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The Fallout From The Mortgage Industry, It's just beginning

jo56
post Mar 13 2007, 11:32 AM
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http://www.truthout.org/docs_2006/031207P.shtml


Just one example of a lot coming by the end of this year. This could have major repercussions on our already weak economy:


Sharon Lewis is facing a 50% hike in the payment on her adjustable-rate mortgage next month.

This week, she discovered she can't qualify for a new loan with payments that she could afford.

And although she's willing to sell the West Hills home she's owned for two years, she has been told it won't fetch what she paid for it. "I have to laugh to keep from bawling," the 30-something Lewis said.


(see article for the rest)

Why there is a real problem with ARMs:

http://www.mortgagenewsdaily.com/9112006_O...RM_Mortgage.asp


http://www.businessweek.com/magazine/conte...37/b4000001.htm

This post has been edited by jo56: May 19 2007, 05:07 PM
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Cary
post Mar 13 2007, 02:27 PM
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The subprime market is just the outer fringe of the much larger mortgage/debt bubble. Here's a couple more articles on the crisis.

http://www.nytimes.com/2007/03/11/business...HWQ&oref=slogin

QUOTE
Crisis Looms in Market for Mortgages

By GRETCHEN MORGENSON
Published: March 11, 2007

On March 1, a Wall Street analyst at Bear Stearns wrote an upbeat report on a company that specializes in making mortgages to cash-poor homebuyers. The company, New Century Financial, had already disclosed that a growing number of borrowers were defaulting, and its stock, at around $15, had lost half its value in three weeks.

What happened next seems all too familiar to investors who bought technology stocks in 2000 at the breathless urging of Wall Street analysts. Last week, New Century said it would stop making loans and needed emergency financing to survive. The stock collapsed to $3.21.

The analyst’s untimely call, coupled with a failure among other Wall Street institutions to identify problems in the home mortgage market, isn’t the only familiar ring to investors who watched the technology stock bubble burst precisely seven years ago.

Now, as then, Wall Street firms and entrepreneurs made fortunes issuing questionable securities, in this case pools of home loans taken out by risky borrowers. Now, as then, bullish stock and credit analysts for some of those same Wall Street firms, which profited in the underwriting and rating of those investments, lulled investors with upbeat pronouncements even as loan defaults ballooned. Now, as then, regulators stood by as the mania churned, fed by lax standards and anything-goes lending.

Investment manias are nothing new, of course. But the demise of this one has been broadly viewed as troubling, as it involves the nation’s $6.5 trillion mortgage securities market, which is larger even than the United States treasury market.

Hanging in the balance is the nation’s housing market, which has been a big driver of the economy. Fewer lenders means many potential homebuyers will find it more difficult to get credit, while hundreds of thousands of homes will go up for sale as borrowers default, further swamping a stalled market.

“The regulators are trying to figure out how to work around it, but the Hill is going to be in for one big surprise,” said Josh Rosner, a managing director at Graham-Fisher & Company, an independent investment research firm in New York, and an expert on mortgage securities. “This is far more dramatic than what led to Sarbanes-Oxley,” he added, referring to the legislation that followed the WorldCom and Enron scandals, “both in conflicts and in terms of absolute economic impact.”

While real estate prices were rising, the market for home loans operated like a well-oiled machine, providing ready money to borrowers and high returns to investors like pension funds, insurance companies, hedge funds and other institutions. Now this enormous and important machine is sputtering, and the effects are reverberating throughout Main Street, Wall Street and Washington.

Already, more than two dozen mortgage lenders have failed or closed their doors, and shares of big companies in the mortgage industry have declined significantly. Delinquencies on loans made to less creditworthy borrowers — known as subprime mortgages — recently reached 12.6 percent. Some banks have reported rising problems among borrowers that were deemed more creditworthy as well.

Traders and investors who watch this world say the major participants — Wall Street firms, credit rating agencies, lenders and investors — are holding their collective breath and hoping that the spring season for home sales will reinstate what had been a go-go market for mortgage securities. Many Wall Street firms saw their own stock prices decline over their exposure to the turmoil.

“I guess we are a bit surprised at how fast this has unraveled,” said Tom Zimmerman, head of asset-backed securities research at UBS, in a recent conference call with investors.

Even now the tone accentuates the positive. In a recent presentation to investors, UBS Securities discussed the potential for losses among some mortgage securities in a variety of housing markets. None of the models showed flat or falling home prices, however.

The Bear Stearns analyst who upgraded New Century, Scott R. Coren, wrote in a research note that the company’s stock price reflected the risks in its industry, and that the downside risk was about $10 in a “rescue-sale scenario.” According to New Century, Bear Stearns is among the firms with a “longstanding” relationship financing its mortgage operation. Mr. Coren, through a spokeswoman, declined to comment.


That was the first of three pages. I copied it because you have to sign up for the NY Times to read it.

http://www.azcentral.com/business/articles...aults01-ON.html

QUOTE
Mortgage defaults start to spread

Ruth Simon and James R. Hagerty
Wall Street Journal
Mar. 1, 2007 12:09 PM
The mortgage market has been roiled by a sharp increase in bad loans made to borrowers with weak credit. Now there are signs that the pain is spreading upward.

At issue are mortgages made to people who fall in the gray area between "prime" (borrowers considered the best credit risks) and "subprime" (borrowers considered the greatest credit risks). A record $400 billion of these midlevel loans - which are known in the industry as "Alt-A" mortgages - were originated last year, up from $85 billion in 2003, according to Inside Mortgage Finance, a trade publication. Alt-A loans accounted for roughly 16 percent of mortgage originations last year and subprime loans an additional 24 percent.

The catch-all Alt-A category includes many of the innovative products that helped fuel the housing boom, such as mortgages that carry little, if any, documentation of income or assets, and so-called option adjustable-rate mortgages, which give borrowers multiple payment choices but can lead to a rising loan balance. Loans taken by investors buying homes they don't plan to occupy themselves can also fall into the Alt-A category.


And I'll move this thread to the "Root of Evil?" forum.
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jo56
post Mar 13 2007, 03:13 PM
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Thanks, Cary!

Two more good articles on the "next bubble" crisis!

Another GREAT IDEA from the financial world to give cheap loans to suck people in, and now they get the BALL DROPPED ON THEM!

Great move, OH ELITE ONES!

rolleyes.gif
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Truthseekers
post Mar 13 2007, 03:48 PM
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You should see how severly poor the housing market is here in the UK. People cannot afford a house at all here. You have to be able to finance at least $500,000 to get a decent house. Considering the average working wage here is approximately $30,000, that says it all. The only way onto the property ladder is to lie to get a mortgage. Then comes the shafting: payments are too much, lost the house, and then homeless.
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jo56
post Mar 26 2007, 07:45 PM
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Florida Foreclosures Lead Nation


http://money.cnn.com/2007/03/23/real_estat...sion=2007032606
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Cary
post Mar 28 2007, 03:48 PM
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Growing concerns that the "sub prime" default is spreading into the mid level and prime markets. No sh*t. Debt bubbles always end badly. This one is a world record.

http://www.nytimes.com/2007/03/23/us/23vacant.html?th&emc=th

QUOTE
Foreclosures Force Suburbs to Fight Blight

By ERIK ECKHOLM
Published: March 23, 2007

SHAKER HEIGHTS, Ohio — In a sign of the spreading economic fallout of mortgage foreclosures, several suburbs of Cleveland, one of the nation’s hardest-hit cities, are spending millions of dollars to maintain vacant houses as they try to contain blight and real-estate panic.

In suburbs like this one, officials are installing alarms, fixing broken windows and mowing lawns at the vacant houses in hopes of preventing a snowball effect, in which surrounding property values suffer and worried neighbors move away. The officials are also working with financially troubled homeowners to renegotiate debts or, when eviction is unavoidable, to find apartments.

“It’s a tragedy and it’s just beginning,” Mayor Judith H. Rawson of Shaker Heights, a mostly affluent suburb, said of the evictions and vacancies, a problem fueled by a rapid increase in high-interest, subprime loans.

“All those shaky loans are out there, and the foreclosures are coming,” Ms. Rawson said. “Managing the damage to our communities will take years.”

Cuyahoga County, including Cleveland and 58 suburbs, has one of the country’s highest foreclosure rates, and officials say the worst is yet to come. In 1995, the county had 2,500 foreclosures; last year there were 15,000. Officials blame the weak economy and housing market and a rash of subprime loans for the high numbers, and the unusual prevalence of vacant houses.

Foreclosures in Cleveland’s inner ring of suburbs, while still low compared with those in Cleveland itself, have climbed sharply, especially in lower-income neighborhoods that border the city. Hundreds of houses are vacant because they are caught in legal limbo, have been abandoned by distant banks or the owners cannot find buyers.


The suburbs here are among the best organized in their counterattack, experts say, but many suburbs elsewhere in the country have had jumps in foreclosures and are also working to stem the damage.

Outside Atlanta, Gwinnett and DeKalb Counties have mounted antiforeclosure campaigns while several towns south of Chicago are forcing titleholders to fix up empty houses, or repay the government for doing it.

Here in Ohio, there are more than 200 vacant houses in Euclid, a suburb of Cleveland north of here. In the last two years more than 600 houses in Euclid have gone through foreclosure or started the process, many of them the homes of elderly people who refinanced with low two-year teaser rates, then saw their payments grow by 50 percent or more.


Euclid has installed alarm systems in some vacant houses to keep out people hoping to steal lights and other fixtures, drug users and squatters. The city has hired three new building inspectors, bringing the total to nine, to deal with troubled properties and is getting a $1 million loan from the county to cover the costs of rehabilitation, demolition and lawn care at the foreclosed houses. (When the properties are sold, such direct maintenance costs will be recovered through tax assessments.)

The Euclid mayor, Bill Cervenik, said the city, with a population of 53,000, was losing $750,000 a year in property taxes from the empty houses.

This will be a major problem for state and local governments who have borrowed like mad over the last 5 to 7 years.  All time record highs in state and local government debt issuance over the period and record levels of state and local government debt in existance today.  Take away a substantial portion of the property taxes and these governments fold into bankruptcy.  Don't count on local utility services (electricity, gas, water, etc.) to be reliable.  As local and state govts. collapse in bankruptcy, we "got problems" all over.  Cary

At greatest risk in Cleveland’s suburbs are the low- and moderate-income neighborhoods where subprime lending has soared. The practice involves lenders issuing mortgages at high interest rates for people with lower incomes or poor credit ratings, usually involving adjustable rates and sometimes no down payment and no investigation of the borrower’s circumstances.

“What makes the subprime mortgages so devastating from a community perspective is that they’re so concentrated geographically,” said Dan Immergluck, a professor of city planning at the Georgia Institute of Technology.

Rosa Hutchinson Yates, 62, had kept up payments on her tidy two-story house on Chagrin Boulevard in Shaker Heights for 30 years. Now, she may well lose the house because of a disastrous refinancing deal in 2003 that brought her $24,000 in cash but bills she could not pay.

Ms. Yates, who has worked as a beautician and a cocktail waitress, was emotional and confused as she tried to explain what happened. Though she signed the closing documents, she said she did not realize that she was getting an adjustable rate mortgage that did not include taxes and insurance.


Just getting started folks. The much bigger fireworks lay ahead.
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jo56
post Mar 28 2007, 11:32 PM
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This was all so unnecessary. That is the part that makes me so mad. It's due to the same issue - GREED.

Gee thx ILLEGAL FEDERAL RESERVE, and all your BANKING BUDDIES for not knowing how to control your GREED, and for being beyond DISHONEST!

This is a disgrace, and not the America I once knew!

angry.gif
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jo56
post Mar 30 2007, 12:34 PM
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The latest from Bernanke

http://www.cnn.com/2007/US/03/29/subprime....ress/index.html

Quote:

"But Federal Reserve Chairman Ben Bernanke told Congress Wednesday that while the problems in the subprime mortgage sector have caused "severe financial problems for many individuals and families," they may not affect the overall economy."


SEE HOW MUCH SYMPATHY HE HAS FOR THESE PEOPLE WHO ARE LOSING THEIR HOMES??????? He missed the f*** point totally. Where was this guy trained? Is he a total idiot like the rest of them to think this won't have an affect on our economy as a whole in addition to putting people on the streets?




angry.gif

This post has been edited by jo56: Mar 30 2007, 12:36 PM
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Cary
post Mar 30 2007, 02:00 PM
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Kinda shows you who he's really working for don't it, Ms. Jo.

Here's another article I found that matches my assessment of how bad things will probably get. Fugly as hell.

http://www.marketoracle.co.uk/Article639.html

QUOTE
Asset Deflation : The Death of Real Estate

Mar 29, 2007 - 03:58 PM

By: Steve Moyer

I sell investment real estate in the San Francisco Bay Area. Have been for 25 years. It's a nice business. I've enjoyed it, and I value my clients.

My pappy's a realtor. My grandpappy was a realtor. My uncle's a realtor; so is my brother. Heck, some of my best friends are realtors (and it takes a big man to admit that).

That's why it pains me to give you the bad news, to wit: Real estate in America is officially dead. But only for a generation or so.

In other words, it is time to sell all of your real estate, save for possibly your home. If you don't, you will likely regret it. You will gradually watch all of your equity disappear into thin air. And then, unless you have little debt against it, you will likely lose your property to foreclosure. It's as simple as that.

The far better strategy is to sell now, even if you are disappointed with the selling price, take your equity (less any capital gains taxes you must pay) and put it into safe, interest-bearing cash-equivalents for a while. Do not put it into the stock market. Do not fiddle with bonds. Don't buy gold (for now, anyway). Stay away from the other metals. Just sit there. Don't be cute. Stop annoying your brother. And try not to be smug. Exercise that virtue known to Job as patience.

Eventually you will be able to buy all the real estate you want, probably including the stuff I'm happy to sell for you now, for literally nickels on the dollar.

I have talked Asset Deflation enough that I'm a light shade of blue in the face, but allow me once again to introduce myself: My name is Steve Moyer and I will be the host of Safehaven's upcoming new series, " CSI America: What the Hell Happened to Real Estate ?!" which will be dominating the headlines for the next decade or two.

In case you haven't noticed, or choose to stick your head in the sand, or don't know much about investment manias and credit bubbles, or think that real estate values "always go up in the long run," or believe that just because Ben Bernanke's Fed has a printing press, they can compel ordinary Americans to borrow increasingly reckless amounts of money, allow me to be the one to pour a big bucket of ice water over your head. The fact is, we have officially entered the frightening, post-NASDAQ-bubble, post-subsequent-real estate-double-bubble, credit-contracting, asset-deflationary portion of the 75 year cycle. So buckle-up for Mr. Toad's Wild Ride, people, because there is no looking back at this point. Mark my words, it's going to be nauseating.

If you were able to see LVI Services Inc . implode the venerable old Stardust Hotel in Las Vegas a week ago, well, that was a fitting representation of what the coming real estate market will look like in the United States. The big difference is that the Stardust implosion happened on purpose; the real estate version will be a little less swift, a lot more decisive and considerably more painful for most Americans.

If you're a financial news junkie like I am, you're reading numerous stories on a daily basis of men and women across America walking away from their homes (and, in some cases, dozens of families moving out of entire neighborhoods). Shinola has begun to hit the real estate fan, beginning with the houses purchased at artificially-high prices, no money down and idiot loans during the housing bubble's terminal, methamphetamine-driven "last run up" in 2005 and 2006.

Foreclosures are up 79% in California; in Florida they've nearly doubled compared to the same period last year. Nevada's foreclosure rate is up 77%. Colorado, Georgia and Michigan report the same tales of woe. Ohio's Cuyohoga County, where folks have abandoned neighborhoods and thieves steal cabinets and copper pipe from vacated homes, has seen its foreclosure rate increase sixfold since 1995. 2,100,000 households in America were said to be in default as of year-end, 2006. Teaser loan payments are rising, home values are falling, and "greater fools" are no longer stepping into the breech to save anyone's financial day.

We're still in the early stages of Foreclosure Mania and nowhere near the point of full recognition, but even at this point, lenders and homebuilders have begun walking away from their obligations just as quickly as those poor, unsuspecting subprime and zero-equity borrowers.

The first-wave victims of the housing bubble implosion are tapped out and must begin their lives anew with statistically no savings. I suppose that means they will no longer be buying flat-screen TV's, new trucks or trinkets from the "Things You Don't Need On Any Basis" store for a while. And you know those Mercedes-driving, $700 purse-toting realtors, loan brokers, appraisers and title company folks? They'll be hunkering down for the foreseeable future, too. How about the subprime, predatory and other assorted, irresponsible lenders and mortgage "securities" dealers? I imagine they've stopped buying original Monets and Picassos at this point but, hey, I'm just guessin'.

All together now -- can you say, "drag on the economy?" All of this -- and it's really just beginning -- is only going to make matters even worse.

Eventually, everyone will come to the realization that 1) just like when the NASDAQ bubble burst back in 2000, real estate values are going down, down, down, then 2) that this time it's not a "normal real estate cycle" but instead a relentless, post-bubble and post-bubble-bubble real estate deflation that we expect will have no historical rival.

That realization will pervade the consciousness of real estate buyers across the board, as they hear about ever-more distressed and foreclosed inventory competing with already-languishing housing stock. Buyers will conclude that, just like computers, "prices will be lower next year" and they will demand significantly discounted prices; sellers who resist selling now will find an even weaker market and a greater dearth of buyers with each passing year. Nightly news reports will further the psychology, and that dampening mind-set will spread to all real estate types: office and retail buildings, industrial and income property, single lots and land. The implosion of the real estate bubble will quickly translate to snap-the-pocketbook-shut consumer spending, declining rents, more bankruptcies, a moribund job market and fire-sale drops in real estate prices. Fannie Mae, Freddie Mac, bank and lending crises are sure to be sprinkled on top of that soggy cereal at some point, too.

Surviving lenders, under constant pressure due to rampant foreclosures, will make lending standards increasingly more stringent and loans more difficult to procure, meaning more equity will be required to buy property. But Americans have been living on borrowed money and have no such equity; they've been conditioned to borrow to buy things because they assumed that the value of their homes would continue to bail their finances out forever. Another segment of the buying marketplace will therefore be lopped off.

As time goes by, those in a position to buy will consider real estate not worth the headaches and a bad investment, to boot. It goes without saying that the real estate market's take-down, concurrent with its attendant, severe and involuntary credit contraction, a stock market pratfall, not enough U.S. savings, the corresponding liquidity crunch and an inevitable value decline in all asset classes will mean that anyone left with 2005-2007 cash will come out the winner.

In my opinion, the ultimate affect of the real estate bubble -- and its mostly unanticipated implosion -- is that the entire asset class will fall out of favor for many years, possibly for a generation. Only a select few will benefit -- those who had the foresight to sell now and squirrel away the money safely before the real anguish begins.

I applaud anyone who has stepped away from the mainstream long enough to consider my unprostituted takes. You are to be commended for at least listening to my point of view and for considering the idea of taking action before it's too late. You have the chance to see the still-manageable snowball forming up near the top of a giant, powder-covered mountain. You're one of the lucky ones who can step aside before a slushball bigger than the planet Mercury rolls down and flattens you (and all of your neighbors) like a gnat.

(Be on the lookout for my upcoming follow-up article on Safehaven, Asset Deflation: The New Rules of Real Estate. I expect to have it out in a week or two. It will give you a jump on the real estate game in the coming environment. As always, we welcome your feedback. Our last article produced our greatest response to date and I apologize if I did not have the chance to respond to every inquiry. From what I read in those emails, I have every confidence our readers will be able to survive the impending mess).

By Steve Moyer
StephenLMoyer@aol.com
PonderThis.net

Copyright © 2005-2007 Steve Moyer
He has been an investment real estate broker since 1982. He is a columnist and the assistant editor of the monthly newsletter, Ponder This .... www.ponderthis.net
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jo56
post Mar 30 2007, 06:48 PM
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Very good article, Cary! I believe what he's saying.
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Cary
post Mar 30 2007, 08:05 PM
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QUOTE (jo56 @ Mar 30 2007, 04:48 PM)
Very good article, Cary! I believe what he's saying.

Kiddo, you're going to experience first hand what he's "saying." We all will. At some point, we're going to wake up in a third world economy. The kind of economy we can't begin to imagine right now. Hope you're prepared. If not, you'll assimilate or perish. It's that serious. A lot of the uneducated to what's coming will perish.
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jo56
post Mar 31 2007, 06:16 PM
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Cary,

How safe are Money Market Accounts? Is it best to avoid those also?
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Cary
post Mar 31 2007, 10:17 PM
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QUOTE (jo56 @ Mar 31 2007, 04:16 PM)
Cary,

How safe are Money Market Accounts? Is it best to avoid those also?

Depends on what kind of "paper" the money market invests in. Corporate paper is probably the least safe. Then a "tax free" short duration muni-bond money market would be the next step up in safety. Finally a 100% US Treas. T Bill money market would be the most safe. These assume you're staying with US assets only. You start looking for money markets that invest in foreign short term paper and the safety factor is all over the board, from very safe to somewhat risky. Let me know if this doesn't make sense.

Big caveat. THERE IS NO 100% GUARANTEED AND SAFE "NO MATTER WHAT" INVESTMENT. EVERYTHING (ESPECIALLY PAPER ASSETS) CONTAINS SOME AMOUNT OF RISK.

Oh, yeah. This IS NOT investment advice.

Hope this helps.
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jo56
post Mar 31 2007, 10:20 PM
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Yes, that makes sense. Thx smile.gif
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jo56
post Apr 3 2007, 09:19 PM
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http://www.rgemonitor.com/blog/roubini/183071

New Century Financial (2nd Largest Subprime Lender Bankrupt)


Good Article - Popping of the Credit Bubble Has Only Just Begun:
http://www.sprott.com/pdf/marketsataglance/03-2007.pdf

Quote:

"The US housing bubble that came crashing down in the latter half of last year wasn't just a 'housing price' bubble. In reality, it was a lending and credit bubble. One that had its germination in the ultra-easy monetary policy that the Federal Reserve implemented between 2001 and 2004 to fight the fallout from the previous bubble in equity markets. By doing so they recklessly created another, much larger bubble that pervaded the whole of global financial markets."

-----------------------------------------------
GET RID OF THE FEDERAL RESERVE - GREENSPAN created this mess during his term. Now Bernanke will continue the lie that 'all is well'. You must do something to protect your lifesavings, and now. IMO

This post has been edited by jo56: Apr 3 2007, 10:02 PM
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jo56
post Apr 3 2007, 10:05 PM
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See for yourself what the fallout is from this GROSS NEGLIGENCE by the Federal Reserve:

Mortgage Lender Implode Meter: (updated regularly)
http://www.ml-implode.com/

This post has been edited by jo56: Apr 3 2007, 10:05 PM
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jo56
post Apr 10 2007, 01:44 PM
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http://www.motherjones.com/news/feature/20...me_suspect.html

Cleveland on the Frontlines of the Mortgage Bust

Ohio is one of just two states (the other is Virginia) whose consumer protection laws do not apply to mortgage lending.
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jo56
post Apr 11 2007, 12:33 PM
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http://money.cnn.com/2007/04/11/news/econo...rices/index.htm


Home prices to fall for first time in 2007

Real estate group sees 0.7% drop in prices this year, the first annual decline in nearly 40 years of tracking.

By Chris Isidore, CNNMoney.com senior writer
April 11 2007: 12:00 PM EDT

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Cary
post Apr 11 2007, 02:24 PM
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For those of you so inclined, here's a great educational article about deflation, how it gets setup, how it gets kicked off and what it means to you. It should mean a whole lot as some serious negative fallout accompanies deflations and the depressions that accompany them. This is from Elliott Wave International.

http://www.elliottwave.com/deflation/

QUOTE
What is Deflation and What Causes it to Occur?

Defining Inflation and Deflation


Webster's says, "Inflation is an increase in the volume of money and credit relative to available goods," and "Deflation is a contraction in the volume of money and credit relative to available goods." To understand inflation and deflation, we have to understand the terms money and credit.

Defining Money and Credit

Money is a socially accepted medium of exchange, value storage and final payment. A specified amount of that medium also serves as a unit of account.

According to its two financial definitions, credit may be summarized as a right to access money. Credit can be held by the owner of the money, in the form of a warehouse receipt for a money deposit, which today is a checking account at a bank. Credit can also be transferred by the owner or by the owner's custodial institution to a borrower in exchange for a fee or fees - called interest - as specified in a repayment contract called a bond, note, bill or just plain IOU, which is debt. In today's economy, most credit is lent, so people often use the terms "credit" and "debt" interchangeably, as money lent by one entity is simultaneously money borrowed by another.

Price Effects of Inflation and Deflation

When the volume of money and credit rises relative to the volume of goods available, the relative value of each unit of money falls, making prices for goods generally rise. When the volume of money and credit falls relative to the volume of goods available, the relative value of each unit of money rises, making prices of goods generally fall. Though many people find it difficult to do, the proper way to conceive of these changes is that the value of units of money are rising and falling, not the values of goods.

The most common misunderstanding about inflation and deflation - echoed even by some renowned economists - is the idea that inflation is rising prices and deflation is falling prices. General price changes, though, are simply effects.

The price effects of inflation can occur in goods, which most people recognize as relating to inflation, or in investment assets, which people do not generally recognize as relating to inflation. The inflation of the 1970s induced dramatic price rises in gold, silver and commodities. The inflation of the 1980s and 1990s induced dramatic price rises in stock certificates and real estate. This difference in effect is due to differences in the social psychology that accompanies inflation and disinflation, respectively.

The price effects of deflation are simpler. They tend to occur across the board, in goods and investment assets simultaneously.

The Primary Precondition of Deflation

Deflation requires a precondition: a major societal buildup in the extension of credit (and its flip side, the assumption of debt). Austrian economists Ludwig von Mises and Friedrich Hayek warned of the consequences of credit expansion, as have a handful of other economists, who today are mostly ignored. Bank credit and Elliott wave expert Hamilton Bolton, in a 1957 letter, summarized his observations this way:

In reading a history of major depressions in the U.S. from 1830 on, I was impressed with the following:

    (a) All were set off by a deflation of excess credit. This was the one factor in common.
    (B) Sometimes the excess-of-credit situation seemed to last years before the bubble broke.
    © Some outside event, such as a major failure, brought the thing to a head, but the signs were visible many months, and in some cases years, in advance.
    (d) None was ever quite like the last, so that the public was always fooled thereby.
    (e) Some panics occurred under great government surpluses of revenue (1837, for instance) and some under great government deficits.
    (f) Credit is credit, whether non-self-liquidating or self-liquidating.
    (g) Deflation of non-self-liquidating credit usually produces the greater slumps.

Self-liquidating credit is a loan that is paid back, with interest, in a moderately short time from production. Production facilitated by the loan - for business start-up or expansion, for example - generates the financial return that makes repayment possible. The full transaction adds value to the economy.

Non-self-liquidating credit is a loan that is not tied to production and tends to stay in the system. When financial institutions lend for consumer purchases such as cars, boats or homes, or for speculations such as the purchase of stock certificates, no production effort is tied to the loan. Interest payments on such loans stress some other source of income. Contrary to nearly ubiquitous belief, such lending is almost always counter-productive; it adds costs to the economy, not value. If someone needs a cheap car to get to work, then a loan to buy it adds value to the economy; if someone wants a new SUV to consume, then a loan to buy it does not add value to the economy. Advocates claim that such loans "stimulate production," but they ignore the cost of the required debt service, which burdens production. They also ignore the subtle deterioration in the quality of spending choices due to the shift of buying power from people who have demonstrated a superior ability to invest or produce (creditors) to those who have demonstrated primarily a superior ability to consume (debtors).

Near the end of a major expansion, few creditors expect default, which is why they lend freely to weak borrowers. Few borrowers expect their fortunes to change, which is why they borrow freely. Deflation involves a substantial amount of involuntary debt liquidation because almost no one expects deflation before it starts.

What Triggers the Change to Deflation?

A trend of credit expansion has two components: the general willingness to lend and borrow and the general ability of borrowers to pay interest and principal. These components depend respectively upon (1) the trend of people’s confidence, i.e., whether both creditors and debtors think that debtors will be able to pay, and (2) the trend of production, which makes it either easier or harder in actuality for debtors to pay. So as long as confidence and production increase, the supply of credit tends to expand. The expansion of credit ends when the desire or ability to sustain the trend can no longer be maintained. As confidence and production decrease, the supply of credit contracts.

The psychological aspect of deflation and depression cannot be overstated. When the social mood trend changes from optimism to pessimism, creditors, debtors, producers and consumers change their primary orientation from expansion to conservation. As creditors become more conservative, they slow their lending. As debtors and potential debtors become more conservative, they borrow less or not at all. As producers become more conservative, they reduce expansion plans. As consumers become more conservative, they save more and spend less. These behaviors reduce the "velocity" of money, i.e., the speed with which it circulates to make purchases, thus putting downside pressure on prices. These forces reverse the former trend.

The structural aspect of deflation and depression is also crucial. The ability of the financial system to sustain increasing levels of credit rests upon a vibrant economy. At some point, a rising debt level requires so much energy to sustain - in terms of meeting interest payments, monitoring credit ratings, chasing delinquent borrowers and writing off bad loans - that it slows overall economic performance. A high-debt situation becomes unsustainable when the rate of economic growth falls beneath the prevailing rate of interest on money owed and creditors refuse to underwrite the interest payments with more credit.

When the burden becomes too great for the economy to support and the trend reverses, reductions in lending, spending and production cause debtors to earn less money with which to pay off their debts, so defaults rise. Default and fear of default exacerbate the new trend in psychology, which in turn causes creditors to reduce lending further. A downward " spiral" begins, feeding on pessimism just as the previous boom fed on optimism. The resulting cascade of debt liquidation is a deflationary crash. Debts are retired by paying them off, " restructuring" or default. In the first case, no value is lost; in the second, some value; in the third, all value. In desperately trying to raise cash to pay off loans, borrowers bring all kinds of assets to market, including stocks, bonds, commodities and real estate, causing their prices to plummet. The process ends only after the supply of credit falls to a level at which it is collateralized acceptably to the surviving creditors.

Why Deflationary Crashes and Depressions Go Together

A deflationary crash is characterized in part by a persistent, sustained, deep, general decline in people's desire and ability to lend and borrow. A depression is characterized in part by a persistent, sustained, deep, general decline in production. Since a decline in production reduces debtors' means to repay and service debt, a depression supports deflation. Since a decline in credit reduces new investment in economic activity, deflation supports depression. Because both credit and production support prices for investment assets, their prices fall in a deflationary depression. As asset prices fall, people lose wealth, which reduces their ability to offer credit, service debt and support production. This mix of forces is self-reinforcing.

The U.S. has experienced two major deflationary depressions, which lasted from 1835 to 1842 and from 1929 to 1932 respectively. Each one followed a period of substantial credit expansion. Credit expansion schemes have always ended in bust. The credit expansion scheme fostered by worldwide central banking (see Chapter 10) is the greatest ever. The bust, however long it takes, will be commensurate. If my outlook is correct, the deflationary crash that lies ahead will be even bigger than the two largest such episodes of the past 200 years.

Financial Values Can Disappear

People seem to take for granted that financial values can be created endlessly seemingly out of nowhere and pile up to the moon. Turn the direction around and mention that financial values can disappear into nowhere, and they insist that it is not possible. "The money has to go somewhere...It just moves from stocks to bonds to money funds...It never goes away...For every buyer, there is a seller, so the money just changes hands." That is true of the money, just as it was all the way up, but it's not true of the values, which changed all the way up.

Asset prices rise not because of "buying" per se, because indeed for every buyer, there is a seller. They rise because those transacting agree that their prices should be higher. All that everyone else - including those who own some of that asset and those who do not - need do is nothing. Conversely, for prices of assets to fall, it takes only one seller and one buyer who agree that the former value of an asset was too high. If no other bids are competing with that buyer's, then the value of the asset falls, and it falls for everyone who owns it. If a million other people own it, then their net worth goes down even though they did nothing. Two investors made it happen by transacting, and the rest of the investors made it happen by choosing not to disagree with their price. Financial values can disappear through a decrease in prices for any type of investment asset, including bonds, stocks and land.

Anyone who watches the stock or commodity markets closely has seen this phenomenon on a small scale many times. Whenever a market "gaps" up or down on an opening, it simply registers a new value on the first trade, which can be conducted by as few as two people. It did not take everyone's action to make it happen, just most people's inaction on the other side. In financial market "explosions" and panics, there are prices at which assets do not trade at all as they cascade from one trade to the next in great leaps.

A similar dynamic holds in the creation and destruction of credit. Let's suppose that a lender starts with a million dollars and the borrower starts with zero. Upon extending the loan, the borrower possesses the million dollars, yet the lender feels that he still owns the million dollars that he lent out. If anyone asks the lender what he is worth, he says, "a million dollars," and shows the note to prove it. Because of this conviction, there is, in the minds of the debtor and the creditor combined, two million dollars worth of value where before there was only one. When the lender calls in the debt and the borrower pays it, he gets back his million dollars. If the borrower can't pay it, the value of the note goes to zero. Either way, the extra value disappears. If the original lender sold his note for cash, then someone else down the line loses. In an actively traded bond market, the result of a sudden default is like a game of "hot potato": whoever holds it last loses. When the volume of credit is large, investors can perceive vast sums of money and value where in fact there are only repayment contracts, which are financial assets dependent upon consensus valuation and the ability of debtors to pay. IOUs can be issued indefinitely, but they have value only as long as their debtors can live up to them and only to the extent that people believe that they will.

The dynamics of value expansion and contraction explain why a bear market can bankrupt millions of people. At the peak of a credit expansion or a bull market, assets have been valued upward, and all participants are wealthy - both the people who sold the assets and the people who hold the assets. The latter group is far larger than the former, because the total supply of money has been relatively stable while the total value of financial assets has ballooned. When the market turns down, the dynamic goes into reverse. Only a very few owners of a collapsing financial asset trade it for money at 90 percent of peak value. Some others may get out at 80 percent, 50 percent or 30 percent of peak value. In each case, sellers are simply transforming the remaining future value losses to someone else. In a bear market, the vast, vast majority does nothing and gets stuck holding assets with low or non-existent valuations. The "million dollars" that a wealthy investor might have thought he had in his bond portfolio or at a stock's peak value can quite rapidly become $50,000 or $5000 or $50. The rest of it just disappears. You see, he never really had a million dollars; all he had was IOUs or stock certificates. The idea that it had a certain financial value was in his head and the heads of others who agreed. When the point of agreement changed, so did the value. Poof! Gone in a flash of aggregated neurons. This is exactly what happens to most investment assets in a period of deflation.
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jo56
post Apr 11 2007, 07:22 PM
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Thx for the article, Cary! Very good information!

Quote from article: (This could be huge and a first for my lifetime)

"If my outlook is correct, the deflationary crash that lies ahead will be even bigger than the two largest such episodes of the past 200 years."

(He's referring to the one that lasted from 1835 - 1842 and the one 1929 - 1932 The Great Depression).

This post has been edited by jo56: Apr 11 2007, 07:43 PM
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