Tip Of The Iceberg

Sub Prime Mortgages— tip Of The Iceberg
Bear Market Soon to Go to Final Phase

By Comstock Partners, Inc. | 7 August 2008

On Monday the New York Times had a front page article about how homeowners with good credit are falling behind on their payments in growing numbers. They discussed the increases in the percentage of mortgages in arrears in the Alt A mortgages. These are mortgages that are just above the subprime mortgages that everyone knows about by now. Of course, no one ever heard of subprime, much less Alt A a few years ago. Alt A were loans made to people with good credit scores without proof of income or assets.

They blame this on the weak economy and the fact that the unemployment numbers announced Friday climbed to a four year high. We have been predicting that the housing market decline, that will probably be over 45% from peak to trough, will have very negative repercussions for the better quality mortgages and the holders of not just Alt A but even the prime mortgages. The article did touch on the prime mortgages, which make up most of the $12 trillion market, just had a doubling of their delinquencies to 2.7%. We have been writing for the past year about the mortgage delinquencies spreading to the high quality borrowers if the market declines as much as we expect. And we expect the home price to continue declining another 30-35% from here.

The comp retail sales for the retailers were reported this morning and they were as disappointing as we expected. The reports confirm that the years of trading up to the higher priced and higher quality stores like Saks and Nordstrom is not continuing and they are struggling with weaker sales as even the affluent shoppers are pulling back. With the benefits of the stimulus checks fading and jobless claims at a 6 year high, the big worry is how much shoppers will retrench in the critical months ahead.

We expect the government to initiate another stimulus package when the recession becomes as obvious to them as it has been to us. The problem we have with this is that the reason we are in this mess now is due to excess debt and excess consumption. These stimulus packages encourage more consumption and debt (we will explain this next). Encouraging more consumption and debt doesn't typically solve excess debt and consumption problems.

The other problem we have with these programs is that the money that was sent out to the public does not really come from the government because they don't have the money. In fact they don't have any money. They will be spending much more than they have and are receiving in tax revenue over the next year (they estimate $482 billion- we think much higher). We are spending enormous amounts of money (that we also don't have) on a futile war that no one is able to articulate what a "win" means. The only way to send out more money to the poor suffering public in this country is to sell more government bonds to the same U.S. public, U.S. institutions, and foreign governments that are already loaded up with Treasury securities and dollars they've accumulated by selling U.S. consumers their goods and services. If we allow this government to initiate another stimulus package we suspect the deficit will head towards $1 trillion and even though this is no joke, we have attached a cartoon that is indicative of the problems we are experiencing with debt in this country.

There are also negatives coming from abroad. As most of you know, the central banks of the ECB and UK did not raise their rates today and made much more dovish comments in the news conference. In the past they only discussed the one worry of controlling inflation. They now finally realize that inflation is not their only problem and they had better start worrying about the global recession we have been discussing for many months. The next move for the central bankers of every developed country will be to lower rates to protect their economies, as well as to keep their currencies low [[against the dollar: normxxx]]. This is all depicted on the chart we show constantly of the "Cycle of Deflation" (chart at left) under the title "competitive devaluations". This chart is not in any textbook since it was developed by Comstock to indicate to you what we believe is evolving.

Finally, there is the insanity of the Auction Rate Securities (ARS) where Citicorp just settled a lawsuit. These are securities that are typically municipal bonds, corporate bonds, and preferred stocks with long-term maturities (usually 30 years). ARS investors receive interest rates that are periodically reset at each successive auction that are held every few days from 7, 14, 28, or 35 days. In an ARS auction, a bidder will submit the lowest interest rate he or she is willing to accept. Traditionally, the interest rates available to ARS investors have far exceeded rates available from money market funds even though they were sold to be as liquid and safe as money market funds.

Does it make any sense to buy securities with 30 year maturities backing them and high interest rates and actually believe they are as safe and liquid as money market funds? What is this country coming to that the investment bank's financial advisors would sell these things as safe and as liquid as money markets? And maybe worse the buyer believed it. It is similar to packaging all those CDO's that were sold worldwide and were filled with toxic mortgages where nobody knew anything about the borrower who was responsible for paying off the mortgage.

Obviously, we continue our very bearish position on the stock market as well as a negative view on commodities and a spreading global recession. We should soon enter, or maybe we have already started, the last stage of the bear market, "Fear & Capitulation".

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Normxxx    
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