Here at The Daily Reckoning, we’ve got substantial doubt about a number of things.

As to GM, we share the auditors’ concern. The world is full of car factories. Most of them can make cars better, faster, and cheaper than GM. Meanwhile, demand for autos is not growing as quickly as the global growth in auto-making capacity – especially in America. Not that we’re trying to pass judgment. Let the Mr. Market do that!

But GM has friends in high places…ready to lean on the scales of Mr. Market’s justice. The automaker has already borrowed $13.4 billion. It is asking for another $30 billion. But what kind of a dope would lend $30 billion to a company whose own auditors say they’re worried that it might go out of business?

Then again, who would lend money to AIG four times in a row…after discovering each time that the company was in worse shape than before?

If you guessed anything but ‘the US government,’ you are not paying attention.

The rest of the world’s lenders are idiots too – but of a different sort.

Allow us to simplify the world’s credit markets circa 2009: the world’s lenders are eager to make loans to the world’s biggest debtor; they don’t trust anyone else. The world’s biggest debtor, meanwhile, lends to the people private lenders don’t trust – the borrowers who can’t pay the money back.

Meanwhile, sales are falling; profits are collapsing; dividends are disappearing; stock prices are plunging.

Yesterday, the Dow closed down 281 points. Oil held at $43. Gold rose $21. The correction in gold could be over.

One out of every five mortgaged houses in America is now underwater. And a record 5.4 million Americans are either behind on their mortgage payments or in foreclosure.

House prices are still going down. You have to be a Lloyd Bridges to explore the U.S. housing market now.

This unprecedented drop in house prices has put millions of households underwater too. Martin Feldstein estimates that U.S. households have lost $12 trillion. It will take a decade of savings at a high rate to replace this money, he says.

The savings rate has soared…from below zero in 2006 to over 3% now. Rising savings will take $500 billion a year out of the consumer economy, Feldstein believes.

No wonder retailers are reporting weaker and weaker sales. In February, only Wal-Mart reported higher sales. Wal-Mart benefits from the ‘trading down’ effect. Now, when people spend money, they want cheaper alternatives…

Meanwhile, the cop who had the Wall Street beat when the biggest heist in history was going on…and who engineered the loans to AIG and GM…is now the chief of police. Tim Geithner said he was working night and day on Obama’s rescue plan, “because we know how directly the future of our economy depends on it.”

But as our old friend Marc Faber points out, neither Mr. Geithner, Mr. Bernanke, nor any of the men who rule us, seems to have any idea what they are talking about. As Chairman of the New York Fed, writes Faber, Mr. Geithner “did not seem to ‘know,’ in the period preceding the crisis, how the future of the economy depends on a sound financial system!”

Faber goes on to explain that not only did the key players fail to understand what was going on – when it was obvious to him, us and millions of others – they then misdiagnosed the problem and prescribed the wrong treatment. They thought it was a liquidity crisis; so they threw billions in cash at dying institutions.

At every step of the way, the feds have been clueless, hopeless, and defenseless. It was the feds who lent money at negative real interest rates for more than five years. It was the feds who pretended to “regulate” and “control” the marketplace…claiming to protect investors from fraud and malfeasance. It was the feds who licensed the banks…set banking standards…blessed derivatives because they “distributed risk more widely” (Greenspan)…urged people to buy adjustable rate mortgages (Greenspan again)…praised sub-prime lending because it encouraged home ownership…and even told consumers to “go out and buy an SUV” in order to give the economy a boost (Fed governor Robert McTeer).

The feds piled up the tinder…poured on the gasoline…and lit the match. And now, what do you know…they’ve all joined the fire department!

*** One small step for the Bank of England; one giant step towards bankruptcy.

“QE”. It does not refer to the Queen of England…but the latest codeword in central banking – quantitative easing. The Bank of England said yesterday that it would buy government bonds itself. This is known to economists as “monetizing the debt.” Because the bank takes in debt…and turns it into cash. Just like that.

The European Central Bank took a little step too. It cut rates – as did the Bank of England – by half a point. That brings the BoE down to 0.5% and the BCE to 1.5%.

Mervyn King, head of England’s central bank, said he was going to quantitative easing because, in effect, nothing else had worked. They were already lending money to English banks below the consumer price inflation level…which is to say, at negative real interest rates. But the banks weren’t cooperating. They took the money…but there it sat. They didn’t lend it out.

That is why it is obviously NOT a liquidity crisis. The problem isn’t that the banks don’t have enough cash…or access to cash…it’s that they don’t know what anything is worth. They can’t make a loan, because they can’t be sure of getting the money back.

We’ve already laid this out for you, dear reader. We’re going to do it again, in case you weren’t paying attention: this is not a liquidity crisis…and not a recession either. It’s a depression. In a depression, the economy needs to adjust to a NEW REALITY…whatever it may be.

Martin Feldstein, mentioned above, provides more figures. In the new reality of 2009, there’s about half a trillion less in consumer spending…because consumers are saving money, rather than spending it. And you can take out another $250 billion just from the crack-up in the housing industry. No building…no construction jobs…no financing jobs…no selling jobs…no furnishings…etc. etc.

That’s $750 billion less each year to support American’s retail…and indirectly, wholesale…providers.

The Obama administration is trying to make up for this private spending with public spending. But his plan, as bold as it is, will only put back about $300 billion each year. That leaves a $450 billion shortfall…which could easily remain for the next 10 years.

This is the new reality that every business, investor and household in the country must live with. Revenues will go down. Sales will go down. Profits…earnings…dividends…you know where this leads.

Well….

Actually, none of knows where it leads…exactly. From today’s perspective, it appears to lead to a Japan-like slump…a long period of adjustment to the new reality…delayed, worsened and stretched out by the efforts of our leaders.

But then…there’s that QE.

We can’t read tomorrow’s headlines…but we can read the names on tomorrow’s tombstones – they’re our own. What has to happen will happen. The United States is now engaged in the most massive spree of Madoff financing the world has ever seen. It needs to borrow more and more just to pay for previous borrowing.

At some point in the not-too-distant future…this system must crack-up. Normally, Madoff would go broke and go to jail. But what would happen if he had a printing press in his basement…and the legal write to print up as many $100 bills as he wanted?

Would the story have ended differently? Would he have the integrity to avoid full-scale quantitative easing? As to that…as to so many things…we have ‘substantial doubt.’

Source: A Crash Course in the World Credit Markets

Immediately, I jump to my feet to scream my guts out that, “It’s because the amount of corruption is, like it always is at the end of long booms, completely off the freaking charts, and nothing is as it seems; everybody is lying to you; everybody is trying to steal your identity and you are being ripped off every freaking day, in countless ways, by corrupt thieving morons in government who are so, so desperate at this point that they are resorting to insanity!”

Apparently, that was not the winning answer, and my powerful entry was tossed aside in favor of, “Financial services are different from other industries, if only because so much of the business is writing bets. One side pays the other for a claim that comes good if, say, oil prices fall, or a company defaults on its bonds, or householders make the mortgage payments on time.”

So, stung at not having my answer selected as the winning entry, I think to myself, “Insurance policies don’t explain why the financial markets are unstable! So my answer is better! Where’s my damned prize?”

Perhaps in response to my anticipated objection, I could tell by long experience that they started to say something like, “You’re a moron, so why don’t you shut up?” But instead they took the “high road” and put me in my place by saying that “Expansion in most businesses is held in check by the need to build assembly lines, rent retail space or hire workers. All that takes time and money. By contrast, financial contracts can be written almost instantaneously and without limit.”

Instantaneously and without limit! Wow! Now I see!

The problem arose when people found out that everybody lied about the money or the collateral that they were putting up as their halves of the bets! Hahaha!

And then they lied about those bets to use as collateral for other bets, around and around until everybody owned, and owes, lots and lots of these derivative bets until one day – surprise! – they are all found out to be a Big Load Of Lying Crap (BLOLC)! Like now! Hahahaha!

They don’t call it BLOLC, of course. They call it “counterparty risk”! Hahahaha!

The interesting thing to me is that The Economist magazine explains that the market for derivatives has gotten so huge because (and this is the important point) they are useful to people signing contracts, as “After America came off of the gold standard in 1971, businesses wanted a way of protecting themselves against the movements in exchange rates”, by which they mean that nobody wants to experience a loss of the buying power of their stupid fiat money!

So, figuratively climbing upon my soapbox to thunder at passersby, once again we have one more damning piece of evidence, to add to the mountain of other evidence, that the dollar being tethered to gold, as per the Constitution, was a Good, Good Thing (GGT), and that any other arrangement was a Bad, Bad Thing (BBT), especially the fiat dollar thing, which was the worst thing of all things, and now the Worst Of The Worst Things (WOTWT) is going to happen to us!

And the reason for the calamity is stupidity, pure and simple, as The Economist magazine notes that the infamous Black-Scholes option-pricing model “showed how to work out an option price from the known price-behaviour of a share and a bond. It is as if you had a formula for working out the price of a fruit salad from the prices of the apples and oranges that went into it”, while at the same time price movements in the option prices come from “the equation in physics that describe the diffusion of heat.” Hahahaha!

The Economist doesn’t go so far as to agree with me that this stupid theory that “all probabilities are always normally distributed, even over the long-term” is ridiculous, and which is even stupider than thinking that “investing in the stock market is the same as saving”, which, along with the tragic concept of “everlasting love”, are the three stupidest things I have ever heard of in all my years on this planet you call Earth.

Well, let’s not forget the other stupidity that brought Black, Scholes and Long Term Capital Management to ruin; assuming that there would always be somebody out there who was so stupid as to take the other side of their bets, no matter what was happening, at predicted prices! Hahaha! Morons!

Apparently, since I see that I am the only one laughing, I assume that I am missing the point, because The Economist magazine keeps insisting that “The idea behind quantitative finance is to manage risk. You make money by taking known risks and hedging the rest” which doesn’t make much sense to me because if the risks are known to everybody, then the option is priced as a 50-50 bet, and I am here to tell you that I laugh at anybody who says that they can make money on a 50-50 bet! Hahaha!

Of course, nobody at the offices of The Economist will answer the phone when I call to argue the point, but they imply that my theory, my ignorance and my sheer stupidity notwithstanding, problems soon arose because “the idea behind modeling got garbled when pools of mortgages were bundled up into collateralized-debt obligations (CDOs)”, resulting in a “baffling complexity” of assets where “each one contained a unique combination of underlying assets”, thus making them “impossible to model in all but the most rudimentary way”.

By this, I assume they mean that if it weren’t for that One Tiny Thing (OTT), everything would be fine, and we would be prospering and laughing, having a wonderful time, perhaps sharing a pizza el supremo mucho grande extravaganza, a princely cholesterol-bomb topped with every pork product known to man, instead of hunkering down in our filthy, stinking bunkers waiting for the world to collapse in flames and the fiat dollar to collapse, as have all other fiat currencies in all of history and all the stupid economies that depended upon them.

Of course, there is still time to buy a pizza, and a little more gold and silver before the prices explode! Whee! This investing stuff is easy!

Source: Financial Contracts and the Lying Liars Who Create Them

We don’t know for sure how this latest rally will turn out. But we do know that most of the others were notable for making lower highs and falling to lower lows than the previous dip.

They also were triggered by some sort of positive government action, from the 75 point hike in January to the fiscal package in April to the Citi bailout a couple of weeks ago.

Source: FusionIQ, Bloomberg

That makes Friday’s little spurt upwards different. It was triggered by a slug of bad news… from record highs in job losses, foreclosures and late mortgage payments.

The SPX is once again hitting its 30-day moving average. It has provided firm resistance since September. If it breaks above, we have another rally on our hands. But only time will tell how sustainable it is.

As I said in the article above, I don’t believe it marks a turnaround. But I wouldn’t be surprised by an end-of-the-year rally.

Source: Eight Rallies and Counting

Today, I’ll share with you two simple facts that explain where we are now in housing and why we could be close to the bottom. Let’s get right to it…

1) Houses are affordable again.

You may be flabbergasted to hear this… But U.S. houses are affordable again.

Since last summer, the change has been extraordinary. The typical mortgage payment on the typical home in America now is 20% cheaper than it was less than a year ago. Let me explain:

Last July, the median U.S. home would have cost you about $230,000. And you’d have paid about 7% in interest on your mortgage. So that’s a $1,200 monthly mortgage payment on that house (assuming a 20% down payment).

Today, the median home price is $200,000 – a $30,000 difference from last summer. And mortgage rates are down to 6%.

Between the lower price and the lower mortgage rate, you’d be paying less than $1,000 a month on your mortgage now – for the same house that would have cost you $1,200 last summer!

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Most people shop for homes based on their mortgage payment… They ask, “How much can I afford each month?” And then they look for homes that will give them a payment they can afford.

So the big question is: Can the typical household afford the typical mortgage payments on a typical home? Last summer, the answer was no. But now, the answer is yes. Take a look:

Already? Yes! Houses are affordable again…

You may be surprised to hear it, but thanks to lower mortgage rates and lower home prices, homes are affordable… They’re just as affordable now as they were right before they boomed in the 2000s.

2) We’ve paid our dues, pricewise.

You may also be surprised to learn home prices in general don’t go up that much…

The median U.S. home price has only risen at about 1.5% per year since the 1970s, after you subtract inflation. That’s not much of a gain. (Even that 1.5% price gain is overstated… Homes have gotten much larger since the 1970s.)

The annual increase in price has been consistent… Whenever prices run significantly above that trend, like in 1978 or 1987, they run significantly below that trend three to four years later.

Have we paid our dues yet?

Cycles happen. You can see it easily in this chart. You can also see in 2005, prices ran farther above trend than any time in history. And now, in 2008, prices have fallen farther below trend than any time in history.

Could we see another year or two below trend? Of course. But I expect that we’re in the process of finishing “paying our dues.” We’ll return to the trend.

In sum… you may be surprised to hear it… but

Don’t get caught up in the gloom and doom. Stick with the simple facts.

These indicators are pretty simple. They show how the worst of the housing bust could be behind us already.

Good investing,

Steve

Source: The Housing Bust Is Over