Printing Money

We have seen a significant bounce in the market over the past few days including a major rally in homebuilders, lenders, and other real estate related sectors. The bulls on wall street are calling for another bull market led by the financials - just as the financials have led for the past 3-4 years. I don't know if this really makes sense anymore. Financials sold off hard prior to earnings on the anticipation of poor earnings reports which would be negatively impacted by slowing lending activity and higher allocations to loan loss reserves. We are through many bank earnings reports and those expectations have come to pass. Apparently however, the earnings although bad were not as bad AS EXPECTED - therefore we are seeing a nice rally in several banks - re: WM, CFC, C, WFC, etc. as well as the largest brokers.

I guess that you need to be a bull if you see this quarter as a dip on the way to better overall 2007 results as compared to 2006 or 2005. However if you think as I do that Q1 2007 indicates the beginning of a trend of declining earnings, a deteriorating real estate market, and more bad loans that might continue throughout the rest of 2007 and 2008, then this rally should be sold into, with any proceeds going into cash or metals, or if you really want to speculate then into some portion of the portfolio in put options on the major lenders and other real estate related sectors.

It is definitely tough though to get a bead on what exactly is happening with all of the government intervention. Fannie Mae and Freddie Mac have just announced that they are going to step into the market and start buying up any subprime mortgage originations that are having trouble selling in order to keep interest rates in that area of the market from rising too much. The ultimate goal of this type of manipulation is to prevent 1) a credit crunch from happening, and 2) by stopping #1 - hopefully prop up real estate prices. I cannot comment on the rest of the country but at least in San Diego, California - condo prices are down in the neighborhood of 20-30% from the peak and single family is approaching 10% down from the peak - this is in terms of actual listings. The scary thing is that there are not that many sales at these depressed prices due to 1) lack of demand and 2) unwillingness of lenders to approve short sales or foreclosure sales at those type of discounts to the loan principal amounts.

I do not believe that any government intervention short of a hyper inflation (through massive printing of dollars) can stop the decline in nominal prices of real estate throuhgout the country, and even the hyperinflation would not be able to stop a decline in the real prices of the real estate. So why does the government even bother? I do not know.

A couple notes on the WAMU Q1 -2007 earnings. Negative amortization accrued interest reported as earnings rose to $361 million or $0.40 a share so that actual cash earnings fell to $0.46 EPS for the quarter. WAMU raised the dividend to $0.55 quarterly. This is also known as ponzi finance - AKA WAMU is paying out more cash money that it is bringing in. Cash on the balance sheet also fell from $7 billion to $4 billion as WAMU bought back $2.7 billion in stock during the first quarter. Because we know the nature of the operating business pretty well right now (aka - it is in free fall) - the way for WAMU to raise additonal cash at this point which it will need is either through additional borrowing OR asset sales. They have already sold off the mutual fund business for $600 million - lets watch to see what comes next.

Best regards,

Ben