Note: For readers not familiar with the concept of our “Melmania” section,
this is where your editor can take any subject and develop arguments regarding
some ultimate conclusions. Since some of those conclusions might sound
extremely radical, the name of “Melmania” seems appropriate.
Without attempting to use hyperbole or undue
exaggeration, it is our opinion that the potential for a perilous meltdown of
the American financial system is growing and, while that may sound outlandish,
once the charts of several formerly-outstanding financial corporations are
examined, it is difficult to escape the conclusion that we are witnessing
something far beyond the ordinary fiscal correction.
The beginnings of the crisis can be clearly traced to the tremendous explosion
of values of residential real estate in the United States of America. Prices
began to rise swiftly in the late 1990s, abetted by incredibly ‘easy money’
policies which saw short-term interest rates driven down to as low as 0.75%.
Other contributing factors included the removal of virtually every lending
restraint by the residential mortgage industry which resulted in a slew of loans
to unqualified borrowers. These loans became known as ‘subprime mortgages’ and
the equally widespread usage of Variable Rate Mortgages which resulted in early
low loan payments, enabled huge numbers of new buyers to afford a home purchase.
Unfortunately, the payments designated by these latter type of mortgages called
for sharply rising monthly payments in the forward years.
In point of fact, however, there was so much confidence in the irreversible tide
of rising real estate values that few lenders were concerned about their
customers’ ability to pay at all, since rising values would likely result in
(very profitable!) re-writes of the loans within one or two years.
Also, there was another factor at play which removed much of any lingering risk
to the original lender. These loans were frequently ‘packaged’ into groups and
sold to second-level buyers who were quite willing to acquire them because they
were insured by some of the world’s largest mortgage insurance corporations and,
since those packages (known as “Asset Backed Commercial Paper”) possessed that
insurance coverage, rating agencies such as “Standard and Poor’s” and “Moody’s”
were rating the packages “AAA” so they qualified for all manner of fiduciary
And so, it was a marvelous picture. Home values were soaring. Millions of new
buyers and old time home-owners marveled at their improving financial status and
their ability to use their homes as a kind of “ATM” from which they could
withdraw bundles of cash almost at will. Consumer-driven businesses prospered
and the banks were delighted, since their loan fees multiplied, both from the
original mortgages and the re-financings. Mortgage Insurance companies made
fortunes as the number and variety of mortgages - all containing some form of
their product - proliferated Seemingly, there was no-one unhappy at all - except
for a few cranky analysts who declared that these skyrocketing residential home
values could not be sustained over time and were bound to correct.
Fast forward now to early 2007 when that correction arrived with a vengeance.
Values began to drop, slowly at first and then with greater rapidity. The loan
rewrite industry, based on ever-growing equity levels, began to flounder and
slowed down dramatically. Suddenly, hundreds of thousands of home owners found
that they would really have to make their monthly payments out of current
income, a literal impossibility for multitudes. Others found that they could
sustain payments during the early stages of their Variable Rate setups, but once
the higher payment schedules kicked in, they rapidly fell behind in their
Foreclosures began to grow, first by a few, then becoming a veritable tidal
wave. Most importantly, quotations on the value of the ABCP holdings began to
fall and those corporations that held them as one of their core values,
including hedge mutual funds, major brokerage houses, some banks (particularly
one in northern England), began to find themselves in varying levels of
difficulty and those companies specializing in mortgage insurance found
themselves falling into increasingly vulnerable positions. As the scope of the
total problem began to become apparent, being estimated at anywhere from two
hundred billion to two trillion dollars, the selling began in the financial
industry and, despite short-term rallies, has reached epic proportions.
Below, please find a few charts that represent the tremendous losses which have
taken place. Also, please note that discussions regarding these corporations are
being used only as sample illustrations of the problems. They are certainly
neither buy nor sell recommendations on the stocks.
MBIA (symbol: MBI, NYSE) - This corporation is perhaps the largest single
mortgage insurance company in its field, plus it also handles many other
financial services. After years of slow but steady performance, the stock of
MBIA began to fall in early 2007 and then plunged dramatically in the second
half of the year, wiping out over 80% of its value.
Countrywide Mortgage (symbol: CFC, NYSE) - Countrywide enjoyed years of solid
profits and prosperity during the real estate boom as demand for its mortgage
services grew steadily. Credit losses were low, profits were high and investors
had few reasons for displeasure. Then, suddenly, the picture changed. Throughout
2007, as the real estate crisis intensified, the stock began to collapse,
eventually falling from a high of near US$45 to a low of under US$5.00 - a loss
of about ninety percent of its value!
Bear Stearns (symbol: BSC, NYSE) - One of the world’s largest financial
brokerage houses, BSC began to run into trouble when a couple of its mutual
funds showed signs of being unable to redeem their obligations. BSC had to
borrow substantial sums just to remain solvent and the stock began to fall. By
early 2008, BSC was down from a peak of US$172 to the mid-70’s, wiping out
fifty-seven percent of its value!
Washington Mutual (symbol: WM, NYSE) - Washington Mutual is one of the world’s
largest savings and loan associations. Until early 2007, WM had built
shareholder value by becoming one of the largest mortgage lenders in America.
However, during the past year, shareholders are probably wishing they had never
heard of the company as the shares have plunged from a peak of near US$45 per
share to under US$11, a loss of three-quarters of their market value.
There are many other additional companies that could also illustrate the point,
but what has been shown makes one conclusion obvious and that is we are not
looking at a ‘garden party’ type of event. The magnitude and speed of the
collapses in these elite financial corporations tells us something unusual is
going on, and there is no sign it is over yet. In fact, based on the continual
decline in home values, worsening Unemployment numbers, diminishment of the
consumer-driven economy and the relentless wave of bad news that continues to
plague these markets, it is quite possible that what we see developing could
turn into a full-blow financial panic.
Should that occur, it would likely be immensely - and we do mean immensely -
bullish for the precious metals markets.