Alan"s Money Blog

Aug 28, 2007

A forex trader's opinion on the subprime mortagage debacle

Here is a very informative e-mail I received from Mr. Felix Homogratus from whom I receive forex trading signals on a regular basis. Some of you might know and already subscribe to his free service. Anyways, he sent out this informative e-mail that shares what a forex trader thinks about the whole sub-prime mortgage debacle. Enjoy it, and hopefully it will enlighten you on the current situation.

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My partner Rob Grespi, from, was recently asked to write an article for a major financial magazine in Europe, regarding the current economic condition of the US, and subprime mortgage crisis. As a courtesy, he wanted you to get this article, before all the other readers of that magazine get it :) Here it is:


Due to the recent market volatility, provoked by the sudden "subprime loan debacle", many subscribers have been interested to know my personal view on this subject, especially that it is something I have been talking about for the last 4 months. But before I go on with this little dissertation I want you to understand that I don't pretend to be an economist, I simply use "basic economics 101", which is something our financial leaders maybe should use.

Basically, when it gets to be complicated and does not make sense, chances are it isn't right. However I am convinced that they basically complicate the principles of a healthy economic logic so that the average unaware person gets lost and therefore doesn't ask any questions in fear of sounding stupid, or they just repeat what they hear on the media to sound educated during cocktail parties.

I told my subscribers in the room that the recent hasty moves from the Fed, (from several massive injections of cash into the market to the recent 1/2 point rate cut was a desperate and hasty move. This "patch the holes" moves, is rendering the market a great disservice, and it will make things a lot worse for the long term.

Basically, the Fed is adding water pump to a sinking ship, instead of fixing the holes, and eventually the ship will sink anyway, because nothing has been fixed. But I don't think they care, they need to make the masses feel better now, because they need a happy consumer to keep on buying crap.

However as harsh as it sounds and as painful as it will be (but not a politically popular move) it is a needed economic cycle, needed to purge the excess and this imbalance that have been created in order to begin a new healthy, and lasting positive economic cycle. The "band aid solution" ( "instant feel better") will only delay the inevitable and once it comes, instead of going thru a "mild and short recession" it will be a lot more painful possibly creating if not a depression but at least a SEVERE long and VERY painful recession .

This credit debacle is far more serious than most even begin to realize, and here is why I think so:

I have been talking for quite a while now (way b4 all this emerged) that we are at a critical credit and liquidity imbalance , and it goes all the way down to the low income consumer. Our consumption society as a whole is now mostly based on borrowed money, practically no one nowadays has the discipline to save his cash to buy XYZ item or a car or take a vacation. Most spend more time planning "credit vacation" than they spend planning healthy finances.

For example I have witnessed in both Europe and the US (I have lived in both continents long enough and have the advantage of knowing both very, very well) and observed consumption habits on both continents and the similarities are very scary, of course the US is by far still the "the leader of the pack".

In general I have observed that families with medium limited incomes were basically shopping on credit most of the time, either for clothes, cars, food, electronics, and vacation. During X-mass time I was amazed to see so many getting trapped in the "buy now pay later" ingenious concept of stores, not to mention store's credit cards which of course are a dangerous sucker trap. Nowadays just about everything they have in their house doesn't belong to them, but to the financing company, and that includes X-mass toys and vacation they took 2 years ago that they are still paying for, and of course expensive cars.

In my parent's days they saved for everything. But at the end whatever they had in their house was 100% paid for, their vacation was 100% paid for, and they still managed to save some hard cold cash for rainy days.

Today the people not only don't have a decent nest egg, they just don't have any, but they drive Mercedes, BMW's, have entertainment centers that would make George Lucas look like a hobo....

In my parent's days whomever was driving an expensive car (well most of the time) really could afford it and actually had money. Today I see in Europe for example, 20 year old kids making 1.500 euro/month at best driving expensive automobiles. Basically, this consumption society is completely out of whack and is imbalanced.

So when it comes to people and real estate, why are we so surprised? It is the same mentality, they have used their overpriced houses like an ATM machine, courtesy of clever and creative financing method to either make some other ludicrous over priced real estate acquisitions they can't afford (hell, they could barely afford the first one in the first place if it had not been for ("creative mortgage facility"), or buying all types of useless adult toys, not to mention extravagant home improvements or vacations.

They bought into the nonsense of these realtors and the media that real estate would go up indefinitely, these realtors, most of whom are no more than improved shoes salesmen and Tupperware housewives have been taught in an 8 hours seminar learning the cookie cutter classic economic theories why real estate will always go up. The funny thing is I hear the same logic being used in the US and in Europe. They all must attend the same 8 hours seminars, and all become economic experts at the end of it, why not!!! They have certificates of completion to prove it...And the media is basically owned and operated by the ones that want the mass to consume and spend for the benefit of some other companies they own. "The basic Asylum runs by its patients"

Now you might think what is then the relationship with subprime loan? well here it is in a nutshell: ( I will simplify the process for you):

This is what Banks, and financial institutions do (which are more worried of making short term money to obtain fat bonuses and fat executive salaries):

They borrow money in Yen (Japan has the lowest interest rate of all industrialized country) actually at almost 0 %, and they either invest in equity and debt markets around the globe (also creating a bubble on borrowed money, btw), and also they loan that borrowed money to other financial institutions that create all sort of "exotic mortgages", and "credit facility", you name it. Then some other layers of financial institutions re-package all these different forms of loans into high yield financial instruments to be parceled out and sold back to the financial institutions that had borrowed money in the first place. Basically, they are creating a gigantic credit Ponzi scheme on borrowed money with the consumer as its base for guarantee, and since the consumer himself is over extended, I don't need to tell you what will happen next.

Of course we try to find an easy typical fall guy "Wall Street" for creating all these derivative instruments, all they did is they found an opportunity and ran with it to make money.

The real "crew of culprits "are the highest and also the lowest level on the food chain, the higher ones: well, we vote for them and the mass buy into their self serving demagogic promises and speeches, the lowest one is the consumer gullible naivety, and greed.

Almost all financial experts want us to believe that whatever the fed is doing is good. Think again.

This will not save the people that are about to lose their homes, this will not save the basic overextended consumer, since most all exotic Mortgage and credit companies are closing their doors anyway, and even the conservative ones are now on "survival mode", they will not cut any slack to the overextended and delinquent consumer, on the contrary. No matter how much liquidity the FED is pouring and no matter how many times they cut rates. The surviving institutions are now in contraction mode, too busy doing damage control or even saving themselves. The only money they will loan back in the market will be to people that don't need it.

The only thing you will see will be fake "dead cat bounces" but at the end the real estate is "cooked" (actually it has been cooked for over 2 years , the masses just didn't know it yet and still don't even know it or to what extend it will be cooked). Houses that are sold today for 2 million dollars they will be lucky to get 1 million for it, and if they even get that.

Keep in mind that in the next year another $700 billion or so of "adjustable mortgage are due to reset, that is over $170 billion more than this year, and more adjustable mortgages will be reset after 2008.

This massive liquidity and credit imbalance which started over that last 20 years or so is only about to enter a severe readjustment and it has barely just begun. I just don't know how long and how it will play out, but it will play out.

Of course the Fed/government will play some of its "voodoo" economic short term magic tricks just in time to benefit some "crooked, lying, greedy, performing monkey ass politicians" election or re election, and it will make the "masses" feel better in short term, just in time to cast their vote, all this trumpeted by their favorite interested (paid off or own) accomplices "cheer leaders", the media.

Also don't forget, because it is related and will play a major role in this grand skim of things, that the US is running an unprecedented account deficit , basically in less than 8 years the current US administration have borrowed more money than any other administration put together, so if the country enters a severe recession ( which I think it will ) not only the US government does not have a "nest egg" but it has blown its wad by already overextending itself "debt wise" and in a period of decent economic time I may add, (for their own benefit btw, but that is another subject all together) .

So when we finally enter this severe recession the US government has already blown most of its "borrowing options"(during the good times), the only option it has left will be to go much deeper in debt rendering the US dollar as valuable as the pesos, the consequences of that will also be severe, and they will have to raise taxes drastically, just to pay the " bar tab" of the previous administration. So when I hear deficit don't matter they will re think that theory very soon, but of course the "fearless leaders" who left the restaurant with this "orgy tab" will be out of office by then, enjoying their pontificated retirement and collecting book deals, consulting deals, speech deals, and other corporate deals they worked out before, leaving the already over extended US taxpayers to pick up the "orgy bill" (via increased taxes) for decades to come. Hell, the US taxpayers are still paying for the S&L debacle they don't even know it, but trust me there (that was when Mr. Bush senior was VP, interestingly enough, most best S&L debacle asset that went into auctions were picked up at ridiculous bargain prices by some of Mr. Bush Senior's friends .The public was only allowed to bid for the chairs and tables and the bailout package was provided again- courtesy of the taxpayers.


It's Felix again :) So I finished reading this article, and I am like: "So Rob, what's your point?" I guess I like to transfer everything into practical advice.
Here is my opinion on this whole situation. After the Great Depression in the US, World War II followed. During World War II, people went into factories to build military equipment, in order to satisfy the demands of the War. After the War was over, the momentum of American production stayed, but instead factories shifted to producing a lot of the goods for local consumption, so the economy flourished. Now history repeated itself with Asia. Asia was in a mess, before the Americans started to massively consume the goods that were produced there. Asians have been working very hard for very little money to satisfy the Americans and Europeans. The only problem is that instead of paying them real money, the US has mostly been issuing them a bunch of "I owe you X amount notes". And then the US consumer has been buying these goods by issuing the same notes to its government. One of the reasons why the US economy flourished so much is because it's been getting basically stuff for FREE :) Everybody thinks that Asians depend on the US and will keep giving them free stuff forever, but they have such big population, and they have so much momentum in their economy that when the time comes, they'll simply make a similar switch like the US did after World War II, and will simply start consuming their own produced goods.
So what's the point? The point is that the US has been issuing so much money in order to continue getting stuff for free, that it even stopped reporting its money supply a while back. Bottom line is that I think that every person that currently owns US dollars is extremely lucky, because they own something that has a lot more buying power than it's supposed to. So if I were you, instead of using your dollars to buy consumer goods that will depreciate in value very rapidly, I would buy something that's more real and permanent, like gold and silver. Imagine that you own a bunch of toilet paper, and by some madness, everybody thinks that it's worth a lot, but you as a sane person realize, that very soon there will come a day, when people will realize that toilet paper has value indeed, but not as much value as everybody thought it had during this madness.
Anyway, that's my take on it, I may be wrong. I know most Asians are very nice people, so they may just forgive all the debts, and consider that all the manufacturing work they did was nice exercise for their bodies, and they loved doing it so much, that they don't mind not getting paid for it.

Thanks :)

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