Markets plunge on credit woes

Source: Reuters

NEW YORK (Reuters) - Stocks tumbled on Monday as investors worried rising mortgage defaults and credit market losses will drag on the economy, fueling fears that consumers will slash spending during the vital holiday season.

The decline, led once again by big drops in financial services stocks, erased year-to-date gains for the benchmark S&P 500 index.

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"People are trying to figure out about the slowdown, and more and more people are thinking more seriously about how severe the economic slowdown is going to be," he said.

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The slide took the indexes down more than 10 percent off their 52-week closing highs set last month. Market technicians consider a drop of this magnitude as a correction in an index or an asset.

Read more: http://www.reuters.com/article/topNews/idUSL235606420071126?feedType=RSS&feedName=topNews&sp=true

November 26, 2007
OP-ED COLUMNIST
Winter of Our Discontent

By PAUL KRUGMAN
“Americans’ Economic Pessimism Reaches Record High.” That’s the headline on a recent Gallup report, which shows a nation deeply unhappy with the state of the economy. Right now, “27% of Americans rate current economic conditions as either ‘excellent’ or ‘good,’ while 44% say they are ‘only fair’ and 28% say they are poor.” Moreover, “an extraordinary 78% of Americans now say the economy is getting worse, while a scant 13% say it is getting better.”

What’s really remarkable about this dismal outlook is that the economy isn’t (yet?) in recession, and consumers haven’t yet felt the full effects of $98 oil (wait until they see this winter’s heating bills) or the plunging dollar, which will raise the prices of imported goods.

The response of those who support the Bush administration’s economic policies is to complain about the unfairness of it all. They rattle off statistics that supposedly show how wonderful the economy really is. Many of these statistics are misleading or irrelevant, but it’s true that the official unemployment rate is fairly low by historical standards. So why are people so unhappy?

The answer from Bush supporters — who are, on this and other matters, a strikingly whiny bunch — is to blame the “liberal media” for failing to report the good news. But the real explanation for the public’s pessimism is that whatever good economic news there is hasn’t translated into gains for most working Americans.

One way to drive this point home is to compare the situation for workers today with that in the late 1990s, when the country’s economic optimism was almost as remarkable as its pessimism today. For example, in the fall of 1998 almost two-thirds of Americans thought the economy was excellent or good.

The unemployment rate in 1998 was only slightly lower than the unemployment rate today. But for working Americans, everything else was different. Wages were rising, yet inflation was low, so the purchasing power of workers’ take-home pay was steadily improving. So, too, were job benefits, including the availability of health insurance. And homeownership was rising steadily.

It was, in other words, a time when Americans felt they were sharing in the country’s prosperity.

Today, by contrast, wage gains for most workers are being swallowed by inflation. In fact, the reality for lower- and middle-income workers may be worse than the official statistics say, because the prices of necessities like food, transportation and medical care are rising considerably faster than the Consumer Price Index as a whole. One striking statistic: the cost of a traditional Thanksgiving turkey dinner was 11 percent higher this year than last year.

Meanwhile, the percentage of Americans receiving health insurance from their employers, which began to decline in 2001, is continuing its downward trend. And homeownership, after rising for several years on a tide of subprime mortgages — well, you know how that’s going.

In short, working Americans have very good reason to feel unhappy about the state of the economy. But what will it take to make their situation better?

The leading Republican candidates for president don’t even seem to realize that there’s a problem. A few months ago Rudy Giuliani, denouncing Hillary Clinton’s economic proposals, declared that “she wants to go back to the 1990s” — as if that would be a bad thing.

In fact, memories of how much better the economy was under Bill Clinton will be a potent political advantage for the Democrats next year.

But simply putting another Clinton, or any Democrat, in the White House won’t ensure that the good times will roll again. President Clinton was a good economic manager, but much of the good news during the 1990s reflected events that won’t be repeated, including low oil prices and the great medical cost pause — the temporary leveling off of health care spending as a percentage of G.D.P. that took place in the 1990s despite his failure to pass health care reform.

And there are good reasons to think that the negative effects of globalization on the wages of some Americans are larger than they were in the ’90s. That’s a hugely contentious issue within the progressive movement, with no easy resolution. I’ll write more about it in the months ahead.

Despite these caveats, Democrats have every right to make a political issue out of the failure of the Bush economy to deliver gains to working Americans — especially because conservatives continue to insist that tax cuts for the affluent are the answer to all problems.

But Democrats shouldn’t kid themselves into believing that this will be easy. The next president won’t be able to deliver another era of good times unless he or she manages to tackle the longer-term trends that underlie today’s economic disappointment: a collapsing health care system and inexorably rising inequality. Louis J Sheehan

The actual mortgages are a small minuscule piece of this fraudulent financial mess widely being called subprime. For each dollar of foreclosed mortgage debt, there are many dollars of other debt leveraged on top of it by banking and investment firms. Then on top of it all are all the derivatives wedged in by hedge funds.

But the poor mom and pops trying to keep a roof over the family keep being blamed.

And, this fraud is bigger than the savings & loan bailout and bigger than Enron but no one is really talking about it as being fraud.

It is definitely the fault of the lenders lending irresponsibly to people who clearly could not pay back the loans. Lending to people that don't have money is, in a word, retarded. The trouble was the shortsightedness of the business that saw others making money originating any loan they could get their hands on, securitizing a bunch of them, and sending them off to the general market for investors to buy. The trouble is that with interest rates so low, investors needed to make riskier loans to get higher returns - gotta get the juice! Same thing in corporate credit with people investing in "covenant-lite" investment grade bonds (to get higher interest rates)...only to have an LBO occur, fucking them over in the capital structure with other creditors lining up in front of them in an entity levered to the gills. Credit markets had spreads that were just way too tight and everybody was along for the carry since shorting credit was so damn hard....that is, until they got carried out!

Banks and I-Banks invested heavily in mortgages through CDOs (That package mortgages together in different classes (or tranches)). In order to get the juice that investors wanted, they would invest in the traunch that suited them - the banks would often sell out the "risker" tranches and just hold the AAA rated tranches thinking they were virtually risk free...trouble was that they were not. An individual loan in the AAA tranche would have been viewed as almost default free at the time of issuance...but this is a big group of similar loans....so if some of them start defaulting and the correlation is big (and grossly underestimated), then many of them start defaulting....these AAA tranches that should not have any default risk are selling for pennies on the dollar - and the banks are levered up on these babies, so a 20% default rate in the CDO absolutely CRUSHES them...and you get these enormous writedowns like Merrill's $9B writedown and all the other monsters coming our way.

Ratings agencies (S&P, Moody's, Fitch) badly miscalculated the ratings of the AAA tranches...they clearly had no understanding of the evils of high correlation when things go to shit.

I have been rambling....for sure...That said, one part of your post, I do disagree with:

"For each dollar of foreclosed mortgage debt, there are many dollars of other debt leveraged on top of it by banking and investment firms."

You insinuate that banks should not be levered. Then they are out of business. The very nature of the business requires leverage - and lots of it. Which is why a good risk management system must be in place. That was what was lacking (unless your bank was Goldman Sachs - who outmaneuvered, and made a huge killing by shorting the subprime loans).

making $60K a year in 1998 are now making $7/hr flipping burgers or working at Wal-Mart because their job was outsourced to the Chinese, and the only jobs that were created to take the place of those outsourced jobs were motel maid or lettuce picker jobs that you have to compete with undocumented workers to get.

There are way too many highly educated people working as cashiers at the local mini-mart nowadays.

American's minds have been washed by optimistism; that things will get better and work themselves out; that, this too, shall pass (quickly); that time heals all(financial) wounds. Ain't necessarily so and pessimism is met with a "oh, you're exaggerating" mentality - it won't be THAT bad.

It's time for the Plunge Protection Team!

I have a feeling we're going to see plunges very often over the next several years. ;)