Seeking Alpha: Farewell, IndyMac: What's Next? (14 July 2008)

Farewell, IndyMac: What's Next?

Mike Stathis

On Friday, IndyMac (IMB) joined the long and growing list of bankrupt mortgage companies (Accredited Home Lenders, Novastar Financial, Fremont General and dozens of others) that have been taken down by what has already surpassed mortgage and bank losses of the Savings & Loan Crisis.

While Indy marks only the sixth bank failure since the official start of the banking-real estate avalanche is February 2007, you can bet this is only the beginning. The last wave of bank failures in the U.S. occurred during the recession of ’90-’91, when 502 banks failed in a 3-year period. Prior to that, more than 1,600 banks insured by the Federal Deposit Insurance Corporation [FDIC] were closed or received FDIC financial assistance between 1980 and 1994 due mainly to the Savings & Loan crisis.

Now if you think that the collapse of IndyMac doesn’t affect you, think again. The FDIC estimates the takeover will cost between $4 and $8 billion. Given what I know about government estimates, it’s likely to cost much more. Whatever the costs, it’s coming from taxpayers. But there’s more to it. Indy’s insolvency signals that the banking crisis is not only live and well, but only just beginning. Before it’s over, I estimate a total of about $10 trillion in losses as a result of Greenspan’s real estate bubble - $1.5 to $2.0 trillion in direct losses by banks and mortgage companies (much more than Wall Streets ever increasing estimates that are now up to $500 billion), $7 trillion in paper losses due to real estate devaluations, and $1.0 trillion in lost incomes (and decreased consumer spending resulting in income losses for others) due to job losses and lay-offs in the real estate, mortgage, banking and construction industries, as well as non-real estate related job losses due declining economic conditions attributed to the real estate and banking crisis.

In total, I would roughly estimate a loss of around 6 million jobs from 2007 to 2011.
Already, an estimated 250,000 jobs have been lost in the residential lending sector alone. And as the economy continues to stall, more jobs will be lost from other industries, causing more foreclosures which will only damage the real estate market further, or at best, cause it to lag for several years. The paper losses will come back over time. But for others, a decline in home values can flip you upside down in no time. And if you need to refinance an ARM, you will be out of luck unless you can come up with the difference between the outstanding mortgage balance and the market value of your home - plus any amount required for down payment. This is how many have lost their homes. When those with ARMs saw their monthly mortgage payments soar to as high as 60%, they tried to refinance. But since their home value declined, they were in a negative equity situation.

Now you might see why Bernanke made a huge error keeping rates so low for so long – it’s not going to help homeowners refinance because they owe more on their homes than they are worth. In fact, he has actually made it worse for homeowners who are barely able to make payments. The low rates have heightened inflation and weakened the dollar further. And that has caused food and oil to soar.

Why Didn’t the Fed Rescue Indy?

A few months ago, banks began the painful process of trying to write down bad mortgage debt. But mortgage defaults continued to pile up. So they had to keep writing down the debt more and more, until finally, much of it became virtually worthless. In order to avoid a liquidity crisis, banks were forced to sell off their highest quality debt, causing more damage to the balance sheet. After the run on Bear Stearns (BSC), the Fed realized that any large bank could become insolvent overnight, which would cause a snowball effect felt around the globe. Therefore, Bernanke extended emergency funding options (once previously reserved for commercial banks) to investment banks – something not done since the Great Depression.
But why not extend this same privilege to Bear Stearns as well? I’d imagine the Fed has not forgotten the refusal of Bear Stearns to participate in the “bailout” of Long Term Capital Management a decade earlier. While several other banks declined to help, Bear was the only major player that refused.

Apparently, the banking cartel decided it was payback time for Bear. But wait a minute. The Fed guaranteed capital to commercial and investment banks if needed, so why did it allow Indy to fail? What Bernanke failed to mention to the public was that his printing presses would only be made available to the banking cartel – basically the “Big 5” from each category (commercial and investment banks) because these are the banks that own and run the Federal Reserve.

Who’s Next?

Thornburg Mortgage (TMA)? Do you remember these guys? The CEO was plastered all over television in the summer of 2007 before anyone knew there was a real estate crisis going on. This company did a lot of jumbo mortgages, so when they began to encounter some liquidity problems due to high default rates, Wall Street paid very close attention. After all, at the time, most people didn’t even think the sub-primes would experience a washout, so to see a mortgage company that specialized in jumbo mortgages run into problems was very troubling. Since falling from $28 in October of 2007, the stock is now trading at $0.28. We will just have to wait and see.
In part 2 of this article, I discuss what’s next for the economy over the next several years.

Say Hello to the ‘70s

Those of you who are familiar with my previous publications know my real estate forecasts remain unchanged since first published in 2006. To reiterate, I’m expecting an average decline from peak prices of 30% (best case scenario) to 35% (worst case scenario), sending home values back to pre-1999 levels. Within the next three years, mortgage rates should approach 8% and take off thereafter. Soon, we will see a 1970s type inflationary period. This will bode well for owners of real estate rental units.

We have already duplicated a portion of the ‘70s, with record gold and oil prices while inflation is mounting. Most likely, the Fed will try to delay raising rates past the 5.0% range until after 2011. By the end of 2011, most of the ARMs and Alt-As will have reset. Thereafter, I am expecting rates to take off. They’ll have to. By that time, inflation is likely to be so high that even Washington’s number games won’t be able to hide the truth any longer. Then again, we should never count out Washington’s ability to deceive those who they have been elected to serve.

My forecasts are contingent on many variables. The largest and most uncertain of these variables is Bernanke. As we know from the past, he has not always acted in a manner that one would expect. But one thing you can be assured of - when I make forecasts, I’m very meticulous in testing all scenarios. And unlike other analysts and economists, I do not modify my forecasts every month or quarter based on newly reported economic data. Why don’t I do this? Because most of this data is usually noise. Understanding the macro trends is what really matters. The big picture doesn’t change based upon daily, weekly, monthly or even quarterly data. So when you see knee-jerk reactions from analysts and economists based on transient changes in data, you should question whether they really know what’s going on or whether they’re just shifting the picture for their own agendas. If forecasts change every month, how can they be taken seriously? I’m talking about forecasting, not broadcasting.

Foreclosure Avalanche

In 2007, government figures show 1.5 million foreclosures were initiated. No one knows yet how many actually closed because of pre-foreclosures other potential transactions. For 2008, consensus estimates expect 2.5 million foreclosures. Since August 2007, the Federal Housing Administration (FHA) has restructured loans for 250,000 homeowners enabling them to remain in their homes. As of July 2007, HOPE NOW Alliance has done the same for 1.7 million homeowners. And now it is helping 200,000 homeowners stay in their homes every month.
Without this assistance, there could be up to 6 million foreclosures in less than two years since the commencement of the real estate meltdown. When I published my forecasts in 2006, I estimated between 8 to 10 million foreclosures would occur by 2014. A few months later I raised this estimate to 15 million by 2016 prior to releasing the real estate book. I usually use the conservative side of my forecasts. And it appears as if this will turn out to be somewhat conservative. Back when I released these books, many thought I was a nut to make what were viewed as ridiculously high estimates. It’s funny how sentiment can change in such a short time.

The Small Banks Will Fail

In the coming months, I expect to see several bank failures. Not Citigroup (C) or Bank of America (BAC). The “Big 5” won’t fail because the Fed would never permit it. You know the Fed – the entity that’s owned and operated by the “Big 5.” It will be the small local and medium regional banks that fail (however, while not one of the “Big 5” it appears likely that Washington Mutual will be bought by TPG over the next two years). By the time the washout is finished we could see several hundred take a fall. If we include those destined for the auction block, I can almost guarantee you there will be hundreds of failures. Apparently, the FDIC understands these possibilities. As of March 26, 2008 the agency increased its staff by an additional 60% in anticipation of many more bank failures. “We want to make sure that we’re prepared,” said Jon Bovenzi, the FDIC’s chief operating officer.

After so much denial and deceit by Washington and the media, at some point you need wonder why this isn’t the kind of news that dominates the airwaves. You know, news you can actually use to your benefit. Let me solve this mystery. The job of the media establishment is not to warn consumers of anything that has not yet happened, especially during a crisis. They feel that it will only create a self-fulfilling prophecy. And you better believe Washington communicates with the heads of each television network to ensure they don’t let the cat out of the bag. Instead, their theme is denial. That is why it’s rare for investors to be warned in advance from anyone in the media.

When the smaller banks fail, the “Big 5” will snatch them up at pennies on the dollar compliments of Bernanke’s printing presses. Maybe now you can see why every nation wants to get as far away from the dollar as possible. They understand the worst is yet to come. Bernanke’s “Big 5” banking bailout is only ensuring the dollar crisis will continue. However, no nation will be able to completely escape the effects of the falling dollar since it remains the universal currency. It is deeply embedded within global commerce and has extensive reach throughout the global financial system.

And of course, you must have the dollar to buy oil. But this could change. In fact, Iran has already tried to convince OPEC members to follow its lead in demanding Euro payments for oil on its newly created oil exchange (I previously discussed this global dependence on the dollar in the article “The Big Secret about Peak Oil and the U.S. Military”). In the meantime, most nations continue to hedge the weak dollar by increasing gold reserves. As for the Middle East, they have their hedge against a weak dollar – oil.