaMu and their current problems.  We are also going to look at the banking system and problems that we will face.  Finally, we’ll tackle the Southern California housing numbers that put a massive Viagraless exclamation mark to a summer selling season.

Whoo Hoo!

Washington Mutual, the nation’s largest thrift has now put itself up for sale with the help of Goldman Sachs.  Has anyone taken a look at these two companies recently?  You have to wonder if someone else needs to find someone to help in a sale:

You may be thinking that WaMu with a $3.4 billion market cap is cheap.  You want to know why people are balking at this sale?  How about having $239 billion in outstanding loans with $52.9 billion in Option ARMs!  The same toxic brew that is sitting here in California waiting to unleash the next leg in the housing market.  We have $300 billion in option ARMs here in the state waiting to recast or hit anniversary dates on a state that has arguably one of the worst housing markets in the country.  You want to know where those $52.9 billion in Option ARMs are sitting?

$26.3 billion are in California and $6.8 billion in Florida.  Now you can understand why that $3.4 billion market cap isn’t so cheap anymore.  In addition, WaMu has a ridiculously large home equity portfolio which is another negative:

Yet another strike.  But you may be thinking that those option ARMs are doing okay.  Wrong:

The Option ARM portfolio is seeing exponential growth in defaults and late payments.  Any company seeking to buy WaMu would be absolutely insane to do so with such high exposure to the most toxic of mortgages.  The only way a sane deal would get done is if the Fed or U.S. Treasury somehow allow only the good to be sold off like the residential component while shipping this sludge onto the U.S. taxpayer.  Take a look at some of the Real Homes of Genius in California, many that were purchased with exotic mortgages and ask yourself if you want your tax dollars at risk for this.

Make no mistake, a failure of WaMu would be enormous.  IndyMac Bank, another model of responsible lending when it got taken over by the FDIC had $32 billion in total assets.  This little bailout cost the FDIC $8.9 billion which ate up about 17% of their insurance fund.  How much in assets does WaMu have?  How about $309 billion with $239 billion of that being loans.  Either way, someone is going to pay.

8,430 Commercial Banks – Many are Unsound

According to the FDIC as of August 22, 2008 there were 8,430 FDIC-insured commercial banks in the United States.  As of this year, 11 have already failed:

Keep in mind that the list of troubled banks put out by the FDIC jumped to 117 from 90 this past quarter.  Even by their own admission, they stated that they did not see IndyMac Bank coming and this one failure cost more than all the other 10 combined!  Given that many of these banks lent money out in a similar fashion as WaMu did, it is almost a certainty that many more will be failing.  Why?  Well once you see the Southern California housing numbers you will understand why.

The financial sector for a very long time was only about 5 percent of the economy.  Now, it is estimated to be about 25 percent.  I’ve argued that since 2000 over 30 percent of all job growth was somehow related to real estate.  Many of these bank failures will add to further unemployment.  WaMu alone has 43,000+ employees.  Lehman Brothers had 26,000.  What do you think this is going to do to the unemployment numbers?  Just take a quick look at some of the banking and financial stocks and you’ll quickly realized that many of these people will not be absorbed into the economy.  Good high paying jobs.  Yes, much of it depended on the casino like world of Wall Street and the delusional accolades of the housing bubble but this still doesn’t answer the employment question.

Many of these banks are capital impaired.  They have “assets” in the form of loans but in terms of capital, are very poor.  They have been overly generous in estimating the value of their assets and that is one reason why the bankruptcy of Lehman Brothers has caused so much chaos.  They dared to look at the Medusa balance sheet and as it turns out, they did turn into stone.  Their worst fears were confirmed.  Why do you think they are doing everything to keep this from happening again?  There are now talks that Morgan Stanley is in chatting it up with Wachovia.  They are doing everything to keep the books closed because we all know what we will find once they are opened up.

Southern California Housing – Pathetic

Only one word can describe the summer selling season for Southern California.  Pathetic.  First let us take a look at the raw numbers:

 

The median price for a Southern California home is now $330,000.  That is off from $500,000 which was reached only one year ago.  That is, $170,000 has been lopped off for the entire region in the space of one year.  And this was during the high volume summer season!  What is going to happen with the slower fall and winter season and we start seeing a much larger number of option ARMs recast into ridiculous payments?

If you look at the sales numbers, you can see that the Inland Empire once again dominated the entire sales activity.  San Bernardino and Riverside made up 33% of all Southern California sales in August.  Foreclosure sales made up 45.5% of all sales.  I know many are going to want to argue that the median price is not a fair reflection since only lower priced distressed properties are pulling the figure lower.  Well when 50% of the sales are distressed properties the market becomes distressed properties.

Sales have jumped up because people are trying to spot a bottom.  Some investors still think that in no time, we’ll be back to the glory days of this decade and they’ll be able to flip these homes.  Have they not been watching what is unfolding on Wall Street?  All you are hearing now is REGULATION.  Meaning, easy access to credit so you can buy homes with zero down are gone.

These numbers are nothing to clamor about and the slight uptick in sales is attributed to the summer selling season and bottom callers jumping in thinking this is it.  This is not it.  I stick by my 10 reasons why California will not see a price bottom until May of 2011.  Everything that is unfolding on Wall Street simply reinforces my thesis.  Let us say prices do bottom out, who is going to buy the place?  California now has one of the nation’s highest unemployment rate and since you have to now verify your income, that $330,000 is actually too high for the median household income of the region which comes in at about $55,000 to $60,000.  $330,000 is still 5 to 6 times the median household income.

I’ve talked to a few people recently and psychologically this is going to be a culture shock.  They know no world where credit is difficult to obtain.  It is a shock that they are receiving letters from their lenders telling them that their home equity line of credit has been shut down.  This is the new reality.  As I discussed in a previous article, the world markets are getting pummeled following our lead.  In Russia they shut down the stock exchange!  Globally there is $75 trillion in real estate, $53 trillion in total GDP, and $675 trillion in derivatives.  You do the math.

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