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December 04, 2007

If you were worried about the economy...

Then maybe you shouldn't read this.

A high(low?)light:

"While it is still open for debate as to whether the overall economy will tip into a contractionary state in the coming year, it became more evident this week that the housing recession is morphing into an outright depression. Over the past year, existing home sales have collapsed 21% and at the same time the unsold inventory has risen over 15%. That is a brew for sustained deflation in residential real estate as the supply curve continuously shifts to the right and the demand curve to the left. To think that over the past year we have seen the inventory backlog soar from around 7 months' supply to 10.8 months now — it's unfathomable. Prices on average are off 5% YoY and the inventory situation has worsened materially — to their highest level nationwide in 22 years, having already broken above the worst levels of the 1991 meltdown. We believe another 10% downward move in real estate valuation is now a conservative estimate, and to think of the instability in the credit markets that the first 5% down created; more to come, that's all we can say."

We are in the beginning stages of a kind of thing that only happens 4 or 5 times in a persons life span, if that. This is Merrill Lynch - the guys dying to sell you some stocks - not some left-wing economics professor. Couple the exhaustive Merrill report with this nugget:

"Much has been made of E*Trade Financial’s recent fire sale, in which it sold a basket of asset-backed securities with a book value of $3 billion to Citadel Investment Group for just $800 million. Many have debated whether or not this deal — nominally priced at 27 cents on the dollar — sets a price floor for collateralized debt obligations and other securities tied to subprime mortgages, whose value has been notoriously hard to pin down.

The case has been made, often persuasively, that E*Trade was getting rid of particularly toxic assets while under duress, so the deal is hardly a bellwether for other banks and securities firms.

But here is a point worth considering: Only about $450 million of E*Trade’s $3 billion portfolio was made up of the riskiest kinds of securities — C.D.O.’s and second-lien mortgages — that have made headlines recently.

What was the other $2.6 billion or so? In E*Trade’s own words, it was “other asset-backed securities, mainly securities backed by prime residential first-lien mortgages.”

In other words, E*Trade’s enormous haircut went far beyond subprime.

A large part of E*Trade’s basket of assets was securities backed by high-quality mortgages — loans to homeowners with strong credit ratings and reasonably large equity cushions. That could raise troubling questions on Wall Street about the true value of “prime” mortgage assets, especially when they need to be liquidated in a hurry."

So - I was a tad early in my recession call - but I am going to blame that on the zeitgeist. If you didn't feel this coming you weren't alive.

More foolish predictions - in the face of another rate cut from the fed the dollar stabilizes around this level and actually begins to rebound as the ECB and the UK start to cut their interest rates in the face of the coming global slowdown.


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