 From
the Sub-Prime to the Ridiculous
Peter Schiff
Mar 15, 2007
With the meltdown in the sub-prime
mortgage sector now laid bare, many on Wall Street desperately
cling to the notion that the pain will be localized. The prevalent
delusion is that the overall mortgage, housing and stock markets
will be little impacted by the carnage ravaging the sub-prime
sector. As such, renewed stock market weakness is seen as an
over-reaction and a great buying opportunity. These assumptions
represent wishful thinking in the extreme.
Those who think that the sub-prime
market is unrelated to the broader economy do not understand
that the problem is not just the fiscal responsibility of marginal
borrowers, but the inherent weakness of the entire U.S. economy.
It's just that the sub-prime sector, being one of the most vulnerable
spots, is where the problems are first surfacing.
Think of the U.S. economy as
an unstable dam. The first leaks will be seen in the dam's most
vulnerable spot. But there will be many more leaks to follow.
Before long the entire dam will collapse. It would be a fatal
mistake for those living downstream to assume a leak is an isolated
event, unrelated to the integrity of the dam itself. But that
is exactly what those on Wall Street are doing with respect the
horrific data emanating from the sub-prime market.
The bottom line is that far
too many Americas, not simply those with low credit scores, have
borrowed more money then they are realistically capable of repaying.
The credit boom was created by initially low adjustable rate
mortgages, interest only, or negative amortization loans, and
an appreciating real estate market that allowed homeowners to
extract equity to help make mortgage payments. Now that real
estate prices have stopped rising, and mortgage payments are
resetting higher, borrowers can no longer "afford"
to make these payments.
Significantly, most sub-prime
loans involved low "teaser" rates that lasted for only
two years. In contrast, teaser rates for most prime ARMs typically
last for five years. This difference, rather than any inherent
distinction in the fiscal health or credit worthiness of the
borrowers, explains why the delinquencies are so much higher
in the sub-prime sector.
Of course, the vast majority
of home loans in the last few years, sub-prime or otherwise,
should never have been made in the first place. However, when
real estate prices were rising, no one cared about the wildly
optimistic assumptions or the out-and-out fraud inherent in the
loan process. Everyone was making money. Borrowers, regardless
of their ability to pay off their loans, thought they were getting
rich as real estate prices rose. On the other side, home builders,
real estate agents, appraisers, mortgage brokers, mortgage originators,
Wall Street brokerages that securitized the loans and the hedge
fund clients who bought them, were all getting rich as a result
of booming credit. For the charade to continue, borrowers pretended
they could pay and lenders pretended that they would be paid.
The fix now being suggested
by some members of the U.S. Congress demonstrates how Washington
completely misunderstands market dynamics. Their legislative
proposals will require that lenders make potential borrowers
verify their incomes and restrict credit only to those who can
afford the payments after the teaser periods end. Washington
fails to grasp that a return to traditional lending standards
would precipitate a return to traditional prices, which are way
below current levels. There is just no way to crack down on lenders
without causing a crash in the real estate market. However, continuing
to look the other way is no panacea either as the real estate
market is already in the process of collapsing under its own
weight.
It is also typical and very
disingenuous for lawmakers to feign outrage, or to have waited
until a collapse occurs before taking action. Just like with
the Internet bubble of the late 1990's, the government refused
to act in advance of the crisis. Had the government taken preemptive
action with regard to mortgage lending, the real estate bubble
never would have been inflated to the degree that it has. However,
a slower housing market would have resulted in a much weaker
U.S. economy. More modest home valuations would not have allowed
consumers to cash-out phony real estate wealth. Instead, home
owners would have been forced to make higher mortgage payments
and had even less money to spend on consumption. They might have
actually considered saving some money for the future as their
homes would not have been doing the "saving" for them.
In reality, the problem goes
way beyond housing. Nearly every big ticket item that Americans
consume is paid for with borrowed money, with foreign lenders
supplying the credit. Without access to low cost credit, the
spending stops. When the spending stops the service sector jobs
associated with robust spending will disappear as well. Without
paychecks, even those with low fixed-rate mortgages and high
credit scores will not make their payments.
The bursting of the technology
stock bubble of the 1990's was simply the opening act. What we
are about to experience with the real estate bubble is the main
event. In that respect, though it may be March of 2007 it sure
feels a lot like March of 2000. However, instead of a mild recession,
this collapse will be followed by the most severe recession since
the Great Depression. The main risk is that Ben Bernanke and
his buddies at the Fed panic, producing something far worse;
a hyper-inflationary bust similar to the one experienced by the
Weimar Republic in Germany. Let's hope that cooler heads prevail,
but get your wheelbarrow ready just in case.
For a more in depth analysis
of the U.S. economy and why it is in so much trouble, read my
new book "Crash  Proof: How to Profit from
the Coming Economic Collapse." Click here
to order a copy today.
More importantly, make sure
to protect your wealth and preserve your purchasing power before
it's too late.
Discover the best way to buy gold at www.goldyoucanfold.com, download my free
research report on the powerful case for investing in foreign
equities available at www.researchreportone.com, and subscribe to
my free, on-line investment
newsletter.
Peter Schiff
C.E.O. and Chief Global Strategist
Euro Pacific Capital, Inc.
1 800-727-7922
email: pschiff@europac.net
website: www.europac.net
Archives
 Mr. Schiff is one of
the few non-biased investment advisors (not committed solely to
the short side of the market) to have correctly called the current
bear market before it began and to have positioned his clients
accordingly. As a result of his accurate forecasts on the U.S.
stock market, commodities, gold and the dollar, he is becoming
increasingly more renowned. He has been quoted in many of the
nation's leading newspapers, including The Wall Street Journal,
Barron's, Investor's Business Daily, The Financial Times, The
New York Times, The Los Angeles Times, The Washington Post, The
Chicago Tribune, The Dallas Morning News, The Miami Herald, The
San Francisco Chronicle, The Atlanta Journal-Constitution, The
Arizona Republic, The Philadelphia Inquirer, and the Christian
Science Monitor, and has appeared on CNBC, CNNfn., and Bloomberg.
In addition, his views are frequently quoted locally in the Orange
County Register.
Mr. Schiff began his investment career as a financial consultant
with Shearson Lehman Brothers, after having earned a degree in
finance and accounting from U.C. Berkley in 1987. A financial
professional for seventeen years he joined Euro Pacific
in 1996 and has served as its President since January 2000. An
expert on money, economic theory, and international investing,
he is a highly recommended broker by many of the nation's financial
newsletters and advisory services.
321gold Ltd
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