Some time ago, he wrote Chinese asset markets have become a giant Ponzi scheme that perked up my ears and got me to thinking.

But, his more recent piece in Caing has me thinking he’s talking about Southern California:

The overwhelming desire for getting rich quick dominates every nook, fissure and strata of Chinese society.

Ok, replace “Chinese” with California, and you’ve got a definite match.

Bubbles exaggerate reality but are not formed out of thin air. Cheap money and strong growth are the usual ingredients for bubble-making.

This is almost exactly what I wrote with “What is a bubble?” several years ago.  However, most interestingly is what is happening in China, and happened in California:

China’s property market is creating winners and losers based on timing. All other factors – including education and experience — have been marginalized as the economy rewards speculators. And as more play the game, the speculator ranks rise and fewer people work, perhaps contributing to a labor shortage.

This is exactly what happened during Southern California’s property bubble.  Many people got rich simply by being in the right place at the right time.  Many of them were incapable of understanding the circumstances of the rise, and so therefore simply did more of the same (buy real estate) without understanding the underlying problem that widespread repetition of that practice would cause a housing shortage (too many people “storing” housing instead of allowing it to be bought).  Rents reflected the “real demand”, and appreciated strongly.  Meanwhile, properties exploded with enough appreciation in 2 years to account for 30 years of inflation to support the prices.

The most poignant in my mind was a short-sale that Brad (my co-blogger and realtor) and I visited.  The original owner was trying to sell from a purchase made in 1996 at more than 300K lower than the short-sale.  The “owner” was so destitute that when the pool pump broke and they were unable to replace the $800 unit, the resulting ground shift due to hydrostatic pressure when quickly emptying the pool caused many more thousands in damage to the surrounding concrete.  They had been trying to support a 600K+ mortgage with a single income from working at Macy’s.  When regular equity withdrawals worked, the Ponzi scheme continued.

In normal times, the ponzi would have never worked, but because of the bubble, it allowed the “owner” to continue to persist in a property many times more expensive than they could support.  At the peak of the market, this would have sold for more than $1M, requiring the income of several well-paid professionals, not a single retail salesperson’s income.  The world did not make sense in 2006.

This separation of is true of a speculation/investment-centric economy.  This is part of the reason why most people make terrible investors; the concept of time is nebulous and fraught with uncertainty.  Indeed, I wrote (and bolded) in What is a Bubble? the following:

The most fundamental concept of investing is the concept of timing. The most fundamental flaw in most participants logic is that the asset provides more than just money… everything that costs money is an investment and can be traded again for money, nothing more.

This Southern California phenomenon of irrational belief has been covered extensively in another blogger’s repertoire, Irvine Renter’s Southern California’s Cultural Pathology.

We are quickly approaching the Day of Reckoning in our housing market. In my view this will be Armageddon for California debtors: the spending will stop, they will lose their homes and with it their illusion of wealth, and they most definitely will not be enjoying life. The cause of all the weeping and gnashing of teeth will not be some exogenous event, but rather a direct result of the circumstances they themselves created.

My thoughts exactly.

Any thoughts as to why over the last 1.5 years, 90 day lates have doubled while bank owned halved?

Any conspiracy theories?

Let me state right now that I couldn’t care less one way or another about debt forgiveness, but many who propose to just “forgive” debt forget 2 main arguments for not doing it.

1.  Banks can’t stay solvent and still do it.  Our entire banking system will probably collapse if wholesale write offs take place too quickly.

2. If you let one person do it, you gotta let ‘em all do it.  Foreclosures are still the best way to liquidate debt.

Bloomberg’s all over it.

Dec. 14 (Bloomberg) — Banks will need to take “substantial” writedowns on home-equity loans to enable loan modifications that will allow the U.S. housing market to recover, according to Amherst Securities Group LP.

The government’s mortgage-modification program will fail to avert many of the 9 million to 10 million looming foreclosures because it doesn’t reduce principal for borrowers, about a quarter of whom owe more than the current values of their houses, Laurie Goodman, a New York-based mortgage-bond analyst at Amherst, said today in a Bloomberg Radio interview.

“It’s important to realize the largest second-lien holders are the largest banks, and there’s going to have to be some very substantial writedowns if you go to a principal-reduction program,” Goodman said. “And this is going to have to be addressed head-on.”

I would remind readers, though, that predicting is a difficult art to perfect.  As Elizabeth herself states, she would have herself been surprised by the outcome of the pressures.  In the same way, “collapse” is probably a misnomer.  We will adjust, but with a quite different set of priorities.  Technology has improved many parts of our lives; but has contributed little to our happiness.  Our ancestors would probably be surprised how little we do with our large amount of spare time, but surprised at how hard much stress our daily lives entail; which is probably the biggest toll that the housing bubble has had on America; the human cost is much greater than the monetary cost, especially considering that our children and grandchildren will pay dearly for our stupidity over the past 5 years.

estimating that without cash-out refinancings and other withdrawals of homeowner equity, only 3 percent of outstanding mortgages would have been underwater at the end of last year

Basically, mortgage borrowers bought the rope to hang themselves.

I would recommend reading the entire article, but here’s an excerpt:

The study didn’t take into account the behavior of lenders or the supply of money available to refinance, instead assuming that borrowers could refinance as often as they wished at prevailing interest rates. That may have been pretty much the case in the decade leading up to the market’s June 2006 peak, the study said, with homeowners eager to take on debt and lenders only too willing to accommodate them.

But the study illustrates a more subtle problem than the “dysfunctional individual and institutional behavior” exhibited during the boom, said authors Amir E. Khandani, Andrew W. Lo, and Robert C. Merton.

“While excessive risk-taking, overly aggressive lending practices, pro-cyclical regulations, and political pressures surely contributed to the recent problems in the U.S. housing market, our simulations show that even if all homeowners, lenders, investors, insurers, rating agencies, regulators, and policymakers behaved rationally, ethically, and with the purest of motives, financial crises can still occur,” the study said.

“Near frictionless” refinancing opportunities, when they occur simultaneously with declining interest rates and rising home prices, create a “ratchet” effect in which homeowners exchange the equity they’ve built in their homes for debt they can’t easily “unwind,” the study said.

The situation poses a risk for lenders, too. A formerly diverse pool of borrowers — some who’d had comfortable levels of equity in their homes, and loans that were well on their way to being paid off — becomes synchronized, as if each had bought their homes at the height of the market with the highest allowable loan-to-value ratios.

When home prices decline, lenders have no way to compel homeowners to add more equity, like the margin calls employed by stock brokers when investors buy shares with borrowed money. Unlike equities investors who can sell off part of their portfolio to meet a margin call, homeowners can’t sell part of their home to reduce their debt ratio.

There’s no easy way to address the “refinancing ratchet effect,” the study said, because the three factors that can lead to trouble — declining interest rates, rising home prices, and easy access to mortgage loans — are “benign market conditions” often seen as indicators of economic growth.

“No easy legislative or regulatory solutions exist, such as prohibiting the Fed from cutting interest rates below a certain threshold, or placing a ceiling on housing prices, or putting ‘sand in the gears’ of the refinancing system and limiting consumer credit,” the study said.

In the end, were using the money from refinancing to supplement declining income, as was the case of a short sale I recently went to see with Brad Davidson (co-blogger and Broker at We-Help-U-Buy).  The homeowner had purchased some 20+ years earlier, but had withdrawn over $500K in the last decade.  Meanwhile, not a cent was put into home maintenance as the entire place was original.  In fact, she had cost the home probably $10K in damage to the in-ground pool draining too quickly because the pool pump broke and she didn’t have $800 to replace it.  (Hydrostatic pressure will do some interesting things to concrete when the opposing force is removed.

The most amazing thing to me during the housing downturn is the number and amount of refis that I have seen.  It seems MOST of Southern California took out several hundred thousand dollars each from their houses; enough to buy entire houses outright in most other places in the country.  Some of the most amazing and bizarre examples have been in the wealthiest enclaves, likely in an attempt to keep up with the Jones’.  This kind of insanity is well-documented in IrvineRenter’s Southern California’s Cultural Pathology.

The road ahead is still going to be fraught with disaster, as it will take us decades to rebuild our consumer balance sheets after having pulled so much of our income forward through equity withdrawals.  Let’s hope that we can do it sooner than later.

The T2 Partners paper provided by More Mortgage Meltdown can be downloaded here:

I recommend looking over the entire presentation, as it provides a play by play of where we have come in the last 3 years, and what to expect for the coming 3 years.  I agree with the general assessment that we are in the middle innings of the overall price declines (perhaps in Inning 5 of 9), but the real movement is yet to come in the middle and high-end price tiers.  Of course, there is no way of accounting for significant outside involvement that might change that outcome, however any change must be structural and permanent (such as offering citizenship to anyone purchasing real estate, offering 20% of the purchase price, no questions asked by the government, or total global thermonuclear war.  I doubt many can understand what those outcomes would look like, so we’ll focus on the most likely scenarios.

The key is really what is happening and will continue to happen California. Their assesment, given by Mark Hanson, is in my opinion spot on to how I expect the next 2 years to play out:

California housing — at the low end — is ‘bottoming’ mostly because: a) median prices are down 55% from their peak over the past two years, thereby making the low end affordable; b) foreclosures have temporarily been cut by 66% through moratoriums reducing supply; and c) demand is picking up going into the busy season.
But the moratoriums are ending and the number of foreclosures in the pipeline is massive — they will start showing themselves as REO over the near to mid-term. The Obama plan held the foreclosure wave back, creating a huge backlog and now the servicers are testing hundreds of thousands of defaults against the new loss mitigation initiatives. We presently see the Notice of Defaults at record highs and Notice of Trustee Sales back up to 9 month highs — there is no reason for a loan to go to the Notice of Trustee Sale stage if indeed it wasn’t a foreclosure. However, the new ‘batch’ are not only from the low end but a wide mix all the way up to several million dollars in present value.
Because the majority of buyers are in ultra low and low-mid prices ranges, the supply-demand imbalance from foreclosures and organic supply will crush the mid-to-upper priced properties in 2009. We already have early seasonal hard data proving this. As the mid-to-upper end go through their respective implosions this year and the volume of sales in these bands increase as prices tumble, the mix shift will raise median and average house prices creating the ultimate in false bottoms. We also have data proving this phenomenon.

You can find this narrative (and much more) on slide 62.

Magical thinking comes in many flavors, but isn’t entirely unuseful.  It helps when systems are so complex that it would take so much time to simply understand the system of events required that it would be impractical to act before a rational decision could no longer be effective.  Much of what we see today in public economic forums is massive amounts of magical thinking.  That somehow, if we meet certain conditions of yesteryear, we will “put a floor” in on home prices, the stock market, and the economy as a whole.  Unfortunately, we are in some cases only delaying the inevitable, and in many cases worsening the outcome of the housing bubble.

In a rational, efficient market, participants act in a personally beneficial way.  Often, when participants act in a personally beneficial way, this benefits society as a whole.  However, because the system of decisions needed is inherently complex, a bit of the system sometimes needs to be mentally “fudged” to make the whole issue work.  This is often what people mean when they refer to the “50,000 foot view”.  In centralized organizations, a leader with this type of view depend on their underlings being able to translate this kind of vision with on-the-ground experience to execute the plan.

Some examples that have recently come to the forefront:
1.    Provide a tax credit to homebuyers

2.    Banks failures cause more hardship than paying to save them

3.    Large industrial producers cannot be reduced because they will crash our economy

Tax Credit to Homebuyers:

Unfortunately, it appears that we have more turned into a Cargo Cult that focuses not on the productive activities, but to somehow hearken back the golden days of yore through repeating the same stupid rituals that brought the original cargo planes and our former riches.  This is a complete erosion of the American fabric; a lie to western peoples that economists know the way out better than prudent business people.

Many in the government have noted that in the last 20 years, rising home prices produced a large benefit to homeowners.  They were able to borrow against their houses to fund growth in the economy.  The solution to our ailing consumption, it must mean, that houses are undervalued and need to be propped up.  Never mind that the last 20 years has been an historical aberration, a flyspeck on the overvalued of all overvalues.  In our current policy, “reversion to trend” means an upward reversion of the home price appreciation to +10% per year.  No matter that in many locales in the US, our incomes have not kept pace with the cost of homes and therefore we are already dedicating too much of our income to housing.  We all need a REDUCTION in home prices for consumer spending to increase.  Anything else (such as increased incomes) would put us as a country even further behind in competitiveness with respect to global wage arbitrage.  I’m not a purist in the sense that I feel that we need to have a large manufacturing base, but our economy has got to consist of more than trading houses and debt amongst ourselves.  The longer we wait to realize this and return incentives to work, risk, and honest reward, the more we as a country suffer.  There should never be a return to leisurely earning above the rest of the world because there is no such thing as barriers to entry in the long run.  Eventually, our wealth will be eroded if we do not continue to maintain a global competitive advantage (and I don’t mean in financial engineering).

People are currently rational.  They’d love nothing more than to return the heady days of 2007 where they spent willy-nilly on consumer goods.  They really would, but they also realize that the only way to do that is to reduce their consumption of something else.  Something that doesn’t produce much satisfaction in their lives: housing.

Bank Failures

This is perhaps one of the most prevalent of magical thinking.  In the participants mind, the bank failures of the 1930’s created a fear of banks when they failed.  At that time, this had 2 effects:  1.  People would have rather stuffed the money in their mattresses, collapsing monetary velocity and trade.  2.  This collapse of bank deposits put otherwise healthy banks in a more precarious positions since they could not maintain adequate reserve ratios and were then insolvent.  I believe that we do not have this type of environment, partially because of the lessons learned over the past 80 years.  The FDIC creates a kind of buffer that assures accountholders that their money is safe (within limits)  Most can ensure all of their money is safe by maintaining multiple accounts at multiple banks.  People do not want money stuffed in their mattresses, and will only do so if they believe the government will begin to confiscate it.  Harebrained ideas such as an asset tax or cash taxes will assuredly collapse velocity and many banks along with it as depositors choose to stuff Ben Franklins in their pillow cases.

Today’s problem has little to do with the same problems as the 1930s.  Today, the mark-to-market accounting rules have substantially decreased the value of assets that depositors’ money was attached to while bank deposits have not done much.  However, most of those assets should never have been purchased because they were junk to begin with.  Most were a Ponzi Scheme where the greater fool needed to come along before their next balance sheet review or FDIC stress test.  In the past, the FDIC would sieze the bank and sell off the parts, making the secured creditors partially whole and making the equity holders eat dirt.  The shortcomings on depositors would be made whole by the FDIC before anyone else.

Circumventing normal market clearing practices for these liabilities and assets will ensure that the required write-downs necessary to produce never happen and that the remaining “Zombie Banks” will continue in perpetuity with damaged assets; unable to lend due to the need to recapitalize.  More importantly, (or at least as important), the current leadership fails to be deposed; ensuring the problems of yesteryear are never allowed to become discovered and the organization can never move on from prior mistakes.  The leadership is every bit as damaged as the assets the banks hold.  To keep them in place is to reward bad behavior and ensure that we do not have a return to long-term profitable business practices.

Our current populace is engaging in magical thinking to believe that if we just keep the banks alive for a little while longer that they will be able to return from the dead.  The only result will inevitably be zombies; having the appearance of life, but dead and hungry for brains.

Large Industrial Producers

This one is about GM.  I believe this one to be a very different animal than banks and requires a more sophisticated resolution; but let’s be clear: allowing GM to continue to operate without destroying the unions as they now exist is in effect transferring taxpayer money directly to GM union workers.

At the present time, bankruptcy for GM holds 2 major obstacles that are not related to the above
1.    No sufficient Debtor In Posession (DIP) financing exists in the private sector.  Without government intervention, GM could only progress directly to Ch7, which would be a shock to the economy.
2.    Even progressing to a Ch11 bankruptcy protection shows that consumers would likely boycott GM products as a safety measure.

Therefore, you can see that a traditional bankruptcy for GM is not an option if we do not want to add several hundred thousand directly to the dole and probably reach several million before all is said and done.

In the 80’s Chrysler was bailed out with a loan from the government.  It is simply magical thinking to believe that we can make a loan with attractive terms and the whole problem will go away.  The issue is that with each infusion, the company becomes more dependent on the donor.  We are raising a vegetable company.  Therefore, the problem must be attacked with swiftness and exactness.  Most importantly, the 30 and done has to be removed and made retroactive.  Sorry, you shouldn’t be able to retire until 70, and if that sucks, it sucks; get a job lowlife.  None of the rest of America has a cush job with secure retirement; you won’t be getting it either.  Sorry.

However, doing nothing while making large loans that go directly to pension beneficiaries is inherently unfair to workers everywhere and distorts normal competitive markets.  With the kind of money that GM is getting, many skilled could come forward and rebuild a competitive auto company.  The failed leadership that has complained about the problem yet done thing for the last 30 years while foreign competitors ate our lunch cannot be rewarded, nor should bondholders who are essentially being treated like Treasury holders be either.

In conclusion:

I believe our country’s leadership is unable to see how the magical thinking of today will translate into actionable items of tomorrow either because they fail to see personal motivations of participants, or because they have failed to see the solution and worked their way back putting into place contingency plans.  Until we have a workable solution, we will continue to pour money down the drain and extend the recover further.

A quick and useful synopsis of the problem can be found in a small regional paper from Neuces County.

In one of history’s more candid reflections, Henry Morgenthau, Jr., Treasury Secretary under President Franklin D. Roosevelt, confessed, “We have tried spending money. We are spending more than we have ever spent before and it does not work.”

Just six years after crafting the New Deal, Morgenthau declared that their efforts to create jobs and restore America’s depression-ravaged economy by expanding the federal government to unprecedented levels had been a failure. By Morgenthau’s own assessment, the New Deal saddled our country with “as much unemployment as when we started…and an enormous debt.”

More than 75 years have passed since FDR signed the New Deal into law, and many noted economists are studying the Great Depression and trying to learn from the experience. In 2004, a team of UCLA economists concluded that the policies of the New Deal, which suppressed competition and kept unemployment in the range of nine to 16 percent, actually prolonged the Great Depression by seven years.

Amity Shlaes, an economic scholar and Great Depression historian, has argued that the sheer “arbitrariness” of the New Deal actually exacerbated the crisis.

The crux of the problem is that once you start arbitrarily trying to assign a value better than the collective wisdom of markets, you create a process of compensating factors.  Yes, markets will react only temporarily to any stimulus and will eventually revert to its given path.  Any stimulus will have been wasted.

Yes, payments to “new homeowners” is an arbitrary effort, almost all of whose profits will go to homebuilders (who led us into this mess with overbuilding due to overstimulus) and bankers (who also led us into this mess with overlending due to overstimulus).

I will state categorically that from an economic standpoint, the best thing for the federal government to do is to spend its money on permanent solutions to permanent problems.  Trying to prop up housing prices only leaves us further in debt and beholden to our own currency.  This will not end well, and is getting worse with every dollar given to the Federal Government.

I am outraged at President Obama’s approach.  Unfortunately, it appears that we will have at least 4 more years of unmitigated idiocy, this time aided and abetted by our own Congress.  There is no incentive in America to work hard, do what is right and pay your bills.  Indeed, it seems, never was there a time where it was more prudent to default than now.  You will get to keep all of your past gains, and the government will continue to fund your gains in perpetuity. I’m frankly disgusted that my tax money is going to scum-of-the-earth bankers and homebuilders.

We could really do well to take our tough medicine now and get it over with so we have some growth.  Instead, we have special interests running this country with threats of financial terrorism (give me billions or I’ll blow up your economy and myself) and an out of control President just weeks after taking office.

I’ll give the President a suggestion:  Give me the money and I’ll find a better way to use it.  I’ll set up a bank that will RIGHT NOW hire people, lend to people at below market rates AND make shitloads of money all at the same time.  This absolute garbage of giving current banks TARP money was from the beginning doomed to failure.  I’d like to have loans at 0% that I can then compound 10 times and sell on the open market at 4.5%.

President Obama, I’m ready.  I’m willing.  Just give me the money.

PS, if I happen to take the money and skip town, chalk it up to learning a lesson about giving billions to an anonymous internet blogger.

While he’s not a policy maker, having more media outlets understanding why high housing prices are putting a brake on our economy is critical to getting past the downturn.

I’m predicting whatever lift we saw this summer from decent rates (muting the crash underway), will disappear and the next leg down of prices will continue.  This dead cat bounce is dead!

I will be officially revising my 2008 Socal Real Estate estimates based on recent action.

The funny thing is, I remember less than a year ago, discussions about how Freddie Mac and Fannie Mae were well capitalized, preeminently prepared for any disaster, and frankly, as unsinkable as the Titanic.  Little good that has done.  We may be witnessing a historic crash of epic proportions, greater by far than the crash we have seen to date.  To put it in perspective, FRE and FNM have pretty much been the only thing that have kept the real estate market together in the US over the past year.

Consider for a moment this statement regarding the mortgage insurance statistics from the GSEs.

There are more hard numbers available to support MI’s recent surge. MICA, the trade association representing the private mortgage insurance industry, began reporting rising volume monthly after February 2007. For example, mortgage insurers wrote 190 percent more business this year, through April, than in the comparable period of 2006, when subprime/Alt-A were in their heyday.

To put that sort of gain into proper context, consider that even GSE production is only up 160 percent — and they are doing an estimated 80 percent of all new mortgage lending. By inference, MI providers have made huge gains in market share.

Let that sink in for a moment:  GSEs are doing an estimated EIGHTY PERCENT of all mortgage lending, up 160 percent.  IN AN ACTIVELY FALLING MARKET.  Any implied “worst case scenario” imagined last year of the US government bailing out the grossly irresponsible GSE lending facilities is quickly not only becoming a reality, but would represent a necessity unless the entire lending business  in the US becomes STATE OWNED.

State owned lending?

Is that such a bad idea?  I mean, we pretty much have so many controls that we expend an enormous amount of government money in oversight, what’s so wrong with giving the federal government the right to nationalize the largest lenders as they fail?

I’ll write the next part only partially tongue in cheek.

Lending is perhaps one of the great debatable rights of Americans in the 21st century.  We have become so conditioned by its availability to believe that it is owed to us.  We need it, we want it, we should have it.  If we want to create our own financial ruin, and by extension the country’s entire financial ruin, we should be able to do so.  It is our right as Americans.  By this rationale, we should allow all Americans the right to open access to low-cost lending much like clean air, clean water, food and drugs free of harmful contaminants, and an interstate transportation system.

For example, if free enterprise were required to finance our transportation systems, we would be required to pay for every trip we consume on local and long-distance roads.  This is where economics has a hard time playing the role of moral coach, because, frankly, Economics is concerned with the free market and the most efficient method of delivering the utility people desire.  Governments have typically only concerned themselves with PUBLIC NEEDS.  Therefore, the big question is, is real estate lending a PUBLIC NEED?

I am certain that many could make the argument for and against, but perhaps the question needs to be viewed in a longer timeframe.  Is lending STABILITY more important as an ongoing public need to ensure the ability to liquidate lending and homes in an orderly manner?  What controls and insurances should the government provide?  How should the government handle lending standards and manipulation?  Could there be a cross-control against lying using collaboration with the IRS?  What kinds of manipulations would this open up the home lending business to?  Would the government “crowd out” any potential competitors and therefore stifle competition?  Has the current role of home lending harmed the public more than it has helped?

In any case, the general public perception is that home lenders have harmed America, and therefore must be harshly dealt with.  I don’t agree with that.  I personally believe that the problems is on its way to being fixed by the free market, and frankly I’m not happy with the directors of the GSEs getting away with fat pensions, stock options, and the like while the public swallows the bad debt.  On the other hand, it would end, once and for all, the deceptive practices and level the playing field by nationalizing lending.  Frankly put, the government could recapitalize easier than a private entity or a stock-owned entity.

I have to say that I oscillate between incensed outrage and cold acceptance of the reality.  There is no simple answer to that.  Lending has changed forever (hopefully).

1. It seems that Bank of America essentially wrote the Dodd Bailout Bill along with Countrywide (merger expected soon). They have probably the most to gain with a generous bailout bill. It helps noone since it doesn’t resolve the fundamental problem of affordability in house, in fact it makes the problem worse. Ever wonder why the 90′s in Japan were referred to as the “lost decade”? It’s because their banking system did the same thing we’re trying to do here. Anyone else see the problem with not punishing gambling banks and housing speculators?

2. The “Subprime Six” were a group of lawmakers given special treatment in exchange for what? What exactly did Senator Dodd besides favorable treatment in his housing financing? What else could be lurking in his past? If you haven’t read about the “Subprime Six”, follow the link. Investor Business Daily, the Wall Street Journal, and the LA times have picked up the story. It’s a story of insider grift and political pandering. If it weren’t so real and true, it might remind me of one of my favorite film lines:

Stuart: Well, it’s a well-known fact, Sunny Jim, that there’s a secret society of the five wealthiest people in the world, known as “The Pentavret.” Who run everything in the world, including the newspapers, and meet tri-annually at a secret country mansion in Colorado known as “The Meadows.”
Tony: So, who’s in this “Pentavret?”
Stuart: The Queen, the Vatican, the Gettys, the Rothschilds, and Colonel Sanders before he went tits up. Oooh, I hated the Colonel, with his wee beady eyes and that smug look on his face. “Oooh you’re gonna buy my chicken, oooh…”
Charlie: Dad? How can you hate the Colonel?
Stuart: Because he puts an addictive chemical in his chicken that makes you crave it fortnightly, smartass.

3. For all of the crap that our President Bush gets, at least he has the foresight to threaten a veto to said bill. There should be no bailout, not just because it’s not fair and would embolden speculators, but because it’s destined to put our banking system in jeapordy for the forseeable future with taxpayers footing the bill. It’s generally understood that this bill has to be done and voted on by July 4th if it is to carry. Any senator that signs this (if it passes) is hopefully going to be thoroughly trounced in the upcoming elections. This is not only unreasonable, it’s unamerican. This place is going to hell in a handbasket. If something like that goes through, I’ll be posting a list of every person that voted for it and their political affiliation here as a feature story.

So, what do I recommend? I’d say get a year’s worth of food and 6 month’s worth of remaining expenses together, if our politicians have any say in it, this is going to be one whopper of a crash and accompanying recession. On the lighter side of things, our grandchildren will be still paying so that people like this can “keep” their homes (and by homes, I mean plural, because, isn’t every good American not just entitled, but guaranteed to own more than one house?).

Hard to believe this crappy site has lasted a whole 3 years. I was one of the first, and thank god, finally, I was exonerated as a non-insane person.

Makes me so proud.

And, a flashback is always great. Someday, we will see this as an example of how wrong people too close to it can call it:

So Subprime Blows Up; So What, Says Cramer

I believe a lot of that timing will come from Bernanke’s will to crush the housing bubble. If he doesn’t, it’ll be a long time before we can get well again. We need to take the tough medicine.

I always enjoy a discussion of how the mortgage mess that we find ourselves in can be “fixed” by using nontraditional methods.  For each of the parties arguing the solution, it often involves directly benefitting them, while the cost is to be borne by another group… “the marks”.

Mike Shedlock’s analysis of the CRL (Center for Responsible Lending) and FDIC’s proposed solutions is particluarly interesting.  His post is properly titled “The Debt Slave Act of 2005 Revisted“, which makes perfect sense considering how consumers have effectively been cut off from the one chance to make a clean break after devastating financial problems.  Instead, the newer law attempts to weed out deadbeat habitual spendthrifts from performing frequent and repeated filings to wipe the board clean every few years.  Instead, it has made it difficult enough to file bankruptcy that there is little to no possible way out.  In addition, with pledges to repay, many become debt slaves to past problems, unable to leave them in the past.

Don’t get me wrong, I’m definitely for personal responsibility in life, perhaps even too much; but the law as it currently stands puts a burden on already destitute people.  It has served to benefit lenders most of all.  So, it is with some twisted satisfaction that I read what Mish has to say on the matter… all of with which I agree.

First, he quotes a CNN Money article (shortened excerpt)

One consumer group estimates that 600,000 foreclosures could be avoided over the next two years by making a simple change to the bankruptcy code.

The Center for Responsible Lending (CRL) calls it a tweak, but it could be a significant change for homeowners and the market for mortgage-backed securities.
CRL’s proposal – reflected in a House bill recently introduced – would make changes to the regulations for Chapter 13 bankruptcies, which don’t wipe out debts, but rather establish a repayment plan.

Under current law, when a person files for Ch. 13 bankruptcy, judges cannot reduce mortgage debt owed on a person’s primary residence, although they may modify mortgages on investment property or second homes.

Under the House bill, the bankruptcy judge would have the option of reducing what the homeowner owes the lender. Say a homeowner’s property is worth less than what he owes. The judge could reduce the principal to match the home’s current market value as well as reduce the loan’s interest rate.

Mish also quotes the FDIC’s proposal:

The heat on U.S. mortgage lenders and servicers was turned up a few degrees this week when the country’s chief bank regulator publicly proposed that they permanently freeze interest rates on subprime adjustable-rate mortgages (ARMs) for many homeowners.

“Keep it at the starter rate. Convert it into a fixed rate. Make it permanent. And get on with it,” Federal Deposit Insurance Corp. Chairman Sheila Bair said in prepared remarks at an investor’s conference.

That solution is nearly as bizarre.

Now, before too many of my readers go off on rants considering how this is supremely unfair… consider 2 things:  first, if balances on loans can be decided in a court and lowered as a judge feels inclined, how many banks will want to loan money, and secondly consider what Mish has to say regarding “fixing” the ARMs:

It should not take a genius to figure out that if ARMs rates are “frozen” at a point where the market does not think rates should be, there simply will be no more ARMs offered. Furthermore, to cover the cost of existing ARMS, prices would rise on new fixed rate mortgages. Oddly enough, price fixing ARMs would not even help the person most at risk because that person cannot afford the teaser rate, let alone the cost of a current ARMS rate. Thus price fixing ARMs is a sure fired guaranteed way to cause a continued weakness in home prices, if not an actual out and out crash.

Which reminds me of the original Chuck Ponzi Law of Unintended Consequences:

If there is any chance that someone can get bailed out by someone else, they will, and you will have to pay for it from your own pocket.

Now, I’m considering that I have to add that while you may need to pay for it, anything other than letting the market deal with it efficiently will likely crash it anyway.  In the end, it is the same thing that my first Econ professor in college always said was the #1 rule of economics:  TNSTAAFL “There’s No Such Thing As A Free Lunch”.  No such thing.

I am willing to bet that any artificial means of attempting to “solve” the problem will only make it worse, both for the person they are trying to help, and the overall group of people.  The only people helped by the above solutions are those who have ALL of the following:

1. Long histories of repayment
2. Excellent credit scores
3. Lots of cash for a down payment, maybe up to 30 or 40% to prevent bankruptcy write-downs
4. Enough income to support purchases on fixed rates with lengthy work history.

This way, only the most qualified can purchase.  At current prices, there are likely only 1 to 2% of the people in the entire Southern California region who could fit this bill for an average home.  And, frankly, there is no way these people will live in an “average” SoCal home.  Imposing the suggested “solutions” will only serve to do three things:

• Depeen the credit crunch
• Crash the housing market
• induce a consumer-led recession, if not depression

The deeper the credit crunch, the harder and farther housing prices will have to fall to meet demand.  The harder and further prices fall, the more likely that good paying homeowners will walk away from an underwater mortgage.  More foreclosures dropping prices and deeper credit crunch will turn off MEW (Mortgage Equity Withdrawals) which is what has been keeping the consumer (along with their credit cards) in clothes, vacations, and Plasma TV’s.  A crumbled consumer is a crumbled economy.

When the service on debt becomes more than the income, defaults are certain.  Since US wages have been in real decline (against inflation), and the US dollar in severe decline, the loss of purchasing power has become an unbelievable crush.  Anyone who has not felt and seen the substantial inflation over the past 2 years has either been asleep or dead.  Even high-end wage earners have felt the sting of higher prices.

All of this leaves me very pessimistic about the local economy that has been so built on the fortunes of real estate.  I fear we may have much, much worse things ahead of us compared with the past few months.

It is no secret that in the past few years, we have seen substantial monetary expansion. Such is not necessarily the case today. A fellow blogger, Mike Shedlock, notes that we are in a very slow monetary growth period compared to years past in his post: “Is the Fed Deflating?”

It is very easy to prove the statement “the Fed is not massively printing” but people believe what they want to believe. However, Fed policies have been such to enable super easy credit transactions to take place by holding interest rates too low too long. When interest rates are held too low, asset bubbles build and credit/debt transactions soar. So does the velocity of money. But the Fed ignores these bubble (in fact even embraces them) as long as consumer prices are held in check.

Mish hit upon some very important points:

1. Inflation is time-lagged.

2. Bubbles are not inflation.

3. People believe what they want to believe regardless of the facts.

Inflation is Time Lagged

Inflation has a place in any money. Yes, even vaunted and irreproachable monies like gold can and have experienced periods of strong inflation when the purchasing ability of gold declined significantly. One such gold inflation periods happened with the California Gold rush in 1849, and later after the discover of dissolving ore in potassium cyanide in 1887.

Indeed, money produces nothing, it is merely a confidence play, though some have industrial uses (gold as an electrical conductor, or paper money as a combustible material to name a couple). Money is a confidence game… nothing more, nothing less. Only barter economies approach removing the “confidence” value. These tend to be terribly inefficient, and are not likely to return, regardless of what happens to our monetary supply. In fact, in today’s global liquid markets, many other assets have taken the place of money as a hedge to traditional fiat currency systems systematic devaluation.

Monetary inflation is valuable to prevent price deflation. In fast-growing economies, where gross domestic output is increasing as well as a growing population, if money were to become scarce, prices would need to drop to reflect that scarcity. To the counterpoint, monetary deflation is also valuable to prevent price inflation. If money is plentiful, removing that money from the market keeps prices from spiraling higher and higher. These facts are accepted in economics textbooks covering basic supply and demand relative to the money supply, and is well understood in all economics circles. So, if the answer is so simple, why don’t we simply measure one and react with the other?

You shouldn’t be surprised that our Federal Reserve has tried just that.

Unfortunately, other factors keep popping up that throw the next administration for a loop.

First, it was productivity as a deflationary force.

Then, it was a credit orgy as an inflationary force.

Then, it was a “savings glut”, reserve currency, or some other reason as a deflationary force (stockpiling dollars, removing them from spending).

As you can see, managing supply and demand is not as simple when poor information is available about who is holding the currency, and what they intend to do with it. Especially since there is a time-lag.

Basically, introducing currency into a system does not provide an immediate change in prices. This works in excellent principle in economics textbooks in perfect countries with names like “utopiaville” and “Gilligan’s Island” where perfect information abounds and prices immediately reflect available money. In addition, money is instantly used on whatever provides the most utility.

Unfortuately, humans are irrational, greedy, and inefficient. Prices are sticky. Expectations vary wildly and change in an instant. In this environment, a steady, stable central bank that moves slowly and ignores short-term glances while focusing on the long-term is likely to be the most successful. There are no heroes in this arena. Middle of the road beaurocracts are the name of the game. However, when forced by the situation, herculean pushes against inflation and short-term fixes such as the time when Paul Volker crushed the inflation of the 1970′s in the US with double-digit Fed fund rates.

Unfortunately, this is not the 1970′s.

Bubbles are not Inflation

This is the era of financial bubbles. These are extremely irrational price moves of assets where fundamental values detach from the current values. Increasing investment and overdependence on a specific asset class produce outsized gains, and more pile on, creating a self-fulfilling prophecy of higher prices and greater inflation.

Then it happens.

The bubble pops. It becomes self evident that the prices moves were irrational, and it painfully returns to it’s longer-term trend. Bubbles are not price inflation, they are driven by inflation. The only way that bubbles can form is by a single enabling forces: monetary inflation. Instead of the money chasing a fixed set of goods and inflating their prices, humans instead choose to purchase assets. That’s not inflation. It may look like it, but it’s only temporary, not systemic.

Before you begin to think that I am a current FED apologist, consider what I believe to be the root of financial bubbles… monetary inflation. That is controlled by the Federal Reserve.

People Believe What They Want

Regardless of the facts. Much like the crush of public opinion when the housing bubble was in full-blown effect, there is now a crush of opinion beginning to build about systemic inflation. Indeed, there is a growing believe in the infallibility of precious metals as a store of wealth. This has all the seeds of a future bubble in precious metals. If asked where I believe the next bubble will be, I’d put my money on precious metals. (and have put some)

Getting back to inflation, however, inflation is much like anything in the financial world… it acts like virus, and once it has infected enough, it spreads on its own, creating a self-fulfilling expectation of increasing prices. Expectations (or confidence) is the name of the game.

Unfortunately, like a virus, the only way to kill it or severely wound it is to remove its source of food… money. If people expect things to cost more in the future, they will stockpile that thing now, increasing demand for it and consequently prices. It is possible that much of the inflation of the 1970′s was a reaction to many Americans stockpiling food, water, and other resources in the shadow of the cold war. The same way that people fearing being priced out forever, they purchase more than they need now in the chance that they might need it in the future. Many people bought houses much larger, and in much greater quantity than their needs or abilities dictated in an attempt to remove that fear of running out.

Summing it up

Are we experiencing inflation? It depends on what you consider to be inflation. Prices are rising of many consumer goods. Conversely, a massive bubble is violently deflating. People’s incomes are not growing as quick as prices.

However, I can be confident about making one prediction. If housing prices in bubble areas do not come down fast enough, wages will need to increase faster than they have been. And, the Fed will allow the first while fighting the latter. As they say… don’t fight the FED.

While there are plenty of references to how the real estate market moved on the way up, one of the best descriptions is that of the Plankton Theory submitted by Bill Gross (Pimco’s “Bond King”), it is everpresent that the foundation of the housing market lies not only in entry-level homes and buyers, but also in lower-priced communities.  Without that “first house”, there is no property ladder.

However, the reckless lending was aimed directly at “getting people on the ladder”.  No matter how you look at it, these were in many cases people who would have never been able to buy a home, either because their credit, income, or both would not support it.  In many cases, these would-be homeowners have trouble with their day-to-day finances, much less than the kind of commitment required to buy, pay for, and maintain a home in the long-run.  No doubt about it, in the long run, buying a house is generally a smart move, but those who struggle with daily living expenses often do so, not because of their income, but rather their lack of financial restraint.

The OC Register takes us down Camile Street in Santa Ana:

A year ago, Angelita Medina Albarran, 47, a garment worker at St. John Knits, took out two loans from Fremont Investment & Loan to cover the entire $600,000 purchase price for 919 W. Camile St., a 1,450-square-foot bungalow. Her five grown children help pay the mortgage – $4,000 a month and scheduled to rise in May.

“La droga,” Medina Albarran said. That’s Spanish for “drug” – Mexican slang for a crippling debt. The people of West Camile Street, she said, are “endrogados” – hooked on debt.

With what happened to Fremont, New Century, and other imploded lenders that reads like the who’s who of subprime lending, it is unlikely that these drug addicts will be getting another fix.  When you consider that these people were paying $400 per square foot to live in one of the worst neighborhoods in Southern California, you can just begin to see the problem.  When I first moved to California in 1999, few places cost $400 per square foot, and only in the poshest neighborhoods (Beverly Hills, Bel Aire, just to name a couple).

This was truly subprime central:

A Register analysis of federal housing data pinpointed West Camile Street as a center of the subprime borrowing binge. In 2005, 75 percent of the home loans in the surrounding census tract were subprime.

That’s the highest concentration of subprime loans in Orange County and one of the densest in California. More than 200 neighborhoods in California, particularly in south Los Angeles and the Inland Empire, were similarly dependent on subprime lending. So were at least three dozen counties in other states.

What this means is that all of the wealth that was “created” in the last few years was primarily created by former entry level buyers selling and buying larger and so on up the food chain.  When these plankton are gone, there is no food for the chain and it dies off.

From April through June a record 17,408 California homes were lost to foreclosure, according to DataQuick Information Systems, a La Jolla real estate tracking company. The Center for Responsible Lending, which opposes predatory lending, estimates that 23 percent of subprime mortgages made in Orange County last year will end in foreclosure. That would be about 2,500 of the 11,000 homes bought with subprime mortgages, or 7 percent of the 36,000 homes bought last year in Orange County.

That would be only a small portion of what the larger problem is.  I wouldn’t be surprised to see 10 to 20% of the homes bought last year to enter foreclosure.  Never before has there ever been this kind of speculation, never before has there been so little to lose put down by buyers.

In a related link, another article trumpets that “OC is Home to many of the Top 10 Subprime Lenders”

Their list is as follows:

1. Argent Mortgage (Orange)

2.  New Century Mortgage (Irvine)

3.  Fremont Investment & Loan (Brea)

4. Option One (Irvine)

5.  National City Bank of Indiana (Indianapolis)

6. Countrywide Home Loans (Calabasas)

7.  Long Beach Mortgage Company (Seattle) a.k.a. WaMu

8.   WMC Mortgage (Burbank)

9.  Ameriquest (Orange)

10. Accredited Home Lenders (San Diego)

While you might marvel  that these top 10 represent over 40% of the subprime market, it is perhaps even more surprising to know that all but 2 are Southern Californian companies.  (although, I might count Long Beach Mortgage as well), but that these 90% of the top 10 by number and volume.  The remainder of the market is perhaps not as concentrated, but make no mistake, lending is the biggest business here.

When we feel the pinch, it will be doubly bad.  Not only were we selling the stuff, we were snorting it too.

Remember, kids, drugs kill.

I’ll leave you with this moment of zen.  21% of the outstanding loans in Orange County are of the subprime variety, and I’d wager a guess at at least that many Alt-A.  Much of those sources of lending are over 10% now, and even Jumbo Prime loans have jumped to rates and spreads not seen since 2000.  Since the median income has not made a substantial move in the past 7 years, you’d be believing a lie if you heard anyone tell you that OC housing prices won’t come down hard.  They will.

“This vast increase in the market value of asset claims is in part the indirect result of investors accepting lower compensation for risk. Such an increase in market value is too often viewed by market participants as structural and permanent… But what they perceive as newly abundant liquidity can readily disappear. Any onset of increased investor caution elevates risk premiums and, as a consequence, lowers asset values and promotes the liquidation of the debt that supported higher asset prices. This is the reason that history has not dealt kindly with the aftermath of protracted periods of low-risk premiums.”

While he didn’t do enough to prevent asset bubble from forming, at least he understands what the aftermath does.  “newly abundant liquidity can readily disappear”.

It reminds me of a post I made back in the heady days of September 2005, Greenspan’s Interesting Clarity.  Yes, nearly 2 years of blogging ago.

Where does this lead us? Well… we’re acting a bit like the japanese in our debt lending by accepting low risk premiums, and the longer this goes on, the greater the risk to all participants, lenders and borrowers. If liquidity were to be suddenly shored up by investors demanding a greater return for thier risk, or if percieved risk were to suddenly jump, borrowing would become much more difficult for buyers. Interest rates will increase accordingly. Even established buyers might not be able to purchase homes due to restricted risk premiums; all of which will only serve to slow the real estate market and put the power of purchasing into well qualified buyers.

It has been my assertion that the housing bubble was caused not by low interest rates, but by excess liquidity that banks could only farm out by lowering lending standards. It was this easy credit that was extended to a whole set of the population that had never before been entrusted with credit; this caused “neverending” demand. Much like college students that max out their first credit card, only to find that the payments exceed their income, many of today’s buyers will be unable to make payments in the future.

Our little “deflationary concern” may soon turn into a financial meltdown since problems tend to spiral: Increases of forced sales trigger lower prices, which triggers lower spending and more foreclosures; lower spending triggers more layoffs; foreclosures trigger financial losses for banks and MBS holders; financial losses triggers less liquidity; less liquidity triggers higher interest rates; which triggers more defaults on ARMs and HELOCs… the list of effects could go on forever. Our economy is increasingly dependent on house price appreciation, but 2 things keep these trees from growing to the sky.
1. Credit has limits, since some risk premium must be attached to borrowing money, and interest must be charged. Investor sentiment is everything here.
2. Even a leveling off will decrease construction jobs that will kick-off the above process, so increasing growth is necessary to keep the merry-go-round going.

As you can see, it is easier to predict WHAT is going to happen, opposed to WHEN it is going to happen.  It was surprising to me that the housing boom ended with a consumer-led paring back of purchases, as I had expected the lending environment to tighten considerably before it did.  What this likely means is that while it postphoned the inevitable crash, it will likely only amplify the severity of the downturn.  As they say, the bigger they are, the harder they fall.

However, not trying to be a Monday morning quarterback, but had the FED raised rates twice more as I had hoped they would, they would have had an additional half-point lowering room when the credit event happened.  The fact that they did not either says that they did not understand the extent of the credit market’s problems and attendant risk mongering, or they simply believed (and perhaps still do) believe that the credit markets can self-correct without affecting unemployment, or currency attractiveness.  It may be that with the weakness exhibited by the currency, Ben B. should likely be raising rates when the world is calling for cutting them.  It’s always easier to get out in front of the problem than cleaning up after the mess, but when has the Federal reserve done that since Paul Volker?

In the first quarter of this year, roughly one of every 41 subprime loans was entering foreclosure, and more than one of every six were delinquent, according to the Mortgage Bankers Association. Those are the worst mortgage default statistics since the Great Depression. And it’s likely to get worse because the 2006 crop of mortgages, which will start resetting next year, were of a particularly low quality. Many carry prepayment penalties and could reset by as much as 5 percentage points when they do adjust.

Good thing it’s “contained”, right?

Remember the good ‘ol days when Subprime was “contained” and we were all just lauging at all of those people with bad credit who were going to lose their homes while we with good credit were sipping Mint Juleps and smoking cigars? Those were the days, right?

How fast a month passes. Impac just created a massive earnings crater.

Impac Mortgage is an Alt-A lender.

If you’re not sure what that means… it’s basically people with good credit, but can’t qualify for traditional loans due to “unreported income” (aka wink, wink, nod, nod)

While the reality could conceivably not be as bad as it now seems, their book losses this quarter were $112M. Which, by most peoples’ standards, is a lot of money (except rich people who own homes in SoCal) However, much of that loss is a book write-downs. The big question is, does it get better from here on out for them, or worse? Does the future hold more, or less write downs?

It is important to remember that in the heyday (just months ago), bubble bloggers everywhere stated that loan loss reserves were incredibly low. Making up for the difference is going to be painful for current shareholders.

Bad Weather, unseasonably good weather, or just the housing slump.

Either way, consumers are pretty much maxed out, as Market Watch tells us. None of this is surprising in light of the ongoing credit contraction and reduction of MEWs going on in the credit markets.

I highly recommend a good read of Barry Ritholtz’s take on “Retail Sales = Hard Landing?”

One of the early casualties of the downturn is Tweeter Home Entertainment who yesterday announced a possible bankruptcy filing and whose stock has dropped from over $8 to currently trading at $.35 over the past year. I surmise we haven’t seen the last of retail pain in this recession.

New Century is now Old Century and some such garbage.

New Century announced that 2000. Yes, 2000 employees will be severed tomorrow (no, not their limbs, just their jobs).

From Forbes:

Financially strapped subprime mortgage lender New Century Financial Corp., failed to receive any bids for its mortgage loan origination business, forcing it to shut down the unit and lay off around 2,000 employees, the company told employees Thursday.

The Irvine-based company, which has been preparing to sell off its assets under Chapter 11 bankruptcy protection since last month, notified employees during a conference call that they would be laid off effective Friday.

Speaking on the call, New Century President and Chief Executive Brad A. Morrice said despite a number of potential buyers for its wholesale and consumer-direct operations, “none of those potential deals have come to pass.”

Just who those original “suitors” were remains a mystery to the outsiders. I remember clearly the day that it was announced that 6 companies had thrown their hats into the ring. I guess there was a realization that little to no value remained in that portion of the business. Of course, not all is lost, the servicing arm has already lined up buyers.

It’s good to take a look back at how hopeful that really was. Irrational Exuberance?

Interestingly, last night, my wife made me watch American Idol. One of the departing contestants (I don’t know or remember who) sang the Bon Jovi hit “Blaze of Glory”.

Therefore, I dedicate this video to New Century:

No I aint looking for forgiveness
But before I’m six foot deep
Lord, I got to ask a favor
And I’ll hope you’ll understand
cause Ive lived life to the fullest
Let the boy die like a man
Staring down the bullet
Let me make my final stand

The suit, filed in Florida by Bankers Life Insurance Co., is “one of three to five in the pipeline” involving securitizations by Credit Suisse, Switzerland’s second-largest bank, said Dale Ledbetter of Ledbetter & Associates P.A., one of two law firms representing the Bankers Financial Corp. unit.

“We suspect that once people understand what occurred here, there’s going to be a lot more,” Ledbetter said. A total of $302.6 million of bonds were originally issued in the deal.

I concur. Once people understand the implications, the flood of lawsuits will make even the security packagers wary to get involved. Nothing like a little risk in the system to flush out the bad blood.

What are the charges?

Credit Suisse units caused Bankers Life to lose money by overstating how much of losses after foreclosures on the loans insurance would cover; accepting “shoddy, inferior” loans; failing to buy back fraudulent ones; and covering up delinquencies, according to a complaint filed April 23 in Tampa. Payments were being advanced on borrowers’ behalf to “maintain the illusion” defaults weren’t occurring, Bankers Life claims.

Whoah. If true, noone will touch a Credit Suisse bank with a 10 foot pole. Those are some heavy accusations of outright fraud for a company whose livelihood is based on trust in their products.

The natural question asked would be… but Chuck, haven’t you been telling us all along that many of these securities are sold with default insurance when they are packaged? I mean, insurance companies are willing to accept lower returns as long as it is guaranteed, after all state insurance commissions won’t allow risky investments, right?

Good point, readers, except in this case, the insurer denied the claim. Didn’t think that could happen? Think again:

Triad, which provided both loan and pool insurance, failed to pay claims for default loans because it claimed they were fraudulent, without responding to Bankers Life’s requests for more information, the complaint said. Bank of New York failed to report when the claims weren’t being paid, Bankers Life says.

The insurer also claims Credit Suisse misrepresented that the loans were from “highly credible financial institutions” when they were made by smaller lenders; put adjustable-rate loans in pools that borrowers couldn’t later afford; and didn’t pursue foreclosures and insurance claims appropriately.

The next question is the best… will we see any cross-defaults when more of these surface? If so, hold on for the financial ride of a lifetime… it’s gonna be a doozy.