Anticipated Result Materializes 6 months late

We are starting to see a major sell-off in the mortgage lenders including WAMU. Uncertainty has got to be a huge driver here. The banks have not been proactive about informing investors about their situation. New Century (major sub prime lender) went under in matter of a few weeks and Fremont General as well as Accredited Home Lenders had their market values go down by 90% in a few weeks and will probably join the ranks of the bankrupt companies soon.

How does this development integrate with some of the other major cross currents which we are seeing in the economy right now re: rising gas prices, rising inflation, slower economic growth, the housing bubble bursting, geopolitical tensions. I think our only hope in making sense of this market is isolating our focus to #1 - the status of the US capital markets. I personally expect the bursting of the housing bubble to drive the rest of teh analysis. Trillions of dollars of "wealth" are going to evaporate right before people's eyes as home prices decline over the coming few years. With this goes away the wealth effect which should cause a decrease in consumer spending. Finally the larger than ever personal debt levels should also dampen consumer spending.

As a result of these anticipated declines in consumer spending we can expect a developing recession over the course of the year. This still does not explain why energy markets, precious metals, and other inflationary type asset classes are ramping. Are we looking at staglation?

I think that any inflationary concerns at this stage of the game are misplaced. As the US economy crashes we should re-enter the deflationary scare type of environment which we experienced back in 2001-2002 during the dot com implosion. I expect these deflationary forces to be EVEN STRONGER this time around.

The reason that the metals and too a lesser extent other commodities including energy may ramp even higher as the year goes on is due to the anticipated government intervention in the US markets. We have to expect an intervention on two levels: 1) cuts in the Fed funds rate, and 2) multiple attempted bailouts of the housing and loan industry although this may occur over several years.

Money supply growth has been around 10% for the past couple years and does not yet show any major signs of slowing down. The implosion of the housing market should slow the money supply growth and reintroduce some of these deflationary concerns into the market. It is during the coming government bailout of the economy that we truly risk venturing into a Weimar Republic type event with inflation ramping and the US dollar essentially becoming worthless. This is highly unlikely. I do not even consider it probable. It is a possibility however, and we will have to see just how good the bureaucrats are able to engineer an orderly decline in both the dollar and the equity markets.

Best regards,

Ben