The following article is such a good summary that I just had to save it here for posterity. From The Rude Awakening: When the Roof Caves In, By Dr. Kurt Richebacher

“America’s income-short, consumer-led recovery is the aberration — not the norm — in this Brave New World. It is all about ever-declining saving rates, ever-widening current account deficits, mounting debt burdens and increasingly wealth-dependent consumers. It personifies what I believe is one of the most precarious macro models that has ever existed for a major economic power.
— Stephen Roach, Morgan Stanley Economist, April 4, 2005

Private households in the United States have embarked on their greatest borrowing binge of all time, fostered and facilitated by the rampant house price inflation and a most aggressive financial system. What has been developing in the balance sheets of private households, therefore, is a race between booming “wealth creation” through rising house prices and soaring indebtedness. It appears that indebtedness will win this race and wealth creation will lose.

Over the five recovery years since the end of 2001, the overall indebtedness of private households surged by 66%. Even though overall indebtedness soared, rising home prices still provided the private households with the biggest wealth gains of all time. The housing bubble, therefore, has been the single most important economic event of the last few years. Homeowners used the sharply rising market values to embark on their greatest borrowing-and-spending binge of all time, financing higher consumer spending through soaring equity withdrawals, even though personal savings were negative in the aggregate. The bursting housing bubble, therefore, should be the single most important economic event of the next few years.

In a recent speech in Atlanta, Donald L. Kohn, vice chairman of the Federal Reserve Board, remarked:

“Our uncertainty about what pushed home prices and sales to those elevated levels raises questions about how the market will adjust now that expectations of the rate of house price appreciation are being trimmed.”

Please note his explicit remark on “our uncertainty about what pushed home prices and sales to those elevated levels.” The Fed slashed its federal funds rate with unprecedented speed to 1% and accommodated America’s greatest credit inflation, yet Mr. Bernanke stresses the uncertainties in the Fed about what truly pushed homes and sales of housing to those elevated levels. There never was a secret about what exactly has been fueling the U.S. asset-inflation bubbles — above all, equities, bonds and the boom in housing. First of all, the Federal Reserve — with Messrs. Greenspan and Bernanke at its helm — played a key role in the late 1990s both with extremely loose monetary policies and highly encouraging public remarks to foster the stock market boom.

Nevertheless, the stock market boom went bust in 2000 and the following years. While the government and the Federal Reserve opened their fiscal and monetary spigots as never before, the economy started its most anemic postwar recovery. The main support for economic growth came from the developing residential housing bubble, which offset the stock market bust of 2000 to 2002 and provided homeowners with soaring collateral for borrowing through home mortgage refinancing.

To quote Stephen Roach of Morgan Stanley: “The Fed, in effect, had become a serial bubble blower.” By the time the equity bubble popped in early 2000, consumers had moved on to a new strain of wealth effects — taking advantage of possible equity withdrawals from rising housing values to extract newfound purchasing power.

But now that home values are falling, this purchasing power is moving in reverse. According to the Fed’s Flow of Funds Accounts of the United States, new mortgage borrowing by private households peaked in the third quarter of 2005 to an annual rate of $1,223.6 billion. One year later, its growth sharply slumped to $672.7 billion, marking a decline by 45% within just one year. Retrenchment in mortgage borrowing and lending over this brief period has been dramatic.  Without rising home values, and continuing access to new credit, the American economy will slide into recession.

The U.S. economy is one of the very cases in the world in which all three main sectors — government, businesses and private households — keep borrowing and spending heavily in excess of their current income growth. In 2005, they together borrowed $3.35 trillion, of which the nonfinancial sector borrowed $2.3 trillion and the financial sector another $1 trillion. This compared with a total credit expansion by $1.6 trillion in 2000. This coincided with a collapse in national saving from $582.7 billion to $7.2 billion.  Therefore, arguments between bulls and bears about the further prospects of the economy and the financial markets are focused more than ever before on one aggregate: excess liquidity and credit growth. Long ago, until the late 1960s, credit growth was closely tied to economic growth, as measured by gross national product. But this formerly close relationship between the two aggregates went completely bust in the 1980s. Ever since, credit has been expanding in excess of GDP growth.

During 2005, total credit grew in that single year by $3.35 trillion. Compared with nominal GDP growth by $0.74 billion. In other words, it required $4.50 of new credit to add $1 to GDP. Clearly, this is excessive liquidity and credit growth. It is a fact that each major economic and financial crisis was preceded by “excess” liquidity. Just think of America’s New Era during the 1920s and of Japan’s famous bubble years in the late 1980s. In both cases, prior excess liquidity vanished in no time when the existing asset bubbles began to burst. If growing asset bubbles are the channels to excess liquidity, bursting asset bubbles are the channels to liquidity destruction and excess debt.

Therefore, we observe with a very critical eye the balance sheets of private households. According to the consensus of economists, American balance sheets are in excellent shape because asset values, mainly equity and housing, have soared in value for years, altogether by about $19 trillion — or almost 40% — since recession year 2001.  But the bulk of these gains has been entirely in illiquid assets, mainly equity and housing. Liquidity, measuring existing cash against overall liabilities, is at its lowest ratio in postwar history. To us, consumer balance sheets in the aggregate look more like a house of cards.

The great question is whether there is anything in the pipeline that might shake this house of cards. Clearly, we do not want to be standing near this house of cards when the macro-economic trembler finally arrives.”

WSJ: “Daily output at Mexico’s biggest oil field tumbled by half a million barrels last year, according to figures released Friday by the Mexican government. The ongoing decline at the Cantarell field could pressure prices on the global oil market, complicate U.S. efforts to diversify its oil imports away from the Middle East, and threaten Mexico’s financial stability. The virtual collapse at Cantarell — the world’s second-biggest oil field in terms of output at the start of last year — is unfolding much faster than projections from Mexico’s state-run oil giant Petroleos Mexicanos, or Pemex. Cantarell’s daily output fell to 1.5 million barrels in December compared to 1.99 million barrels in January, according to figures from the Mexican Energy Ministry.

…In many older oil fields, companies inject gas to keep the pressure in the wells high and the oil flowing. In the case of Cantarell, Mexico injected vast quantities of nitrogen in the past few years. But the gas can only do so much, and using it means the decline in production can be sudden and sharp. In the case of Cantarell, which lies in the shallow waters of the Gulf, experts say that seawater is fast invading the wells.”

Matt Simmons (”Twilight in the Desert”) warns that the same thing is happening to the big old fields in Saudi Arabia.

Just a note, I disable comments to an article as soon as it gets spammed. I have found that if I don’t, a spam-storm hits.

These jerks really ruin things for the rest of us. I hope Dante reserved a special place for them. I’m not sure what their penance should be, but it will give me some satisfaction to work on the problem.

“WASHINGTON (MarketWatch) — The number of vacant homes waiting to be sold surged 34% to 2.1 million at the end of 2006 compared with the end of 2005, by far the fastest increase ever recorded, the Census Bureau reported Monday.

A year ago, 1.57 million homes were vacant and awaiting a sale.

The vacancy rate for owned units jumped to a record 2.7% from 2.0% a year earlier. From 1965 to 2005, the homeowner vacancy rate had never been above 2%. The long-term average is 1.4%.

`We have more than a million housing units of excess supply,’ said James O’Sullivan, an economist for UBS. `If you are looking for evidence that the worst is over for housing, you’re not going to find it in this report. This argues that housing starts need to go down more.’

In the past 12 months, housing starts have slumped 18% to a seasonally adjusted annual rate of 1.64 million.

In 2006, the number of housing units in the United States rose by 2.14 million, or 1.7%, to 126.7 million. The number of units occupied, however, rose by less than half as much — 1.04 million.

Meanwhile, the homeownership rate (the percentage of homes occupied by their owners) was essentially steady at 68.9%, the government said, close to the all-time high of 69.3%.”

So the absorption rate was 1.04 million, and that was the result of scraping the subprime bottom of the financial barrel. The build rate is 1.64 million and the inventory is a million units above average. Just to achieve stable inventory, housing starts probably need to fall by half. To work off the inventory (which is still increasing), they need to fall by two-thirds for three or four years. And that’s the bullish case, where there is no real wipeout in housing, just a slowdown in absorption to maybe 500K units per year.
If you can read that without saying “Gulp!” then you’re more phlegmatic than me. But the bearish case is that there is so much fraud and over-commitment out there that absorption goes to zero or negative – remember a lot of these units are being counted as “second homes” and so forth, or the borrower has simply lied about them being owner-occupied to get a better rate.

The subprime mortgage business is collapsing.

The Mortgage Lender Implode-O-Meter is now up to 16 companies that have either failed or withdrawn from the business in the last month or so. The ABX indexes continue their plunge, showing that credit conditions for subprime borrowers are deteriorating on a daily basis. The cost of credit insurance for these loans is now so high that the secondary market, where lenders have been selling the loans, is no longer economically viable for the lenders. The New York Times has picked up on this story, with a piece entitled “Tremors at the Door“. The scary graphic on the left, showing the skyrocketing early default rate, is from that article. Some of this is credit issues – people would pay if they could, but can’t – but a great deal is just plain fraud, in my view. The Mortgage Fraud Blog has lots of good information, including links to the complaints in civil lawsuits that spell out the details of the now-standard cashback fraud.

In any event, the net effect is that credit is becoming much harder to get for the subprime (typically, a FICO score less than 680 will be counted as subprime). This means that the bottom-of-the-barrel buyers that have supported the lower end of the housing ladder are rapidly being eliminated. Clearly this will ripple up the ladder.

However, the homebuilder companies’ shares continue to be recommended and bought, despite the gloomy warnings from the homebuilders.

Here is an amusingly annotated transcript of analyst questioning of an executive from one of the major homebuilders (D.R. Horton). The analyst is desperately searching for support for his position, rather than gathering information. Classic.

The rumor that B of A was buying Countrywide blew me out of my CFC puts today. Annoyed, I sold my MTG and COF puts as well. Now I’m just in indices. Too many of the individual stocks have been subject to short squeezes for me to want to play that game anymore. The indices are a different matter. This week showed some weakness and the shorts are starting to look better.