Here is an easy economic forecast with a high probability of realisation; Venezuela is heading for a calamatious fiscal crisis. It is going to happen the moment that oil prices start to decline. Last year, el jefe and dictator for life – Hugo Chavez – increased public sector expenditure by a staggering 48 percent. Despite the fact that oil prices are at an all time time, oil-producing Venezuela is running fiscal deficit.
The country's stretched finances should come as no surprise. Chavez spared no effort to win another six-year term in office. His generous social programs helped grease the political machine that handed him the presidentcy chair once more. However, the guy is addicted to public expenditure. His spending continues to rise this year even in the absence of elections. Buying elections can be expensive, and it has become a habit. He carries on with it, even after he has effectively abolished parliament and now rules by decree.
The quasi-communist leader who often rails against the "evils of capitalism" spent a record amount and left a 2.28 trillion bolivar ($1.06 billion) gap in the country's finances even in the face of record oil gains. Soon, he will find out that there is an even greater evil that capitalism; it is called fiscal reality.
The arithmetic of the Venezuelan budget is simple enough. Over 53 percent of revenues come from oil. The price of oil is currently around $55 a barrel. So long as it stays there, he will be OK. If it drops off, he starts to slip into trouble. Nevertheless, the economy is starting to show the strains arising from his extravangence. He has also propelled inflation to 17 percent, making it the highest in Latin America. At the current pace, many expect rising prices to top 20 percent this year.
As we know, inflation always hurts the poor. So what he gives in entitlement programs, he takes back with inflation. Viva la revolution!
U.S. Treasury Secretary Henry Paulson has been in China, trying to persuade the communists over there that the US current account, the housing market crash and the subprime catastrophe are actually problems that need a Chinese rather than US policy response. He thinks that if Chinese authorities deepen reforms of financial markets and to let in more foreign investors and investment banks, then the bilateral trade deficit might be resolved. Better Chinese banks will obviously stop Americans from buying crappy Chinese goods at Walmart.
In a 45-minute address to financial executives in Shanghai, Paulson urged Chinese leaders to speed up financial reforms in order to create more balanced economic growth, encourage innovation and make better use of natural resources. He told his skeptical audience that "I don`t know of a single economy in the world with a successful and sustainable well-balanced economy that does not have a strong capital market in place," Actually, he hadn't thought hard enough. The Chinese have been doing just fine without the kind of financial sector reforms that he had in mind.
Paulson also urged China to let foreign companies take majority control of domestic investment banks and asset management companies - where they are currently limited to 33 percent and 49 percent stakes respectively in joint ventures. He said Brazil, Russia and India had all eliminated ownership caps in the securities industry. "Experience demonstrates that the joint venture model does not work in the securities sector because investment banks are difficult to manage and control," he said.
Again, the Chinese experience suggests otherwise.
Medical costs are one of the fastest rising components of the US CPI. With insurance premiums running out of control, many families can no longer afford effective coverage. So why is health care so expensive?
Doctors will tell you that it is litigation, excessive bureaucracy and paperwork and greedy HMO managements. In contrast medical salaries are rarely mentioned as a potential cause.
Well, there is a blog for every subject on the web, and there is even one just devoted to physician's salaries. It contains some amazing posts. For example, can can anyone resist reading a post entitled "the million dollar surgeon".
However, the most revealing post was called "physicians dominate top 50 highest paid list". According to the Bureau of Labor Statistics, a staggering 9 out of the 10 highest paid jobs on the list were found in the health care industry. Here is the list of shame:
1. Surgeons -- $177,690.
2. Anesthesiologists -- $174,240.
3. Obstetricians and Gynecologists -- $171,810.
4. Orthodontists -- $163,410.
5. Oral and Maxillofacial Surgeons -- $160,660.
6. Internists, General -- $156,550.
7. Psychiatrists -- $146,150.
8. Prosthodontists -- $146,080.
9. Family and General Practitioners -- $140,370.
10. Chief Executives -- $139,810.
Alan Greenspan still hasn’t quite realized that he is no longer in charge of US monetary policy. Rather than seeking a quite retirement, he has chosen to stir up controversy., complicating the job of his successor Ben Bernanke. On Tuesday, he told the Bloomberg news agency that there was a “one-third probability” of a US recession this year. Unfortunately, the former Federal Reserve chairman’s comments doesn’t quite rhyme with the upbeat and optimistic assessment of the US economy made by Helicoptor Ben.
Mr Greenspan’s latest remarks come a week after he told investors that he thought a US recession this year was “possible”. The earlier comments destabilized financial markets, leading to a global sell off. Somewhat later, and too late to stop the slide in equity prices, Mr Greenspan clarified his statement, declaring he had said that a recession this year was “possible” but not “probable”. Indeed, all things are possible.
Greenspan on Tuesday told Bloomberg he was “surprised at this recent episode”. He said: “I was aware of the problem that if I stayed public I could make it difficult for Ben. For the most part it has worked. I was beginning to feel quite comfortable that I was fully back to the anonymity I was seeking.”
He said there were signs that the US’s economic expansion was ageing, not unlike the former chairman. “We are in the sixth year of a recovery. Imbalances can emerge as a result,” he said. However, the former chairman declined to link these emerging imbalances with anything he might have done while in charge of the Fed.
When it comes to unsecured debt, the British are the champions of Europe. According to Datamonitor, individuals in the UK have an average of £3,175 ($6,223) unsecured debt, more than double that in the rest of western Europe and now accounts for a third of all personal debt on the continent. Despite these staggering levels of debt, UK banks seem unconcerned about rising levels of personal indebtedness. In recent years, personal bankruptcy in the UK has rocketed (see chart above). Last year, over a 100,000 people entered into Individual Voluntary Arrangements (IVAs) – the British equivalent of personal bankruptcy, forcing lenders to write of £1.4bn of bad debts.
Meanwhile, the total stock of UK mortgages now stands at over £1 trillion; a figure that has risen by over 24 percent compared to last year. Taking mortgage and unsecured debt together, this means that every man, woman and child in the UK owes an average of £21,000 ($41,660). This rising stock mortgage debt has not been accompanied by a similarly rapid rise in personal income. Moneyfacts, the financial information company, said that on average mortgage payments account for 24 percent of people's pre-tax salary today. In 1996, just 16.5 percent of households' salaries went on mortgage repayments. The situation for first-time property buyers, is even more desperate. Mortgage debt accounts for nearly 27 percent of first-time buyers' salary compared to 18 percent in 1996.
Incomes have not kept pace with housing prices. Between 1996 and 2006 the average income for first-time buyers has nearly doubled from £17,308 ($33,924) to £34,216 ($67,063) while average house prices have soared from £64,692 ($126,796) to £211,453 ($414,448). During the same period, the ratio of house prices to incomes have risen from 3.7 to above 6. Yet despite increasing signs of a massive and bloated bubble, house price inflation shows no signs of relenting. Last year, house prices increased by a staggering 9 percent.
Given that UK residents pay around 40 percent in personal taxes, most people are paying almost a half of their personal incomes on mortgage costs. In such circumstances, it is perhaps not surprising that people have resorted to personal unsecured debt to finance consumption expenditure. Nor is it surprising that an increasing number of debt soaked homeowners have resorted to personal bankruptcy.
New Century - one of America’s largest subprime mortgage lenders – is careering towards bankruptcy. The company’s shares are down almost 70 percent, and languishing somewhere south of $5 a share.
As concerns grow about the financial viability of the company, its creditors are taking fright and cutting credit lines. Bear Stearns analysts reduced their estimated liquidation value to $8 to $9 a share, down from $10 to $11 previously and "expect the stock to trade toward this level as the odds of bankruptcy appear to have increased." Creditor confident was shattered after revelations that the company is under investigation for violating debt covenants with several investors.
After years of fat commission selling exotic loans to desperate homebuyers, mortgage brokers are now waking up to the post-bubble reality. The loan officer forum - an industry notice board - tells a sorry tale. Brokers are finding it hard to make a living as increasing sub prime defaults, falling housing demand and tightening credit standards have led to a collapse in mortgage applications.
The opening post says it all:
"As I sit here felling like I just watched a train wreck, I am trying to comprehend everything we just witnessed. This is my 12th year in real estate so I can tell you it will be fine in the end, but wow what a day. Email after Email from lenders telling us of their guide line changes, and the layoffs. This is a lot to take in. So won't you join me and raise your glass to the end of a great ride, and the beginning of a better one."
Yes, the "great ride" is definitely over. The great housing market collapse has only just begun. Subprime lenders are falling like flys, and it is only a matter of time before financal failure infects the entire market.
Check out this cracking post, discussing New Century:
"After watching in disbelief how long the sub-prime ponzi scheme continued to receive the support of regulators, creditors and investors. It's amazing how rapidly New Century's house of cards has come crashing down. All at once:
Regulators are seeking to stop New Century from performing their primary business. Creditors are considering cutting off short term credit to the company. Stock Market Investors are beating the crap out of the stock. Mortgage Backed Security Investors are beating the crap out of their securitizations.
I seriously doubt NEW will survive this attack from all sides. Just as Enron and World Com crumbled when creditors pulled the plug, so too (I expect) will New Century.
Here's a post I made to the Mish board on the Motley Fool on 2/3/05 about New Century.
If you are a Fool member, the link is: http://boards.fool.com/Message.asp?mid=22012317&sort=whole#22020551
Financial Fantasy Land
I listened to the New Century Financial conference call today, and I'm convinced the executives of that company are from another planet. I think most of the analysts who called in would agree with me. They seem to be from a fantasy world where financial results according to GAAP are all that matters, and to the extent they can manipulate earnings, they are able to manipulate the truth.
When the call started, the stock was already down about 3.7%, having missed their estimates for the first time in ages. As the call went on and one amazing revelation after another came out, the stock kept dropping and now is down about 10%. Among the things that were revealed:
1. They borrow $1 Billion for 1 day every quarter so that they can show that Cash on their balance sheet.
The Billion dollars they borrow for a day is to help them "explain" their financial situation better. If they didn't borrow that money, then people might be confused and think they didn't have that much cash. As we all know, the amount of cash you own is of course equal to the amount of money people are willing to loan you. We should thank them for simplifying their accounting for us by borrowing money they don't really need right now and putting it where we can see it on their balance sheet.
2. They sell mortgages to themselves because they can report higher gains on the sales than if they sold them on the open market.
They were especially proud of becoming a REIT and all the imaginary benefits that bestowed on their results. While selling mortgages from their lending unit to their REIT unit resulted in nice gains on their income statement, the gains weren't taxable because they weren't real. Talk about the best of both worlds!
3. They aren't assuming any losses on certain portions of their loan portfolios now because most defaults occur later in the life of the loans.
The business of profiting from making bad loans depends on lending more money each and every quarter. People don't usually buy homes if they are already in deep financial trouble. It takes them awhile to get in trouble, so new loans rarely default. Therefore, new loans don't need to allow for losses because losses won't happen until the future. Since there's no guarantee there will even be a future, what's the point in allowing for such losses anyway?
4. They lowered their assumptions of future defaults which boosted earnings by 8 cents per share, and they now think $90 Million is enough reserves for future defaults on $19 Billion worth of loans.
Sure, some of their loans are delinquent, and while its nice to report late fees on these loans as profits, some allowance should probably be made for the remote possibility that there is a tiny inkling of a chance that they might lose money on these a minute faction of these loans, so it wouldn't do too much harm if they reserved a little bit of money for these loans when earnings are good. If they ever have a need, they can lower their assumptions to inflate their earnings, like they did this quarter.
What's that? All you banking analysts don't think they're setting aside enough reserves? By an order of magnitude? Well, let me assure you that their experience during the last 8 years (the greatest housing boom, HELOC expansion and cash out refinancing surge of all time) indicates that loans almost never go bad. All they have to do is rely on past results to indicate what will happen forever into the future. So obviously you are all wrong!
5. They believe that their customers can handle a 34% increase in mortgage fees on their ARMS. 20% of their loans over the past 2 quarters have been interest only, so obviously their customers understand interest. Besides, they have a lot of customers who actually have decent credit ratings. These types of people know how to budget and plan for the future.
6. They believe that housing prices can't go down by 10% and even if they do, their customers won't walk away from loans.
It's never happened before on a national level, and they say that all the talk about a housing bubble is dying down. Besides, they aren't making any more land and housing prices always go up. Plus, once customers learn to account like New Century, nobody will ever have to lose money again!
7. The compression of margins is temporary.
As rising short term rates crashed head long into falling 10-year bond rates, and as increasing competitiveness among mortgage lenders crashed head long into declining demand, margins were squeezed. But relax, this is temporary. It will only last until the weak links are squeezed out of the market. NEW tried to "lead the way" by raising rates higher, but their competitors didn't follow. When they lowered rates back down again, their competitors lowered rates further. Even though demand for loans is still slowing, and the lenders all depend on increasing originations to avoid blowing up their business models, the pressure on margins must decrease!
8. They can hedge away the risk of rising interest rates.
They buy derivatives that pay off if interest rates rise. If rates rise slowly over time, they get clobbered like CFC did. If rates rise rapidly they get to report a nice short term gain, then buy new derivatives at higher prices. If interest rates rise so quickly that their counterparties can't make their payments, then the housing market is doomed anyway, so there's no point in worrying about that single aspect of a meltdown.
In a sense, the views of the NEW executives typifies what is wrong with our entire financial system. Risk has been imagined away, and the resulting imaginary profits are taken as reality. Level upon level of creditors has leveraged themselves into the false reality that will one day come crashing down. We have:
1. Interest rates at suppressed levels because the Fed has injected record amounts of liquidity and foreign central banks have bought treasuries disproportionately to keep their currencies week, while propping up a US Government that is bound for bankruptcy.
2. We have homeowners borrowing more than they can afford at these temporarily reduced adjustable rates who are bound to default once rising payments and their inability to borrow new funds push them past the breaking point.
3. We have crazed mortgage lenders like NEW, CFC, IFC, NFI and others making bad loans at an accelerating rates to stave off the inevitable.
4. We have mutual and pension funds throwing other people's money at the crazed lenders to purchase exploding corporate bonds.
5. We have hedge funds selling derivatives to soak up interest rate risk in search of short term profits and higher NAV based fees.
In short, we have one domino after the next, all lined up ready to topple once the kindness of foreign governments runs out and the unsustainability of our twin deficits comes home to roost and the fantasy world we live in is exposed. "
Hey! You've won a ride back to the top
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