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Full Throttle

Posted by Larry Doyle on May 27, 2009 11:28 AM |

To say that we are in the economic fight of our lives would be a gross understatement. While we are feeding ammo into all our weaponry on the main deck, are we remiss in keeping a close eye on what is happening “in the engine room”?

Let’s go into the control room on the main deck and scope things out. On one wing, we see the plans to combat the problems in the commercial real estate market have suffered a setback. Bloomberg reconnaissance provides details: Top Rated Commercial Mortgage Debt May Face Cuts:    

The highest-graded bonds backed by commercial mortgages may be cut by Standard & Poor’s, potentially rendering the securities ineligible for a $1 trillion U.S. program to jumpstart lending. 

As much as 90 percent of so-called super senior commercial- mortgage backed bonds sold in 2007 may be affected as the ratings firm changes how it assesses the debt, New York-based S&P said today in a report. About 25 percent of the bonds sold in 2005, and 60 percent of those sold in 2006 may be cut.

“We believe these transactions are characterized by increasingly more aggressive underwriting than prior vintages,” S&P said. “Furthermore, recent-vintage CMBS, particularly those issued since 2006, were originated during a time of peak rents and values,” and may be more affected by falling rents.

Cutting the ratings would exclude the securities from the Federal Reserve’s program to bolster credit markets by financing the purchase of older commercial real-estate debt. To be eligible for the program, collateral can’t carry a rating below AAA from any rating firm.

This development is a MAJOR setback in our economic battle. An overhang of office space and underperforming real estate properties will be a significant drag not only on earnings for holders of the loans but also on the economies where these properties are located.

On our housing flank, we witnessed yesterday how default rates for mortgages which have been modified, as well as for those that haven’t, continue to move higher.  I inquired yesterday

Are home prices continuing to decline despite the support of a variety of government programs or perhaps because of them? 

I further asserted:

The simple fact is a significant percentage of the loans being modified NEVER should have been written in the first place. Modifying these loans merely forestalls the home from being foreclosed and sold. I do not believe government officials have real appreciation that this forestalled supply actually puts further pressure on housing overall. Why? The market is not being allowed to “clear,” a process in which an asset is moved from weaker hands to stronger hands. To wit, I believe we will continue to see ongoing declines in home values on a going forward basis. 

Today, the WSJ unequivocally agrees and states as much in a lead editorial, Foregone Foreclosures

The reasons for the high redefault rate aren’t surprising. Many of the borrowers never could afford these homes in the first place, yet the political pressure has been strong to modify loans even for these borrowers. As home prices continue to fall in some markets, borrowers remain underwater and many of them simply walk away from the home and thus redefault.

This study has to come as a blow to the Federal Deposit Insurance Corporation, which has invested a great deal of political capital in the modification thesis. It also means that to the extent that public money has guaranteed any of these loan modifications, the taxpayer will be an even bigger loser. Banks don’t like to foreclose on borrowers, so the best public policy was always voluntary renegotiation. As for the housing market, the quickest way to begin a recovery is to more quickly let prices find a bottom. On the evidence so far, the mortgage modification fervor has been a giant political exercise with little impact on housing prices.

While these commercial anad residential battles are being waged, the automotive engagement is a foregone conclusion: Uncle Sam is in the car business and will take an approximate 70% stake in General Motors. The WSJ charts this repartee: GM-Union Deal Raises U.S. Stake.   

With all of this activity going on above board, in my opinion, the biggest battle is actually occurring in our engine room. Under Big Ben Bernanke’s watch, we are literally flooding our engines with fuel. How so? The gas provided by a Fed Funds rate left at near 0% for a foreseeable future. Bloomberg again sheds light on this “development” in the engine room, and reports: Fed Funds Rate May Be Near Zero For Years.  

What is the risk implicit in that policy? Our engines, engine room, and literally our entire ship may be flooded in fuel. What does that mean? Hyperinflation. Noted financier, Marc Faber, looks through the smoke of our daily skirmishes and onto the horizon and offers a daunting forecast. Bloomberg reports, U.S. Inflation To Approach Zimbabwe Level

The U.S. economy will enter “hyperinflation” approaching the levels in Zimbabwe because the Federal Reserve will be reluctant to raise interest rates, investor Marc Faber said.

Prices may increase at rates “close to” Zimbabwe’s gains, Faber said in an interview with Bloomberg Television in Hong Kong. Zimbabwe’s inflation rate reached 231 million percent in July, the last annual rate published by the statistics office.

“I am 100 percent sure that the U.S. will go into hyperinflation,” Faber said. “The problem with government debt growing so much is that when the time will come and the Fed should increase interest rates, they will be very reluctant to do so and so inflation will start to accelerate.”

Maybe we would have been better off utilizing a number of submarines, some well placed PT-boats, and a battalion of Navy SEALS.


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