http://www.financialsense.com/fsu/editorials/willie/2007/0713.htmlCollateralized Debt Obligations are the CDO bonds under fire, soon to suffer huge losses, subject of debt downgrades, object of failed auctions. We are talking about hundreds of billion$ in bond losses. A vicious circle has begun, sure to continue for a length of time ten times greater than what is expected, like into 2010. Home values are on the decline, the basis collateral for such asset-backed bonds, some of which hold car loan portfolios also in trouble. Homeowner defaults are on the decline, the basis income for such asset-backed bonds. The foreclosure process will aggravate the already swollen supply of homes. Hedge fund collapse will aggravate the already shaky supply of CDO & mortgage bonds. This is a worst case scenario unfolding on a horrific scale.
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COMPOUND DAMAGE ORGY (CDO)
by Jim Willie CB
July 13, 2007
Collateralized Debt Obligations are the CDO bonds under fire, soon to suffer huge losses, subject of debt downgrades, object of failed auctions. We are talking about hundreds of billion$ in bond losses. A vicious circle has begun, sure to continue for a length of time ten times greater than what is expected, like into 2010. Home values are on the decline, the basis collateral for such asset-backed bonds, some of which hold car loan portfolios also in trouble. Homeowner defaults are on the decline, the basis income for such asset-backed bonds. The foreclosure process will aggravate the already swollen supply of homes. Hedge fund collapse will aggravate the already shaky supply of CDO & mortgage bonds. This is a worst case scenario unfolding on a horrific scale.
Mortgage rates will continue to be reset upward for two more years, a process not ended. The Bear Stearns & Merrill Lynch failed bond auction kicked off the process, described in an article last week. The process continued this week with two blocks of debt downgrades by the sleep debt ratings agencies, Standard & Poor and Moodys. The next painful phase will feature huge portfolio writedowns, reduced bond valuations on the balance sheets, in addition to forced bond sales as billion$ in CDO and mortgage bonds are rendered no longer investment grade. Imagine throwing gasoline on the fire This vicious circle can be outlined loosely.
The backdrop includes a USGovt with mindboggling federal deficits, aggravated by outsized ongoing war costs. The honest annual deficit is of the order $1300 billion, when all the costs and illicit borrowing is tallied, like the off-budget items. My forecast made last year was that by 2007, it would be painfully clear that the weakest national economy on the planet would be in the United States. WE HAVE PRECISELY THAT. For three years, nitwit economic pundits and heretical bank officials boasted that the USEconomy was a viable legitimate ‘Asset Economy’ which was fueled by the engine of assets like housing. For three years, the same incompetent policy makers were justifying the ‘Macro Economy’ whose credit supply was fueled by Asian and OPEC trade surpluses. Now both economic tenets have been smashed, revealed as empty, each disguised Economic Mythology nonsense. The housing crisis and mortgage debacle are in full swing, worsening each month.
The Asians outside China do not support USTreasury Bonds at all anymore. The Persian Gulf nations are in the gradual process of dismantling the tight US$ peg, the essence of the Petro-Dollar defacto standard. So as the USEconomy and US bond sector are under siege, the USDollar and USTBond are also under siege. Even with no monetary action in a rate hike by the Euro Central Bank this week, the euro currency is pushing into record territory. The British did hike rates, and the pound sterling is also in record territory. A USDollar crisis is unfolding. New Dow index and S&P index highs only reflect preserved purchasing power in stocks, compensating for the lower USDollar. Monetary inflation is running at over 13% in US$ money supply, the real concept of inflation, matched by crazy levels of money growth in Europe and England. We are in Weimar times! As distress broadens and depends, expect even higher money growth!
Here is a list of events, which will continue to occur, continue to wreck havoc, and suffer a repetitive process until official bailout, and probably past that eventual certain event. This list will cycle over and over, in a vicious feedback loop and continual pathogenesis. England is subject to a similar vicious circle. The breakdown will succumb to additional systemic weakness and debilitation. The strength of many factors is growing, not lessening, sure to amplify the power of damaging forces. Talk of a housing recovery, sector stability, lack of contagion, and assured containment will all be replaced by questions of when the destructive process will end, how low will housing prices go, how deep the bond losses will be, and what arenas might be spared. This is a systemic contagion of absolute proportions, in the great housing & bond bust. One could have written this script years ago, since the bust is always inevitable.
All reference below of bonds is to asset-backed bonds, both the dominant mortgage bonds underlying and the packages of CDO bonds, which contain an assortment of securities of various levels of credit quality. Each mortgage bond is rated highest as ‘AAA’ or subprime at ‘BBB’ with shades in between. The CDO bonds include credit default swaps (insurance for mortgage portfolios), swap options, interest rate swaps (balance short-term & long-term yields), USTBond futures contracts (hedge on rates generally), and so on. These powerful factors are discussed and analyzed in the July issue of the Hat Trick Letter. The order can be rearranged, since so much occurs simultaneously.
THE CYCLE OF REPEATING FACTORS:
1) failed auctions and unsatisfactory public sales of asset-backed bonds
2) debate on value in illiquid opaque markets, driven by models
3) rating agency debt security downgrades
4) forced sale of bonds which lose investment grade status
5) huge writeoffs on balance sheets holding bonds
6) compensatory sales of other bonds to improve debt ratios
7) downgrade of ‘AAA’ rated bonds from falling home collateral assets
8) available mortgage funds reduced from collateral sales
9) continued bankruptcy of lending institutions
10) inevitable bankruptcy of a major bank and many home builders
11) return of bonds to broker dealer issuers for non-performance or fraud
12) lawsuits against lenders for predatory practices, misrepresentation
13) Congressional action to clarify liability from fraud and predatory practices
14) hedge fund failure, credit disposition, liquidation of bonds
15) falling housing prices, pressured by heavy unsold home inventory
16) mortgage rates reset upward, ending initial bargains
17) rising mortgage defaults, delinquencies, and foreclosures
18) bankers return foreclosed properties to the market for sale
19) mortgage bonds fail to perform on income from monthly payments
20) base long-term interest rates rise from market conditions
21) tighter lending standards, big pre-payment penalties inhibit refinances
22) stronger homeowners decide to sell so as to avoid going underwater in equity
23) state legislation to attempt to protect homeowners soon to lose homes
24) Congressional threat of ratings agencies and bond issuers for liability
25) REPEAT THE PROCESS
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