The Sham of “Reform”

by Addison Wiggin – March 30, 2011

  • Government gets religion on mortgage lending standards… The 5 notices Uncle Sam had his fingers crossed during the conversion ceremony…
  • Ominous chart that points to “enormous backlog of foreclosures” about to hit the market
  • Patrick Cox on a threat to the economy far bigger than rising oil prices… and how it can be nipped in the bud
  • Rare earth investing becomes trickier than ever: China looks to import supply, among other unexpected developments… plus, a rare opportunity to save big on our best offer…

0:00 — The housing bubble — engorged by atrocious lending standards that apparently no one noticed — peaked in four or five years ago. Mayhem ensued.

This morning, thank God, the FDIC and five other agencies are proposing a new set of rules to make sure the bubble doesn't happen.

0:10 — So say the proposed rules: For a mortgage to be designated "prime," the buyer will have to meet these stringent requirements:

  • 0% down payment
  • Monthly payment cannot be more than 28% of gross income
  • Total monthly debt payments cannot be more than 36% of gross income.

In retrospect, this would have been progress. The rare borrower who succeeded in getting a permanent modification to his mortgage under the HAMP — the Home Affordable Modification Program, which was instituted in 2008 to clean up the mortgage market — had payments totaling 61.3% of monthly income.

0:38 — The proposed rules were met with hue and cry, of course. "Twenty percent down… are you crazy?" we make up our own hue followed by an equally fervent cry: "Think of all the working folks you'd deny the opportunity to achieve the American Dream, you heartless scoundrels."

And so the news story goes. If you take the media's point of view, the debate is between the government trying to "restore confidence to the housing market" and the people "who have a right to own their own home." The tension is fierce. O, the drama.

1:03 — Trouble is… the fine print in this story is huge. Under the proposed rules, Fannie Mae, Freddie Mac and the Federal Housing Authority (FHA)… are exempt.

The careful reader of The 5's jaw just dropped in amazement. The government is the housing market.

The red line, keyed to the right axis, is the part that matters most. It shows the percentage of new mortgages backed by Fannie and Freddie ("government-sponsored enterprises," or GSEs) and the FHA.

Only those private enterprises trying to drum up business in this scorched-earth housing market would have to adhere to the new "stringent" rules.

Far from ensuring confidence in the housing market, these rules would, by incentive alone, drive more business to Fannie, Freddie and the FHA.

Ah, well, at least they're on top of the crisis.

1:26 — The number of homes in foreclosure is up 7.4% over a year ago, according to new figures from Lender Processing Services (LPS). For four months straight, four out of every 100 homes have been in foreclosure — not delinquency, foreclosure.

And of that four, one of them has a mortgage that's gone unpaid for two years or more. We direct your attention to the orange segment on this chart…

Bottom line: The "shadow inventory" remains in the dark. Banks are still holding off on sending the sheriff to repossess, lest the bank have to sell properties at a substantially lower price and book a loss.

Don't expect this to change. The LPS report warns of an "enormous backlog of foreclosures" among adjustable-rate mortgages. ARM foreclosures have soared 23% in the last six months.

They now make up 18% of all foreclosure actions — even higher than subprime at their peak.

People laughed when we forecast the Total Destruction of the Housing Market in 2004-05. We haven't even seen the half of it yet. Ironically, that report highlighted shenanigans going on behind the scenes at the perpetually exempt Fannie Mae and Freddie Mac.

1:37 — Crude oil is back below $105 this morning. The price has seesawed around that figure for nearly a week now.

Oil production now is one-fifth of normal in Libya.

1:43 — "While we are obsessed as a country with the price of petroleum," writes Patrick Cox, "the truth is that chaos in Libya or Iran would have less impact on our economy than a flu pandemic."

Patrick points to estimates from the World Bank and Oxford Economics: A pandemic would drag down GDP by as much as 4.8%. "Part of this is due to the direct cost of illness. Part is due to the fact that people, concerned about infection, restrict all manner of economic activities."

But Patrick just got a glimpse of incredibly promising research on an anti-viral drug. Animals treated with this drug survived 2½ times as long as animals treated with Tamiflu.

"For all practical purposes, influenza A is effectively over with the approval of this drug. This includes all the really scary flus we hear about, such as bird, swine and H1N1.

"I haven't talked to any scientist working with this technology who has real fear that for some reason, it will not work when finally administered in humans. This is truly great news for humanity and the economy" — to say nothing of shareholders of the tiny company developing this drug.

In fact, Patrick says it's one of seven companies about to change the world at least as much as the Gutenberg printing press did nearly 600 years ago. And for the next two days, we're offering you the chance to learn about all seven of them, free, at no risk to you. Details of this extraordinary offer here.

1:48 — Stocks are up again today, the S&P pushing past 1,325 at last check. Not much data for traders to chew on today, although the payroll firm ADP estimates that private employers added 201,000 jobs last month.

We'll take this opportunity to remind you that our special video 6 Stocks for Right Now — featuring the pick of the litter among all our editors — goes online tomorrow evening at 5 p.m. Learn how to secure access here.

1:51 — "Could things get worse for Western buyers and users of rare earths?" asks Byron King, rhetorically. "Well, yes."

As we told you a week ago today, prices of Chinese exports have exploded 676% in a mere seven months — thanks to export quotas. That's what happens when one country controls 97% of world production.

The new wrinkle: "China may soon start importing some of the rare earths that its economy needs but doesn't produce in sufficient quantity," says Byron.

According to Liu Junhua, the deputy secretary for China's Baotou Rare Earth High-Tech Industrial Development Zone Committee, "China may eventually need to import [heavy rare earths] materials." According to Mr. Liu, speaking at a recent conference, there's a "strong possibility of [China] importing heavy rare earths" in the next three-four years.

"So here's the scenario," Byron sums up. "Chinese export volumes are down. World prices are rising, and fast. And China may soon be importing the heavy rare earths for its own industrial needs."

2:05 — Then came this news: "Supply for rare earth carbonate has been so tight in northern China during the past days," reports Metal Pages, the industry website, "and sources reported that many rare earth processors may have to halt production in the coming weeks due to the shortage of raw material."

Share prices for the "usual suspects" in the rare earth space popped as much as 7%.

For some of them, Byron warns, it could prove to be a flash in the pan: "First, only a few non-Chinese companies will achieve output — and begin to generate cash flow — within the next three years. And second, only a small handful of companies will survive in the long-term race to supply the world with rare earths over the next decade or so."

Rather than mess with the usual, Byron has his eye on a dark horse candidate, one with far more potential than the familiar names. He tells you all about it in this presentation.

2:37 — Hmn… perhaps people are coming to their senses, bit by bit.

"Carmen" below thinks you'll pay big money for a phone number with a Manhattan 212 area code prefix.

Would you buy a used phone number from this man?

He wouldn't give his full name to the New York Daily News. But he says he needs to take care of his 98-year-old mother. So he's willing to give you the Manhattan number he's had for the last 35 years. For a price, of course.

"212" is prestigious, Carmen's logic goes, far more established than the hinky new 646 "overlay" code. He's had the number for 35 years, he ought to know. "I advertised considerably back in those days. The name and number association was one and the same."

A year ago, Carmen thought the number was worth $1 million. He put in on eBay. And waited.

Top bid so far? $500. That's not a "serious" bid for the number, says Carmen.

Yeah, it probably is.

2:49 — "For the sake of a good argument, the corporate tax rate should be 0%," writes a reader in response to yesterday's Fight or Flight issue. "But we all know who would howl bloody murder. So let's agree to lower the tax rate to Ireland's or less, maybe 10%, thus removing the incentive to move jobs offshore and invest in tax-dodging schemes.

"Like GE, most politically connected big corporations pay zero taxes anyway. So maybe there is a point where it would be cheaper to pay the tax rather than pay all the lawyers and political contributions to bend the tax laws."

2:57 — "I struggle to understand why I should feel bad for Cisco," counters another. "CSCO ships jobs overseas at will, and it's not because of tax rate. It's cost of labor.

"We could drop our corporate rate to 5% and that will not bring one job back to the U.S. Only way to make that happen is to tie any reduction in tax rate to commitment to create permanent jobs in the U.S. that will not be moved. CSCO, Oracle and the rest will not do that.

"You guys need to do some proper research instead of listening to these fat CEOs."

The 5: We're not asking you to feel sorry for anyone. U.S. companies are holding $1.2 trillion overseas for tax reasons. We expect more companies' executives, regardless of their belt size, will choose to add to the total.

If you disagree, we invite you to join us at our investment symposium in Vancouver, July 26-29, so we can talk it out. Please call Barb Perriello at (800) 926-6575 and tell her whether you want to "fight" or "flee"… she'll know what you mean… and get yourself set up with your reserved seat.

3:39 — "If you go into a store and get s*** service," writes another reader, "you will take your business to another store next time. Should it be any different with countries? If you don't provide what the customer wants, you go to the wall.

"BTW, the Isle of Man has 0% corporation tax, no capital gains tax and no inheritance tax… and a AAA rating from the rating agencies… if that means much these days. Might be worth a look for some of your 'flighters'?"

3:46 — "This looks like a great BUY list," a reader quips after seeing Sen. Bernie Sanders' list of politically connected corporations that pay little or no corporate income tax.

The 5: We compared the performance of all 10 companies with the S&P 500 since the market bottom two years ago. Seven out of 10 outperformed.

3:54 — "I just finished reading When Money Dies," a reader writes, on a more sobering note. "It's a cautionary tale, no error. I.O.U.S.A. is facing a Katrina-like financial hurricane, and we sit and do nothing. But this is not about that.

"I propose that the reason 'the Ben Bernank' will not be able to pull a lever or push a button or monkey around with basis points to stop hyperinflation is this: Inflation seems to me to be a monetary phenomenon. If the money supply expands faster than the pool of goods and services available to purchase, prices go up. It's just math.

"Hyperinflation, on the other hand, seems to me to be a psychological phenomenon. And when people decide that dollars aren't worth s*** and start to dump them, a 50- or 100-basis point rise in interest rates will likely not be noticed by most people. Panic will set in and the game will be on.

"I take the Mogambo's advice and encourage everyone to do so. Otherwise, they will ultimately find out that they are freaking doomed. Must be why dinner invitations are so infrequent."

The 5: Germany's central bank cranked up the printing presses six or seven years before people needed wheelbarrows full of cash to buy a loaf of bread… a tale told eloquently in When Money Dies.

One condition, however, made hyperinflation possible in the Weimar Republic: Cost-of-living adjustments (COLA) for labor unions in the Rhine Valley coal district. The more money the central bank printed, the more paper cash the workers took home… regardless of its purchasing power.

If workers didn't have wheelbarrows full of paper to buy bread… "hyperinflation" would have snuffed itself out.

We're still making the book available with a one-month trial of Capital & Crisis. Both are free. All we ask is that you cover shipping for the book. Check out the offer here.

4:41 — "Now that bottled air was one hell of a presentation," adds another, commenting on the inimitable Rachel Sequoia's presentation to venture capitalists.

"Thanks, guys, for the great laugh. It made my day!"

4:58 — "Like, you know, air's a good thing," another adds. "Keep in mind that in about 10 or 15 years, Ms. Sequoia's cohort will be running for office.

"Food for, like, you know… thought."


Addison Wiggin

The 5 Min. Forecast

5:30 — "This has nothing to do with economics, energy or minerals," Byron King prefaces an email this morning, which we share to give you a peak behind the curtain here at Agora Financial. "But…

"I was at the gym this morning. The TV set had Good Morning America on."

[The scene: our in-house oilman, Harvard-trained geologist, former Navy pilot and bankruptcy attorney watching GMA on a treadmill…]

"They have this big segment on Britney Spears live from San Francisco, where its 5 am or something. Indeed, it's a shameless promotion of Britney Spears by GMA.

[…curiously observing programming choices by one of America's leading networks (sic)…]

"So Britney does her dance-singing routine… and it struck me. She's doing a pale imitation of Lady Gaga.

[…offering critical comparisons between Britney Spears and Lady Gaga…]

"The producers must have locked the songwriters in a room, shoved pizzas under the door and told them they aren't coming out until they write her some music that sounds like Lady Gaga.

"Even then, Britney is, perhaps, a better singer than her backup dancers. She's a better dancer, perhaps, than her backup singers.

[… and commenting on the former's dance skills…]

"Really… this is modern entertainment?

"It's all special effects, costumes, choreography and not very good. What a waste. Maybe it does come back to the economy. Our culture allocates good money, energy and minerals to popularizing this kind of crap?"

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