... let me redefine the term a bit.

"FIRE" meant "Finance, Insurance, and Real Estate" for the last few years.

Now we need to redefine it to "Fraud, Insolvency, Ripoffs and Explosions"

As in "tape bomb" explosions, you know, the kind that sink the stock market?

Yep.


Fraud

Let's boil this all down shall we, with references and tidbits from previous Tickers, but not the whole thing - look folks, that you need to read is not a bad thing, its a good thing, 'K?

The simple fact is that this entire credit bubble was driven by fraud, and intentional, even willful blindness on the part of regulators.

All of them.

Both State and Federal.

The Federal Government did in fact step in to preempt state regulation of mortgage issuers, thereby preventing anyone who "got out of line" in allowing the real estate bubble to inflate from stopping it.

The State Governments (particularly NY) did in fact grant waivers to the monolines allowing them to become "other than monolines" - that is, to insure CDOs.

Neither State or Federal governments did a thing about off-exchange derivatives - their willful blindness included the total disregard for margin requirements, capital adequacy ratios or anything else even remotely related to proper oversight.

Neither State or Federal governments did a thing about the "liar loans" and inflated appraisals, even though there was a petition filed with the Federal Government as early as 2003 complaining about it - by appraisers! HUD did its own study and found that more than half of all "no-doc" loans were contaminated by fraud at an extreme level, with incomes overstated by more than half, and yet there was no enforcement action taken.

Investment banks sold this garbage off to anyone who would buy, without a hint of fiduciary responsibility to the investor. (Not that such has ever been in their charter, natch.) They further kept creating and selling these instruments even though they had every reason to believe that the "housing price bubble" could not inflate forever - in fact, it was mathmatically impossible for it to do so.

In short, there was absolutely no oversight of any material sort at all by anyone for more than a decade, and the "animal spirits crowd" ran rampant.


Insolvency

That's the key word here and now.

We have builders who have been granted waivers from debt-covenant violations - just look through the major builders' EDGAR filings, and you will see them left and right. What does this mean? That they'd be bankrupt if they didn't get them. The very definition of intentionally-overlooked insolvency.

We may have bank insolvencies being covered up by The Fed and others. We have no way to know, but the H.3 report strongly hints that in fact The Fed is the only and entire reason that banks have working capital to make loans with. Does this make them insolvent? There is no way to know because the collateral that is being taken via the TAF is "opaque" - the entire point of the TAF was to prevent banks from having to identify themselves in accessing The Fed's primary credit facility!

Corporate and municipal insolvencies? Not yet, but those are likely coming soon, and in significant numbers. If you're The Port Authority of NY and you just had to pay 20% for short-term financing, what do you think that will do to your operating cash flow? Put in perspective, this takes an $80,000 interest payment and turns it into a $400,000 one. Is that good? Delphi is in danger of having its exit from Chapter 11 (restructuring) scuttled, which could lead to a Chapter 7 (boom, you're dead) filing - again, due to seized credit markets.


Ripoffs

Too many to list, but we can take a stab at a few.

• Homedebtors who lied about income to "afford" a bubble house.
• Realtors who played "time to get in the game", "buy now or be priced out forever", and similar refrains, all, of course, to insure that their commission payments kept flowing.
• Mortgage lenders who sold people "teaser rate", "Option Arm" and other similarly exploding mortgages, a rip-off in two distinct fashions - in the first instance in that they allowed people to buy something they couldn't afford, and in the second instance in that even if the bubble continued they insured that the buyer would have to come to refinance again and again as soon as the teaser expired or "recast" happened. Since fees were in fact the overwhelming profit center within these lenders, it simply would not do to have a buyer purchase a house and only visit the lender's office once in 30 years. No, we had to make sure they came back at least every two years for another bite, so we could strip their equity with even more fees. In the stock market world this is called "churning" and it happened through the entire real estate marketplace.
• Wall Street, who bought and paid for ratings, shopping them hard to get that coveted "AAA", and then claimed that these ratings were "impartial." In a pig's eye something is impartial when you're writing the check. "AAA" debt doesn't trade at "90", say much less 50 and 60. Ever.
• Ratings agencies, who are not compelled to list their accuracy ratios nor will they downgrade alleged "AAA" (not to mention "AA" and "A") credit when the market says it simply isn't worth what it was sold at. Witness Citibank, which has this very pretty chart up on its web site, and yet paid eleven percent for capital recently. Can there be a company with an "AA" or better credit rating that pays 11% for capital when Fed Funds is at 3% (to be fair, it was at 4.25% when they did that deal, but still.....)

Explosions

You only think you've seen 'em all.

There will be many more. Until all of the above are stopped, the markets are subject to "tape bombs" going off without warning.

The simple fact of the matter is that houses are still radically overpriced - 30% on a national basis and double or more "fair value" in many "bubble" areas such as California. This correction in pricing will happen whether or not the government or Wall Street likes it. I can guarantee you that they won't like it, and it will almost certainly take down all the "private mortgage insurers." Ultimately this development threatens Fannie and Freddie who are relying on those private mortgage insurers to keep their "book" whole just like the big investment banks are relying on "monoline" wrapper policies.

Commercial Real Estate is likely as big a mess as residential. The "cap rates" on these deals has been insanely low - too low for a debt market that won't give away free money. Well, the free money is pretty much gone, and those deals which were done predicated on "free money" will explode in investor's faces. Typically commercial R/E lags residential in a downturn by 12-18 months. Guess what - time's up!

Consumer credit capacity is pretty much done. Oh sure, not for everyone, but it doesn't have to be for everyone. The fact of the matter is that even a 10% contraction in consumer credit capacity is calamatous for the entire economy, because the consumer is 70% of GDP and they've spent $6 trillion over the last few years in the form of MEWs. That, to put this in perspective, is 10% or so of GDP all on its own. If half of that - conservatively - has disappeared it will place a 5% downward bias on GDP; now add in the additional effects from the construction sector and you've got the potential for double-digit declines in real GDP growth. I do not expect it to get that bad, but a mid-single-digit contraction is not only reasonable, it is expected at this point.

To those "economists" who don't think it will happen, I simply want to ask how they passed fourth-grade math....... there's nothing complicated in figuring this out.

We're nowhere near the end of this mess. In fact, I think I just heard the Umpire shout "Play Ball!" - that's how early in the game we are.

The folks with actual money have been ripped off to the tune of over a trillion dollars thus far and they're not about to let it continue. Those who think that "Sovereign Wealth Funds" are going to continue to throw money into a furnace need to have their heads examined. None of these "investments" have gone well; every single one of them has turned out to be a huge net lose.

Never mind the so-called "great investors" like Bill Miller. I do seem to recall that Legg was a big buyer of Countrywide Financial at as much as $40/share, never mind a number of his other "great calls" on value. Exactly how much of a loss have you taken on that one dear sir, and how much more is to come? Your upside there is capped now - that's kind of a problem, no?

Until the fraud, rip-offs and insolvency are flushed out of the system, the explosions will not cease. Oh they may be hidden for a while, but that is simply because someone cute put a pressure vessel around the blast so you didn't hear it.

It still happened.

Unfortunately pressure vessels have a working pressure limit, and it is rapidly being exceeded. When (not if) they fail you simply get a bigger blast than the original with "extra shrapnel" for your trouble.

For the near and intermediate term, here are the players on the field that you need to watch:

• Long term interest rates are rising. The TNX, 10 year treasury yield, which (loosely) controls mortgage funding costs, has posted a bullish flag. Twice in the last two days it has threatened to break out of that north - decisively so. The target on the TNX, should it confirm, is 4.20%, which would be a calamity for what is left of housing, pushing rates on 30 year money into the mid 6s at a minimum, and possibly even higher. The nasty here is that if equities move higher the TNX will move higher as well as some of the "risk adversion" money comes out of bonds into stocks! This move is all that has prevented a rocket shot in the TNX over the last two months - which means that paradoxially, The Housing Market benefits from a stock market crash!
• The monoline insurers and banks appear to be headed for a nuclear confrontation regarding how they will deal with the CDO/monoline mess between them. There are no good options here, only bad ones; the "long side" bet here is to go "long lawyers." If the monolines are split up then the CDO portion of the firm is likely to get hit on its ratings instantly, which will in turn translate into enormous BASEL-II mandated capital reserve charges at the banks. This will precipitate tremendous and instantaneous forced contraction in lending capacity. A straight credit downgrade of the monolines does precisely the same thing. I see no scenario that is remotely plausible that can prevent this from happening, as the actual amount required to "backstop" it all is tied to the eventual contraction of home prices, and the exploding CDOs go exponential in number and cost as the maximum home price decline increases.
• Lots of people are talking about how "bank credit continues to increase and this means the economy is ok." Wrong. Bank credit is being involuntarily expanded as companies (and people) are drawing down "available" credit lines in anticipation of those lines being shut off and as a response to seizures in the credit markets. Witness Countrywide Financial which drew down all of an $11 billion facility in late summer. The banks are wising up to this game and either have or are withdrawing the remaining "non-drawn" lines.
• Lots of folks are still talking about "hyperinflation", and citing "M3" and similar. This is pure nonsense; if you want an example of this idiocy listen about 44:45 into this audio link. The fact of the matter is that "M3" did not capture the shadow credit creation by non-bank entities but it sure as hell does capture the forcible conversion of that "shadow" credit into bank credit! If you invest today on the premise of a "Weimar Hyperinflationary Explosion" you are going to get killed. We already had severe monetary inflation but the statistics failed to capture it - now we're experiencing the deflation that must follow as debt defaults but most are failing to recognize it due to the original false signal. Simply put, the cost of government debt service makes an intentional decision to "hyperinflate" as a potential path "out" impossible; compare the outstanding present federal debt ($9 trillion) .vs. the Federal Budget ($3 trillion in the latest budget) and the problem that such a path presents becomes clear. The government's funding costs can and will exceed the entire budget if they attempt this sort of scheme, which is why the government will not allow it to happen. The Federal Government is NOT going to put the shotgun of monetary policy into its own mouth and pull!
• Equity markets still do not take into account negative S&P earnings estimates for the next quarter, nor do they account for the haircut in full year 08 earnings that is now certain to occur. As usual the "analysts" are behind the ball. We have just now seen the 1Q estimates go below zero. What's the "P/E" of the S&P 500 if the "E" is negative?
• Equity markets are NOT discounting a consumer spending recession. Not even close. We are 12% down from the peak right now, more or less. In recessions equities typically lose 30% of their value. This is likely to be a deeper than "typical" recession and thus losses of up to 50%, peak to trough, cannot be ruled out. To those who say "stocks are cheap" based on the theory that treasuries are yielding almost nothing, I simply point at Japan and what happened to their equity markets when they went through a credit bust, or, if you prefer, what happened to the S&P 500 from 2000-2003.
• Short interest is falling rapidly and there are still too many bulls, with margin debt remaining extraordinarily - and dangerously - high. Markets don't bottom until nobody wants to own stocks. We're nowhere near there. So long as you hear people like Kudlow telling everyone to "buy buy buy" and every analyst on CNBC is talking about how there's a great "buying opportunity" either right now or just around the bend, we have further to go.
• The political landscape favors The Bears at the present time. Obama is leading Hillary in the Democratic Race, but irrespective of which of the two is the Democratic candidate either is likely to win, simply on the economic landscape come November. People will vote their wallet and both are promising Bread and Circuses. The ugly in there is that both are also promising to get rid of "Bush's Tax Cuts For The Rich", which means dividend and capital gains rates will go up significantly. These tax cuts made stocks more attractive in the 2003-2006 time frame, and their recission will make them less attractive going forward, shifting investment preference to tax-free municipal bonds. Since the market discounts events ahead of their occurrance, a likely Democrat White House will add significant downside pressure to the equity markets.
• Bull markets don't feature "spike bottoms", but bear markets do, and those spikes almost never hold. How many times do you need to be screwed buying one of these "relief rallies" before you give up? So far you've been fooled in August, November and it looks like January will be #3. When do people wake up? That's hard to know, but eventually the most-ardent Bulls run out of rocket fuel - or margin capacity.