Beyond The Credit Implosion

From: Charles Hugh Smith
Sublime Subprime: Beyond The Credit Implosion
To investment bankers packaging all those mortgage-backed securities and derivatives (CDOs), subprime/exotic loans were indeed sublime. Despite daily exhortations by financial leaders such as Treasury Secretary Paulson that the credit meltdown was "contained," we find that the credit reactor core has in fact burned through its containment shield and is in full "China Syndrome"--i.e., burning straight through the Earth to the Central Bank of China, who holds $1.3 trillion in plunging dollars and billions in MBS and other rickety U.S. credit instruments.

Like drops of water falling, each mortgage default in the U.S. is a seemingly small amount of money. Yet as the defaults grow into the hundreds of thousands, they come together to form a mighty river of fear cutting straight through the soft sand of the global credit markets.

The credit "dislocation"/panic doesn't stop with subprime. Take a look at this chart of total U.S. mortgages, and see how few are "safe" 30-year fixed-rate loans:

Add in all the other at-risk loans--FHA/VA, alt-A, no-down, adjustable-rate and HELOC--and you get a domino effect which is unstoppable:

The defaulting of tens of thousands of mortgages promises to topple dominoes far beyond the mortgage credit markets. Consider just this small sampling:

* Local government tax revenues immediately drop. Empty houses, bankrupt/closed lenders-- who's responsible for paying those sky-high property taxes which have fed the spectacular growth of local government spending? Answer: no one. Good luck on finding someone to pay those overdue property taxes, and good luck on finding a buyer willing to pony up thousands in taxes to clear the title. The Housing Bust: Local Government Fallout.

Let's say the eventual "owner" of the property claims the house is worth $300,000, and tries to sell it for $280,000, telling potential buyers that they've dropped the price to reflect the $20,000 in property tax liens which have to be paid by the new buyer. Who will be dumb enough to think this is a good deal? Very few, I suspect, for everyone knows the house may well actually be worth $250,000--who even knows? Meanwhile, every 6 months the tax liens grows larger.

* Mosquitoes breeding in stagnant swimming pools. A seemingly trivial concern? It will suddenly seem very serious when someone you know comes down with West Nile virus. Vacant pools leave neighbors swimming in mosquitoes (USA Today)

* Lawsuits over shoddy construction will clog the courts and may eventually drive teetering homebuilders into bankruptcy. Readers of this humble blog have known about this issue for a year: Construction Defects: The Flood to Come? (June 1, 2006)

and Construction Defects, The Flood to Come, Part II (June 3, 2006).

BusinessWeek finally woke up and ran a story this week: You Call This A Home? The next boom for builders may be complaints from angry homeowners.

* Nervous foreign owners of dollars, U.S. mortgage and corporate bonds may decide to cut their losses and unload some of their holdings. These owners are unlikely to be persuaded by Paulson and Company's sweat-flop pleas to buy more or even hold on: China stopped buying US mortgages in May. Even modest selling could beget further selling, creating a selling frenzy beyond the control of our financial markets' handlers. Thus do raindrops become rivulets which becomes streams which join into a massive unstoppable flood.