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Mark's Market Blog

7-25-09: The Eye of the Hurricane

By Mark Lawrence

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The market has shot up the last two weeks in an historic run-up, reaching its highest value for the year. The bulls among us still have energy to run off. There's talk on Wal Street that this is the beginning of a new bull market and stocks will continue to raise to achieve all-time highs in the next 18 to 24 months. Buy in now or miss the boat. . .

S&P 500, Jan 1 2009 to July 24 2009

The California Public Employees' Retirement System (aka CalPERS) - the nationís largest pension fund - is suing Wall Streetís top three credit rating agencies. CalPERS blames Moody's Investors Service, Standard & Poor's and Fitch Ratings for more than $1 billion in investment losses. The suit claims ratings agencies gave investments "wildly inaccurate and unreasonably high" grades. CalPERS lost a total of $60B last year.

Analysts consider this lawsuit the tip of the iceberg. Not only are the ratings agencies vulnerable to many such claims, but there are mounting questions about the investment bank's liabilities - after all, they're the ones who created the toxic debt. Goldman Sachs just posted huge profits due in no small part to getting $13B from the AIG bailout and being able to borrow tens of billions of dollars from the Fed at nearly zero interest. Since Goldman currently makes about 77% of their profits trading their own account, the free Fed loans are huge in impact. Goldman was a major player in the subprime mess, and may face bankruptcy-threatening lawsuits also. No wonder they paid off their $10B in tarp funds as quickly as possible and have now announced $11B in bonuses for the first six months of 2009. The average Goldman employee will make over $1M this year. It's clear that this CalPERS lawsuit is testing the waters - if the suit goes anywhere (it will, there are some great emails that will be put into evidence) then a lot more people will sue both the ratings agencies and the bond dealers. It's believed on Wall Street that these lawsuits will be on-going for 12 to 15 years.

AIG got themselves in trouble selling CDSs - credit default swaps. These were insurance policies that would pay off if a particular mortgage based bond were to become junk. AIG made several billion on insurance premiums on these policies, but had no money set aside in case a claim was actually filed, leading one analyst to say "Basically they were selling things they didn't own. Anywhere else in the US this gets you sent to jail, but on Wall Street it gets you a bail out."

While some parts of the economy are showing signs of recovery, the airline industry looks like it is headed for a turbulent ride, ending with at least one major carrier possibly going out of business.

Data released Thursday seems to show that the U.S. housing market has started to recover from the most far-reaching crisis since the Great Depression. Sales of previously occupied homes rose for the third month in a row. In another encouraging sign, the share of foreclosures on the market is shrinking. About one out of three homes sold in June was foreclosure-related, down from nearly half earlier this year. The glut of homes up for sale dwindled to 3.8 million. That's a 9.4-month supply at the current sales pace and another important sign of a recovery. When the market balances at a 7-month supply prices should begin to stabilize. It's reported that that probably won't happen until next year because of a backlog of foreclosures that have yet to come on to the market.

There are these very interesting storms that form over the ocean, Hurricanes. These are cyclic storms - the winds and clouds spin about a center. Wind speeds can reach 200 mph or higher. However, if a hurricane passes directly over you, just after the winds hit their maximum speed, they drop to nearly nothing for a while - 15 minutes to an hour - and the skies above you clear of all clouds. Flying in circles in this calm area in the middle, the eye of the hurricane, are hundreds or thousands of birds keeping safe. However, the eye will pass in a short period and winds will pick up almost instantaneously to their maximum speed. It's a big mistake to be in the eye of a hurricane and think it's all over, actually it's only half-time, a brief period where you can enjoy a short break.

This financial crisis we're in got started when a bunch of "sub-prime" mortgages went bad. Since then it's widely believed that the sub-prime crisis has mostly worked itself out; about half of these mortgages have now gone into foreclosure, and that's likely to be by far the worst of it. However, the deteriorating economy and job market is now calling other mortgages into question. First will be the Option-ARMs, the Adjustable Rate Mortgages with unrealistically low initial teaser rates and payments. A large number of these ARMs will have their interest rates and payments reset in the next 18 months. After that moat is breached, the crisis will spread in an unknown amount to the prime mortgages. The chart below has become very popular on Wall Street in the last two weeks. 2009 is the eye of the mortgage crisis.

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