Monday, March 21, 2005

GM's woes one more blow to housing bubble

Low interest rates from the failed Fed let GM's finance arm offer cheap loans that helped owners use homes as ATMs. With rates rising and its own troubles, that party is over.

By Bill Fleckenstein

To state the obvious, General Motors' (GM, news, msgs) bleak first-quarter forecast last Wednesday was the big news of the day, the preannouncement heard 'round the world. But in our own "what, me worry?" market environment, people seemed unwilling (or unable) to connect the dots. So I will.

Along with Fannie Mae (FNM, news, msgs), GM is a significant cog in the financing of the housing ATM (which I have discussed often, including in my March 7 column.) Why does that matter? Because last Wednesday, the yield on GM's debt widened to 454 basis points (4.54 percentage points) over Treasurys. In my opinion, it won't be much longer before that debt is downgraded. GM has been trying to finance autos, homes and second mortgages at record-low interest rates, but it's hard to see how the company can continue to do so.

This will also continue to tighten the noose around Fed chief Alan Greenspan's neck. He must raise rates to maintain the pretense of addressing inflation concerns and weak-dollar issues. But Easy Al is in a box (along with the whole country) because of his policies and the ways folks have behaved.

Furthermore, foreign holders of our dollars will see Easy Al's predicament and know that, at the margin, he will be slow to tighten. At the same time, the handful of big-dollar holders all know that they are the lender of last resort. The fact that the "maestro's" genius is being called into question will only hasten the undermining-of-confidence process.
Banks and insurers
check your credit.
So should you.

Sir G hides behind royal 'we'
I am suggesting that his halo is slipping because at a Senate hearing last Tuesday on Social Security, Greenspan was forced to make the following admission about budget-surplus projections: "It turns out that we were all wrong."

That is not the fact. Anybody who believed in surpluses was all wrong, but there were a handful of folks with enough common sense to understand that the surpluses were a function of the mania and would vaporize when it ended.

The next time down
Al was dead wrong on this subject, as he has been on just about everything else he's opined on. As folks slowly come to figure that out, the realization will add to the fear that I laid out in a recent speech as my "next time down" scenario:

"The use-your-house-as-an-ATM-to-live-beyond-your-means stimulus is finished, thanks to the recent de-leveraging/crackup in the bond market. The refi game and the bull market in housing it created postponed the consequences of the largest stock-market bubble in history. Though the Fed and the rest of the government succeeded in postponing the fallout from the massive misallocation of capital that took place in the mania, they have also succeeded in compounding and exacerbating those consequences. Even more leverage was created in the system, as we attempted to speculate our way to prosperity.

"In short, the excesses from the bubble have not been cleared away, but they will be, along with the recent excesses from the housing bubble. I believe the economic rebound has peaked, the economy will slow down in the second half and we will ultimately slide back into recession. I believe we are headed for a large decline in the stock market, as well as a resumption in the decline of the dollar. These developments will tend to be self-reinforcing and especially damaging when housing prices join the decline.

"If that weren't bad enough, in addition, the Fed is finally trapped. Easy Al can't cut rates when trouble starts, because he has already created a decent-sized inflation problem. As this scenario unfolds, in whatever variation, we will experience the 'next time down.' The realization that the market is going down again -- and with it the economy -- will force people to come to grips with the fact that the interlude of the last two years was just that. This will deal a crushing blow to confidence, causing the public to finally comprehend that the Fed can't save them. Once the business of clearing away the excesses begins again in earnest, your guess is as good as mine as to how ugly it all gets."

Out sprout the shoots of seismic change
So, what does last Wednesday's break in GM mean? I believe it's the start of billiard balls moving around the financial system in a way that will seriously add to the corrosive forces already at work. When the real estate market finally breaks, we are going to experience an economic period very similar to what Japan has endured for the last 10 years.

One reason why Japan's bust has been as bad as it has is that Japan has had to endure a sizable real-estate bust and a stock-market bust at the same time. Originally, the United States was only dealing with an equity-market bust. But with the Fed trying to bail that bust out with a housing bubble, we, like Japan, will now experience a housing bust and a market bust at the same time.

To top it all off, the Japanese save about 11% of household income; we save less than 2%. Japan has a current-account surplus. We have a massive current-account deficit (which last week was reported to be $188 billion for the fourth quarter of 2004, roughly 6.3% of GDP). So, there is every reason to think that as we encounter the twin busts, we will experience a period like Japan did, only worse.

While the macro imbalances are going to work against us, we do have one thing working in our favor: Our brand of capitalism tends to clear out the deadwood and clean up problems in less time than Japan's semi-centrally-planned approach to capitalism. However, our creative-destruction mechanism has been held at bay by Easy Al and the Boys for so long that it has made the problems that much worse.

Though the busts that lie before us are unavoidable, at least we can hope that if Al and the federal government are forced to stand aside, thanks to the discipline of a falling dollar, it will mean that we experience the pain over a shorter period, rather than a longer one. In other words, it's going to happen, so let's just get it over with.


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