Economy, Housing Bubble, Credit Crunch and Stock Market
Last month, we experienced large number of mortgage resets. The foreclosure rate doubled year over year. All the major banks and financial institutions have reported bad earnings led by both Citigroup and Merrill Lynch, which have no less than $8 billion write-down. This is just the beginning. As Jim Cramer has pointed out
A large group of people, 50% of the 14 million homebuyers, are going to default on their “2 and 28″ adjusted-rate mortgages now that they are being reset. Many of these people paid for the 2% with home equity loans that they can’t pay back.
I am just hoping that things stop at $500 billion. The only hope is 2%-3% refinancing, which can be had if the Fed cuts rates to 3%. Otherwise we have $500 billion in losses.
I believe the Fed kind of gets this Armageddon for homeowners of the 2005-07 vintage. Remember, despite misstatements to the contrary, my “rant” in August on CNBC was about the 7 million homeowners who are soon to be renters.
I believe that’s what’s going to happen, regardless of the Fed. But aggressive cutting could spare those who are reset from the beginning of 2007.
People might have different opinions on the number. For example, CNBC Squawk Box mentioned 2 million foreclosures instead of 7 million. Given 70 million first home owners country wide, we are seeing 0.3% to 1% home owners that are forced to foreclose their house, which is really wide spread. The latest Business Week mentioned that in the next 2 years, 1.2 trillion mortgage loans will be reset. We are still on the verge of the biggest real estate slide in the history ever.
When facing foreclosure, people don’t have a lot of choices. They could pile up debts on their credit cards, which pull credit card companies into the swamp. They could file Chapter 13 Bankruptcy to protect the ownership of their houses, which worsen the financial situation of mortgage lenders. They could also simply return the house to their banks, which further devastate the housing market. Obviously, none of the solutions would have positive impact on the financial industry.
What could most likely happen is that Feds will cut the interest rate and to maintain the rate as low as inflation doesn’t severely impact consumer confidence. Given so many mortgage defaults and foreclosures, consumer spending will slow down. Even without housing bubble bust, consumer spending might still slow down since nobody can keep buying computers, clothes, and refrigerators, all the time. Economy is cyclic. Lower interest rate means weak dollar, which boosts exports significantly. Government needs to further change the policy to welcome foreign tourists spend their money in US. Last but not least, financial institutions need to build strategic partnership with foreign banks for survival, which needs to be sooner than later.
Stock market might do OK at least until the beginning of next year. Again, I cite what Jim has said
Why aren’t I more concerned (about stock market)? Because of the monster rally we had after the country wiped out the S&L industry.
One days like Thursday (Nov. 1, 2007), people always are skeptical of my bullish view, because 20% of the market is finance. I always come back with two things: one, that 20% is going to shrink considerably in this downturn, and two, the rest of the market ex-housing and retail is a big enough playground that you can make money.
The second paragraph is quoted from Cramer on BloggingStocks: Fed has grounds to cut to zero.
Retail is still very strong. PC sale is predicted to increase another 15% this quarter. Amazon’s revenue is growing 40% year over year. Microsoft had fantastic quarter on its game sector. People are paying higher price on eBay for good products. Finally, don’t forget Apple and its iPod/iPhone product family. Once Bernanke gets his job done, stock market will have a good run!
