We expect home prices to fall by at least 70 percent before the “subprime mess” has run its course in perhaps 7-8 years, so Wall Street’s recent show of exuberance would appear to be premature. Case-Shiller estimates that home values have fallen 11 percent in the last 12 months, but that would imply prices have only barely begun their slide. For the Dow Industrials, the bottom may lie even further below, since, like Bob Prechter, we believe the blue chip average eventually will trade for under 1000.  That would represent an approximately  90% fall from current levels – not quite as bad as the most extreme cases witnessed during the dot-com crash, but with much broader consequences nonetheless, since ownership of the 30 Dow stocks is far more widely distributed than tech shares were. Concerning payroll numbers, we think the loss of a mere 80,000 jobs in March will come to be regarded with nostalgia at some point and that the economy will shed another two million jobs before the end of next year. The 80,000 figure was of course significantly worse than the 50,000 that had been predicted, but we were puzzled that the predicted number should have been viewed with such dread. If our much darker forecast is correct, monthly job losses should soon start ratcheting up into the 120,000-140,000 range.

Considering the above, last week’s rally on Wall Street might be viewed as a flight from reality. The celebratory mood will surely pass, and probably soon, but until that happens, we should expect the mainstream press to continue force-feeding the theme that the Fed’s heroic and unprecedented measures have saved the day. The catalyst for this latest outbreak of good feelings was of course the Bear Stearns deal. From a public relations standpoint, it has succeeded thus far only because so few investors understand what actually went down. JP Morgan was able to buy bear with a $29 billion line of credit whose ultimate guarantor is Joe Taxpayer. Over ten years, Morgan will pay the discount rate of interest, 2.5 percent -- a privilege that ordinarily is extended only to overnight borrowers.

The reason the terms of the deal are so sweet is that Morgan knows the assets the Fed has asked it to acquire will never be worth much. The Fed stands to reap all of the profits if those assets fetch more than $30 billion eventually, but Morgan’s exposure in any case is limited to $1 billion. Effectively, the bank has purchased a ten-year at-the-money put option on Bear’s toxic portfolio for relative peanuts. 

‘Mother of All Subsidies’

One commentator, David Freddoso, writing for National Review Online, referred to this sweetheart deal, which will effectively rescue of Bear’s bond-holders, though not shareholders, as “the mother of all government subsidies --a non-legislative appropriation that doubles the size of all this year’s congressional pork projects combined. Without  so much as a vote of Congress, taxpayers are to buy securities of undetermined value for $29 billion — roughly Panama’s GDP, or the Federal Reserve Bank’s entire annual profit.”

The scariest thing about the deal is that it has probably exhausted the potency of the “too-big-too fail” illusion that until now has helped keep the banking system from collapsing. Bear Stearns was indeed too big to fail. But so, for that matter, are Lehman and Citi, and if one of those banks should follow Bear into oblivion (presumably taking the other with it), “too-big-too-fail” would almost surely mutate into “too-big-to-bail.” It seems quite clear that the financial system cannot afford even one more bailout of the magnitude of Bear Stearns. Unfortunately, we do not share the Fed’s evident confidence that Bear will be the last U.S. banking giant to go down.

Immune to Crash?

Meanwhile, anyone who believes that the worst is over for real estate should keep an eye on New York City’s terminally bloated market. It has not crashed yet, but the likelihood that it will seems as certain a bet as that the sun will rise tomorrow. Last week’s report that prices are up while unit sales are down was regarded, incredibly, as evidence that the Big Apple might somehow be immune to the crash that has already spread to most other big cities. We are asked to believe that the high level of foreign ownership is what is keeping NYC’s housing prices buoyant. But if that were true, then how to explain the fact that Citigroup shares, which are heavily owned by foreigners whose pockets are almost infinitely deep, have fallen by nearly 70%?  

In fact, signs of an impending collapse in New York City real estate have been masked by the sale of a relative handful of apartments at exorbitant prices in the $25 million-$40 million range. Despite this, in the broad middle of the market – i.e., run-of-the-mill co-ops valued at $1.5 million to $3 million -- buyers have peen pulling back in droves. Under the circumstances, only an imbecile could believe that NYC real estate will somehow weather the devastation of Bear Stearns, Merrill Lynch and hundreds of other financial firms both big and small. Such firms are the life’s blood of the city’s economy, and to think they could implode as they have been doing without a commensurate impact on the real estate market is on a par with believing that the Fed will be able to keep bailing out banks “until things turn around.”

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Only 10 Days Left

There’s good news if you’ve wanted to take the Hidden Pivot course but have been unable to attend on weekend mornings, when the class has typically been held.  In mid-April, I’ll be conducting the six-hour class over two consecutive evenings – Wednesday and Thursday, April 16-17, from 6 p.m. to 9 p.m. MDT.  Click here, and then on the “Upcoming” tab to register; or here if you would like more information as well as a detailed description of the Hidden Pivot Method and a free Hidden Pivot calculator.