Recession : The Great American Nightmare

The Great American Nightmare

by Martin D. Weiss, Ph.D.

The rally you saw last week was little more than a normal, bear-market bounce — predicated on the myth of government omnipotence ... spurred by the blind faith in fiat money ... and triggered by the official attacks on short-sellers.

For investors who jump into financial and other vulnerable stocks now, it's a trap door. But for those who feel like they're still stuck in all the stocks we've been telling you to get rid of, it's an escape hatch. Use it as your selling opportunity. And don't look back.

We spelled out the reasons in our Special Midyear Update. And behind me on my monitor is just one of them.

I hope you were able to attend. But whether you did or not, this gala, double-length edition of Money and Markets is the edited transcript, which I've taken the liberty to update with the latest inflation numbers ...

Nearly every major bank, brokerage and lender you can name is up to its eyeballs in leveraged investments whose value is going up in smoke. They're borrowing hundreds of billions from the Fed. They're raising billions more from investors, diluting their shares. They're selling massive amounts of assets — scrambling any way they can to raise cash to survive.

Merrill Lynch, America's largest brokerage firm, has lost more than two thirds of its stock value. Citigroup, once America's largest bank by market cap, has lost even more. Washington Mutual has given up nine tenths of its value. On average, even including the strongest of the banks, half of the wealth of bank shareholders has been wiped out.

This is the first stage of the deep recession we've been warning you about. Banks have no choice but to deny loans to all but the most highly qualified borrowers; and as a result, corporations and consumers have no choice but to cut back on their spending.

Consumer confidence is the worst since 1980. Mortgage default rates are the worst since the 1970s. Even the government's highly suspect official numbers show that the growth of the U.S. economy is grinding to a halt.

First, they told us it would be limited to the subprime mortgage market. Then, they told us it would be limited to housing. And of course, every time the Fed pumped in more money for a new bailout, they swore on a stack of Bibles that it would not re-ignite inflation.

The gap between what you see and what they say has never been greater. Today, we're going to show you how they're cooking the nation's books, distorting key economic data, and perpetuating the deception that things aren't nearly as bad as they really are. And we're going to show you why this great deception is, in itself, one of the greatest dangers of all.

As grim as the situation is, though, never forget: As a nation, we will get through this. We faced reality in the Great Depression and we created a stronger country as a result. We faced reality during World War II and we helped create a better world in its aftermath. And that's what we need to do again — face reality.

But right now, unfortunately, we live in two worlds. We live in a real world that average citizens experience each day — sinking home values, surging gas and food prices, the disappearance of easy credit. Plus, we live in a fantasy world that Washington bureaucrats have created — an American economy that they say is "still growing," inflation that they say is still "still moderate," a credit crisis that they repeatedly say has been "overcome."

How big is the gap between fiction and reality? Is it getting bigger? What are the real consequences for investors?

Mike: My point is that in its last full year of operations, New Century made about $60 billion in mortgage loans. Then later last year, another big lender, American Home Mortgage, failed. In its last full year, it wrote about $59 billion in mortgages.

Martin: And IndyMac?

Mike: IndyMac is the biggest of the three. It originated $77 billion worth of mortgages last year. Now, the FDIC has taken over. But they've got their hands full handling depositors. They're not going to lift a finger to revive the mortgage business.

Martin: That's just one company.

Mike: No. IndyMac is far from alone. Almost every day, another regional bank, another mortgage insurer or another broker takes a bath.

For example, Marshall & Ilsley is a midsized bank based in Wisconsin. It said it will have to set aside $900 million in the second quarter to cover losses on housing and construction loans. That was 35 times its loan loss provision of a year earlier. Result: The stock has plunged more than half this year alone!

Then there's Triad Guaranty. It is — or should I say, was — a major mortgage insurer, a company that pays lenders off when borrowers can't make good on their loans. Well, Triad has been losing money hand over fist — including $150 million in the first quarter alone — because losses are off the charts. And now, the company has been forced to stop writing new policies. Its shares traded hands for $58 last January. They go for about 72 cents now.

Or how about Merrill Lynch? Merrill lost $2.2 billion in the third quarter of last year ... $9.8 billion in the fourth quarter ... $1.9 billion in the first quarter of this year ... and another $4.65 billion in the second quarter, far more than expected.

They've already been begging to borrow billions of dollars from sovereign wealth funds and other investors. But even that wasn't enough. The company is now reportedly looking to dump more assets in a fire sale. They're desperately looking for capital, and as I said — as both Bernanke and Paulson admitted — this thing is far from over.

Martin: Mike, I know you're just warming up. But let's use the remaining time to talk about steps investors should be taking right now.

Mike: Sure. But let me say this: Up until late '07 and early '08, most of the problems were confined to real estate. The rest of the economy was holding up. Now the river is overflowing its banks. The whole economy is losing jobs — more than 430,000 in the first six months of this year alone. The service sector is starting to roll over, following construction and manufacturing over the cliff. My point is that investors need to take major action on several fronts — not just housing.

Martin: And, naturally, the first step is to simply get out of danger.