Whew! Everyone Back in the Pool

Don’t be fooled. Forget the media hype. Market sentiment is fickle. Nothing substantial has changed.

Good news! Crisis over! Let’s all run out and borrow some more money. Quick, buy a few more shares; you can double down if you hurry. It’s back to business as usual.

But wait. Has anything really changed?

Judging by recent stock market action, you would think that the economic crisis was over and good times were back for good. Last Tuesday, the Dow Jones industrial average rocketed 400 points as investors bought just about everything in sight. The jump was the eighth-largest in market history. The Standard & Poor’s 500 index gained a stellar 3.6 percent. Beleaguered banking shares did even better. At one point, Citigroup Inc. and JP Morgan Chase & Co. stock was up 11.3 percent and 9.43 percent respectively. ubs was up 8 percent. Meanwhile, gold, often seen as the investment of choice in unstable times, has plummeted about 10 percent over recent days.

So what was the good news that sent the stock market soaring and gold tumbling? Get this: Banking giants ubs and Deutsche Bank announced losses totaling in excess of $22 billion! That’s right, the market soared on news of a $19 billion writedown by ubs, the biggest loss so far by a bank in the current economic crisis (besides the collapse of Bear Stearns).

That has got to be one of the most ridiculous reactions to awful news I have ever witnessed.

And oh, the other good news: Investment brokerage firm Lehman Brothers was forced to sell $4 billion worth of shares to prop itself up.

“There’s a ‘hooray’ from the stands, but investors don’t realize that the bench has been weakened,” says Meredith Whitney, an analyst at Oppenheimer & Company.

Once again, everyone is saying that the worst is over and the most recent losses will be the last. But the truth is, it’s not over—not even close. This is not the time to jump back in the pool; it’s the time to tighten your safety belt, pay off debt, and ramp up savings as quickly as possible.

Let’s put ubs’s loss in context. The bank lost $19 billion during this first quarter alone. That makes a sum total of $40 billion in losses the bank has admitted to since June of last year. $40 billion is how much China, the fourth-largest economy in the world, is spending on the Beijing Olympics. ubs is just one bank.

According to the bbc News, the world’s 14 biggest banks have so far divulged losses of almost $130 billion. Yet according to Goldman Sachs estimates, there is at least $340 billion more in losses waiting to be revealed by banks, brokers, hedge funds and government-sponsored housing entities in America.

But it doesn’t stop there. By the time it is over, Goldman Sachs says global losses will reach $1.2 trillion. One trillion is approximately on a par with the Russian economy. Bloomberg cites estimates that are even worse. According to Bloomberg sources, there may be $1 trillion of losses just within the United States as write-downs “cascade through high-yield bonds, commercial mortgages, leveraged loans, credit cards and—the big unknown—credit default swaps.”

“We have entered the Domino Depression; it’s not a recession,” says precious metals investor Bob Moriarty. “Every day some bank or a couple of hedge funds will be announcing more massive losses until [all the] fraud has been accounted for. It will be one domino, then another, until you think it has gone on for a century.”

So ask yourself, has anything real changed that might indicate the fundamental cause of the banking crisis is over?

Has the housing market improved? After all, it is the plummeting housing market with the soaring number of mortgage delinquencies that is taking the blame for the hundreds of billions that banks are now losing.

Let’s take a look.

Home prices are still falling just about everywhere. According to the most recent data released by Radar Logic (for January), home prices fell in 23 of 25 major urban areas. February was even worse. The habitually optimistic National Association of Realtors estimates the national median price of existing single-family homes dropped 8.7 percent from a year earlier—the most in 40 years.

Yet even as prices fall, people still aren’t buying. According to the U.S. Commerce Department, sales of new homes in the U.S. fell in February to the lowest level in 13 years. Consequently, the total number of empty homes for sale increased to 2.8 percent in the fourth quarter, matching the rate for 2007’s first quarter, which was the highest in records going back to 1965.

According to Millennium Wave Investments President John Mauldin, the boom years during the early 2000s (which were fueled by artificially low interest rates and historically lax lending standards) led to artificial demand and therefore to the construction of far too many homes. For example, he says, in 2005 alone, there were 48 percent more housing-related transactions than historical averages expected.

“What all this speculation did was create 3.5 million excess homes that need to be filled,” says Mauldin. Those are homes above and beyond regular housing demand. At February sales rates, there was 9.6 months’ worth of inventory on the market—about double the supply during the peak of the housing boom.

And here is one additional interesting tidbit from JP Morgan Chase & Co. chief economist Anthony Chan: An astounding 5 percent of 2006 subprime mortgages went delinquent at their first mortgage payment—meaning that after purchasing a home, 5 percent of buyers didn’t even send one check to the bank!

Meanwhile, the pool of prospective home buyers is being constricted.

Probably the biggest consequence of the banking crisis has been tightened lending standards. Because of soaring mortgage defaults, banks have practically stopped issuing subprime loans, and have severely restricted Alt-A loans too (loans in between prime and subprime). Together, subprime and Alt-A loans account for about 21 percent of loans outstanding and comprised almost 40 percent of mortgages issued in 2006. Considering that 40 percent of demand has disappeared, it is no wonder that sales have shriveled up. And since home prices are still far above long-term trend lines, homes in many regions are still far above bargain prices.

Okay, so the housing market is clearly in a free fall, but what does that mean for the average person and the economy?

According to some estimates, housing and its related industries accounted for 40 percent of all new jobs between 2001 and 2005. The economy is shedding those millions of jobs now. Even seemingly unrelated industries such as environmental consulting may get hit, since much of their work is related to property transactions. And if that isn’t enough, since home prices are one of the largest determinants of consumer spending, corporate America from Applebees to Macy’s will come under pressure—which could translate into further job losses.

In March, employers slashed 80,000 jobs—the third straight month of job losses. Expect the national unemployment rate of 5.1 percent to worsen significantly. Currently 2.94 million people collect unemployment benefits, according to the Labor Department. Expect those numbers to increase too.

The economy is clearly in trouble.

Look at consumer bankruptcies: up 27 percent in the first quarter over the same period last year. March bankruptcies were up 13 percent over February.

How about factory orders? New orders to America’s manufacturers fell for the second straight month in February. The February drop of 1.3 percent followed an even bigger 2.3 percent in January. The manufacturing sector has lost jobs consecutively for each month for almost two years now.

Still more proof: “Automakers Post Worst Q1 Sales in Years,” reports BusinessWeek. General Motors sales plummeted a massive 18.9 percent, Ford Motor’s fell 14.2 percent. And Chrysler sales have cascaded 19.4 percent so far this year. Toyota, Honda and Nissan each saw sales fall by 10.3 percent, 3.2 percent and 3.8 percent respectively. One estimate suggests that sales could drop by 400,000 vehicles in 2008. That’s certainly not good news for the economy.

And to top it all off, here is a headline from the Associated Press: “Last Hope in a Weak Economy? Mom and Dad.” More and more people can’t pay the bills and are moving back in with the folks.

“This drama is far from over. We are only at the beginning of it. The next scenes should be even more interesting,” says bestselling investment author Bill Bonner. “The dollar will lose its status as the world’s reserve currency (possibly with episodes of hyper-inflation) … China and Russia [and, more importantly, Europe] will greatly increase military spending (with some dangerous moments, as the U.S. still tries to throw its weight around) … U.S. stocks will work their way down to real values—with P/Es below 10 … and the average American household will find itself no better off, financially, than the average family in, say, Latvia or Malaysia.”

So don’t be swayed by fickle headlines or short-term media hype. It is amazing how fast media sentiment can change. One day it’s all gloom and doom, and the next, nothing but sunshine. Stick to the fundamentals and the facts—and the facts say, the fundamentals are deteriorating. Things are going to get much worse before they get better.