Wednesday, August 08, 2007

It's About That Time

Before I get started, I would like to welcome my visitors from Germany. I lived there for three years, and I have a lot of family over there, so I am glad to see so much traffic coming in from Deutschland. Servus!

At any rate, there have been some interesting developments this week. If you haven't seen it, check out this segment with Jim Cramer from Mad Money. Here's the clip:

Although a lot of people called that a 'meltdown', sometimes you need to do that in order to convey the seriousness of a situation. And that's exactly what we have now - a serious situation.

Jim's right about one thing - a lot of homeowners are going to get smashed in the not-too-distant future. I've talked about the mechanism behind this before, but you can't drain the water out of a lake and not expect the fish to die.

A lot of homeowners are stretched to the limit right now because they borrowed money that they are now unable to pay back. And now they are going to have to deal with the consequences. Unfortunately, so are the rest of us.

It sucks that you can make wise decisions, plan carefully, and still get dragged down by the actions of others. And yet, as easy as it is to sit back and point the finger at them, they aren't alone. Because if you look past the American people, and examine our government as a whole, you will see that the US as a whole is almost in the exact same position.

The government has to borrow billions of dollars EVERY DAY just to meet its obligations. And, most of that money comes from abroad. As long as people keep buying our IOU's, we're good.

But what happens when they stop?

We may end up just like those the homeowners who tread water for a while, then go belly up when there is no longer any money to borrow.

Take the article that just ran in the Telegraph. It talks about China's ability to cripple the dollar simply by liquidating its vast holdings of US debt:

Described as China's "nuclear option" in the state media, such action could trigger a dollar crash at a time when the US currency is already breaking down through historic support levels.

It would also cause a spike in US bond yields, hammering the US housing market and perhaps tipping the economy into recession. It is estimated that China holds over $900bn in a mix of US bonds.

If that happens, you can bet money bad things will happen. Like what? Well, we can look at what happened to one of the biggest participants in the Housing Boom, American Home Mortgage:
American Home Mortgage Investment Corp. shares plunged 90 percent after the lender said it doesn't have cash to fund new loans, stranding thousands of home buyers and putting the company on the brink of failure.

Investment banks cut off credit lines, leaving American Home without money yesterday for $300 million of mortgages it had already promised, the Melville, New York-based company said in a statement today. It anticipates that $450 million to $500 million of loans probably won't get funded today, and the lender may have to sell off its assets.

``They can't function without access to capital,'' said Bose George, an analyst with KBW Inc. in New York. ``The company either has to file for bankruptcy or go through some type of rescue or restructuring, and either way will leave almost nothing for the common shareholders.''

No one likes talking about negative things. But, look at what happened. The investment banks cut off credit, American Home Mortgage couldn't meet its obligations, and the common shareholders got screwed.

Now, lets go back to our analogy. If China and the rest of the world are the investment banks, and the US government is American Home Mortgage, who do you think the common shareholders are that are going to get screwed? That's right buddy, you and me.

Welcome to the party! Glad you could make it :)