Things That Have Not Yet Happened

I have been staring in amusement at Bernanke's latest proclamation: Danger of downturn appears to have faded.

Despite a recent spike in the nation's unemployment rate, the danger that the economy has fallen into a "substantial downturn" appears to have waned, Federal Reserve Chairman Ben Bernanke said Monday.

The Fed's powerful doses of interest rate cuts, the government's $168 billion stimulus package, further progress in the repair of problems in financial and credit markets, a gradual ebbing of the drag from the deep housing slump and still solid demand from abroad for U.S. exports should help the economy over the remainder of this year, he said.

Wishful Thinking or Blatant Lie?

Bernanke�s statements are like standing in front of a tsunami proclaiming "The Worst Is Over" before the wave even hits the shore.

Professor Depew called Bernanke on his statements in point 1 of Tuesday's Five Things: Bernanke Says There's Never Been a Better Time to Sell Your Gold Jewelry for Cash.

Here's my take: Before we can say the worst is over or the danger has passed, the storm has to reach shore first. With that in mind I thought it might be interesting to look at a few headlines of things that are going to happen but have not happened yet.

Bank Failures

Bigger U.S. bank failures may be coming � FDIC

Future U.S. bank failures linked to the downturn in the real estate market may include "institutions of greater size" than in the recent past, Federal Deposit Insurance Corp Chairman Sheila Bair said on Thursday.

I talked about the expected wave of bank failures in Too Late To Stop Bank Failures.

Monoline Fallout

Citi, Merrill, UBS Face Monoline Losses, Whitney Says

We have yet to see the fallout from the downfall of the monolines (Ambac (ABK) and MBIA (MBI)) but we will.

$500 Billion Option ARM Crisis Coming Up

Option Arms - The Next Real Estate Crisis

By April, 2009, hundreds of thousands of option ARM mortgages will begin resetting, bringing on a fresh wave of foreclosures.



According to Credit Suisse (CS), monthly option recasts are expected to accelerate starting in April, 2009, from $5 billion to a peak of about $10 billion in January, 2010. Today, outstanding option ARM loans in the U.S. total about $500 billion, about 60% of which were sold to California homeowners, according to Credit Suisse. Option ARMs were especially popular in the state, where they were heavily marketed during the boom by such companies as Countrywide Financial (CFC), Washington Mutual (WM), and Wachovia (WB).

"Most of the public is thinking that the subprime thing is over, but this is another thing waiting," [said Chandrajit Bhattacharya, vice-president and mortgage strategist at Credit Suisse Securities].

By the way, that article is not contrary to what I presented in Greenspan Conundrum In Reverse. The problems with Pay Option ARMs are negative amortization, falling home prices, and payment shock. Those are far bigger problem right now than the risk of rising interest rates on regular ARMs that are about to reset.

Bernanke has minimized the fallout from ARM resets by slashing interest rates. Negative amortization, falling home prices, and payment shock problems are another matter altogether. I have expected an acceleration of Pay Option ARM problems for quite some time. The storm is about to hit.

Additional Problems

• A rising unemployment rate. I expect 6% by the end of the year and 7% or higher in 2009-2010.
• An imploding commercial real estate.
• Rising junk bond defaults.
• Rising numbers of foreclosures and bankruptcies.
• Rising credit card defaults.

Economic Picture Worsening

The economic picture is worsening across the board. And not just in the US but in the UK and Europe as well. A housing bust is now underway in the UK. Inquiring minds may wish to consider UK Housing Market Seizes Up.

In the meantime, Until Things That Have Not Happened Yet Do Happen, it defies credibility to suggest that danger has faded.

Impact of the Highly Improbable

The above is a discussion of "the known". There is also a huge risk factor from a Black Swan Event.

Last May, Taleb published The Black Swan: The Impact of the Highly Improbable. It said, among many other things, that most economists, and almost all bankers, are subhuman and very, very dangerous. They live in a fantasy world in which the future can be controlled by sophisticated mathematical models and elaborate risk-management systems. Bankers and economists scorned and raged at Taleb. He didn�t understand, they said. A few months later, the full global implications of the sub-prime-driven credit crunch became clear. The world banking system still teeters on the edge of meltdown. Taleb had been vindicated. �It was my greatest vindication. But to me that wasn�t a black swan; it was a white swan. I knew it would happen and I said so. It was a black swan to Ben Bernanke [the chairman of the Federal Reserve]. I wouldn�t use him to drive my car. These guys are dangerous. They�re not qualified in their own field.�

In December he lectured bankers at Soci�t� G�n�rale, France�s second biggest bank. He told them they were sitting on a mountain of risks � a menagerie of black swans. They didn�t believe him. Six weeks later the rogue trader and black swan J�r�me Kerviel landed them with $7.2 billion of losses.

So not only is there the risk of the known, there is also risk of the unknown. Bernanke and Paulson have factored neither into their Pollyannaish statements. Talk from both of them is getting more ridiculous by the minute.

Mike "Mish" Shedlock
http://globaleconomicanalysis.blogspot.com
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