Week in Review 
For the week 3/12/2007 - 3/16/2007
Brian Trumbore
President/Editor, StocksandNews.com

In their earnings reports this week, Goldman Sachs, Bear Stearns and Lehman all said their exposure to the subprime mortgage market was small and any interest they maintained well hedged. Good for them. But some of their own analysts aren't as sanguine when it comes to the rest of those holding the paper.

Jan Hatzius, chief U.S. economist for Goldman, said in a research note, "Mortgage credit-quality problems go well beyond the subprime sector. The underlying problem is not the subprime market per se, but the reset of large quantities of adjustable-rate debt - some of which is classified as subprime some as prime - to higher interest rates in an environment of flat or falling house prices in most of the United States." Hatzius adds that there is still a large segment of prime buyers with ARMs who are about to experience their own reset issues. [Wall Street Journal]

Adam Topalian, fixed income strategist at Lehman, told a CFA Society of Seattle dinner that the greatest risk facing investors is for the troubled subprime lending sector to lead to a spiral of falling home prices and further defaults. While Topalian added there isn't enough evidence this is happening yet, the risk of a broader market impact is "very real."

$900 billion in adjustable-rate mortgages is resetting over the next two years, he allowed. "Any kind of sharp pullback in lending could lead to a vicious spiral of continued housing price depreciation and defaults. This does have the potential to feed on itself and it's a real concern." [Reuters]

Merrill Lynch chief economist David Rosenberg, who has been warning of housing's difficulties for quite some time, says tighter credit standards finally being implemented by mortgage lenders could lead to a 10% decline in home prices. He worries about the "knock-on effect" in sectors such as appliances and furniture; which of course can severely impact employment.

A former Federal Reserve chairman (I said last week I wouldn't use his name anymore) weighed in on the side of Rosenberg this week, even as current chairman Ben Bernanke last insisted there will be no "spillover" from rising delinquencies. But the Fed meets this week and we await the language in the statement accompanying the certain move to continue to hold the line on rates.

Speaking of delinquency rates, this week it was announced that a staggering 13% of all subprime mortgage payments were late, while the rate of foreclosure for all classes of mortgages hit an all-time high.

Credit Suisse analyst Ivy Zelman, another who has been bang on in calling the problems in real estate, sees another issue; a 20% drop in new-home sales. Her argument is if you can't sell your entry level home, you can't move up. Inventory levels will thus continue to soar.

As for the homebuilders themselves, last week it was D.R. Horton CEO Donald Tomnitz who told investors "2007 is going to suck, all 12 months of the calendar year." This week Toll Brothers CEO Robert Toll said the start of the spring selling season was "pretty much a bust," adding "When will the market rebound? Who knows? The Shadow knows. I have no idea. I would've thought that it would've rebounded by now and I would've been dead wrong, and I was." [Bloomberg News]

Actually, with their recent choice of words, some of these CEOs are beginning to lose it. And you're still not hearing enough about their tremendous exposure to land that they remain on the hook for (and/or their banks).

All of the above spells ongoing troubles for the collateralized mortgage sector, or CDOs; the packaging of which hit $918 billion last year. According to JP Morgan, $173 billion of this paper was backed mainly by subprime mortgage bonds and related derivatives. Well, remember the old mantra around here. Many of those responsible for the coming debacle just aren't that smart.

In the end, though, it's the little guy who is still the biggest loser. As Countrywide CEO Angelo Mozilo told CNBC, his company being a diversified operation and not subprime heavy, the "concern is for the country." The "rush to judgment in cutting off programs first-time buyers have used" could be crippling. The have nots lose another round to the haves, and the full carnage has yet to be felt during this developing credit crunch.

Street Bytes

--It was the third losing week in four for both the S&P 500 and Dow Jones, off 1.1% and 1.4%, respectively, with the Dow now trading at 12110 and the S&P back below 1400 (1386). Nasdaq lost 0.6% to 2372. There simply aren't any reasons to be an aggressive buyer these days.

--U.S. Treasury Yields

6-mo. 5.12% 2-yr. 4.59% 10-yr. 4.55% 30-yr. 4.70%

Treasuries rallied a bit despite hotter than expected inflation news. The producer price index soared 1.3% in February, but 0.4% ex-food and energy, while the consumer price index rose 0.4%; 0.2% stripping out the stuff we use. The core CPI is up 2.7% year over year, higher than the Fed's comfort level.

So you'd think bonds would have taken it on the chin, but a sick retail sales figure for February, up just 0.1% when a 0.4% increase was expected, led to the belief that there is no way the Fed will raise rates anytime soon and now with the economy softening it could lower them before summer.

As for Treasury Secretary Hank Paulson, he reassured us "the consumer continues to be healthy." Ah, but we've got the sniffles, Mr. Paulson. Time to rest the pocketbook.

--The federal budget deficit for the first five months of the fiscal year that began Oct. 1 is 25% less than a year ago as revenues continue to stream in. For fiscal 2007, the Congressional Budget Office is forecasting a deficit of just $214 billion, or 1.6% of GDP. Last year it was $248 billion. But the rate of growth for corporate profits is starting to drop precipitously, as are capital gains.

--OPEC opted to hold the line on production, this as the International Energy Agency warned that inventories of most oil and gas-related products are falling unusually fast this year; thanks primarily to unplanned refinery outages and continued high demand around the world. But since the Saudis have the most clout, it would appear they are quite satisfied with $60 oil. "Good shopping, fair princes!"

--South Carolina Republican Senator Lindsey Graham warned that the Democratic controlled Congress will clearly intensify pressure on the administration to crack down on China to raise the value of its currency. Graham himself supports most efforts to create "pain" for the Chinese "when they cheat" on trade. Graham had withdrawn a proposal to levy a 27.5% tariff on Chinese imports last fall when he and Democratic co-sponsor Charles Schumer of New York were convinced by the White House that China would begin to comply with their wishes.

Trade remains a ticking time bomb. As the U.S. economy weakens, Congress will be under increasing pressure from constituents in many districts to go after China?at the worst possible time for such action. And China holds $350 billion in U.S. Treasuries, which some of us have long argued could yet be used as a weapon of mass destruction if Beijing feels Washington is going too far.

--It's clear that the No. 2 subprime lender New Century Financial was simply a house of fraud as the SEC and U.S. Attorney's Office in California quicken their investigations into accounting errors and probable insider trading. New Century's lenders, including Bank of America, Citigroup and Goldman Sachs, are demanding accelerated payment on New Century's obligations to buy back outstanding mortgage loans under certain circumstances?like today's.

[Shares in some of the other subprime lenders rallied on Friday on word their bankers were extending lines of credit.]

--General Motors warned investors that its accounting controls are "ineffective," the same ones already under investigation by the SEC. "The lack of effective internal controls could adversely affect our financial condition and ability to carry out our strategic business plan."

Now this was in a filing that was part of its annual report and a supporter of the company could say this is nothing more than boilerplate. I would observe, why would you ever touch the stock until you know GM has its books straightened out?

--Goldman Sachs had another spectacular earnings report, a profit of $3.2 billion and far above expectations. But it was for the three months ending Feb. 23, before the stock market slump and the worst of the subprime lender news. CFO David Viniar, though, was optimistic that Goldman's future results would not be hurt by the real estate debacle.

--As for rival Bear Stearns, while its own earnings were also solid, an independent research firm specializing in corporate cash flow analysis, CreditSights, says BS's buying activity in the subprime mortgage sector "aided and abetted the industry's collapse. They did nothing to ensure that the loans they were buying were kosher. There was no 'good guy' here, no voice of reason or advocate for conservative standards." CreditSights said the percentage of borrowers who were more than 90 days delinquent in Bear Stearns' mortgage pools was 4.57%, vs. leader Countrywide's 1.42%. BS executives dispute this. [Bloomberg News]

--Viacom sued Google-owned YouTube for "massive intentional copyright infringement," asking for $1 billion in damages. Viacom is also seeking for an injunction to prevent YouTube from further infringement, though experts in copyright law do not expect a court to comply with the latter demand. The latest tussle between the two is a result of negotiations breaking down over Viacom's demand that YouTube remove over 100,000 of its clips in February after failing to hammer out a licensing agreement. For its part Google said it complied with the request, but Viacom maintains thousands of clips reappeared just hours after being removed.

--Microsoft CEO Steve Ballmer, talking to a group at Stanford, criticized Google for failing to achieve significant traction beyond its online business, adding that it's "insane" to keep trying to double its staff. "I don't think anyone has proven that a random collection of people doing their own thing has created value." You know what does work? Two young kids messing around in a garage with some gizmos.

--Private-investment giant Blackstone Group plans on selling a stake to the public and could file plans for an IPO over the coming weeks. Blackstone would then take the proceeds, leverage up 100 times, and take over every business west of the Mississippi. Others, such as Apollo Management, KKR and Carlyle Group are also reportedly looking at public offerings, leaving them to divvy up the asset rich northeast and Europe.

--Wal-Mart has abandoned its plans to establish its own bank. Too many roadblocks from regulators and Congress to maneuver around.

--Mark R. notes that in Naples, Fla., developers are offering Cadillacs to buyers of still overpriced properties. Josh P. says if residential real estate is this year's debt story, next year it's corporate debt. I don't disagree.

--A California court dismissed all charges against former Hewlett-Packard chairman Patricia Dunn who was forced to resign under a cloud of controversy over a boardroom spying scandal. Charges against four co-defendants were reduced to misdemeanors. While I understand there was some sympathy for Ms. Dunn, who is battling cancer, the fact remains that operatives acting on behalf of HP's board used false pretenses to obtain private telephone records in an attempt to figure out the source of a leak.

--Citigroup chairman and CEO Chuck Prince was paid $26 million in cash and stock for another job poorly done in 2006. And the Chuckster even got a 13% raise over 2005.

--Are you rich? The Journal's Robert Frank notes that these days the richest 1% of U.S. households have at least $6 million in assets, including homes, while the richest 1% of tax filers (individuals or households filing jointly) required $314,000 of income. [Both figures for the latest recording period, 2004.] As part of the SEC's efforts to regulate who can invest in hedge funds, the commission is proposing that investors need to have investible assets of at least $2.5 million, excluding equity in any homes, to be eligible to sign up for one. Today the requirement is a net worth of at least $1 million, including the value of primary residences, or an annual income of $200,000 ($300,000 for couples).

--Talk about a dirtball, Christopher Palmeri wrote a piece in Business Week on music mogul Louis Pearlman who is being investigated by the State of Florida for orchestrating a Ponzi-like scheme "that may have bilked some 1,800 investors out of $317 million." Pearlman's main company, Trans Continental Airlines, sold money-market like investments offering rates slightly higher than the banks. Pearlman then distributed brochures claiming the funds were backed by the FDIC and insured by AIG and Lloyd's of London. Florida regulators say none of this is true. Pearlman preyed on the state's elderly, and he's now also defaulting on various commercial loans to the likes of Bank of America and Washington Mutual. Pearlman until now was best known for promoting the Backstreet Boys and *NSYNC. Thus far, the man appointed by a Florida judge to oversee Pearlman's businesses says he's recovered just $50,000.

--And then there is the case of former GOP congressman Michael Oxley, he of Sarbanes-Oxley fame; the corporate reform act that was in response to the collapse of the likes of Enron and WorldCom. Oxley, like all the other dirtballs in Congress, is now parlaying his former job into a lucrative career at, get this, the Nasdaq, where he will be vice chairman and just another high-powered lobbyist.

Foreign Affairs

Iran: President Ahmadinejad remains defiant against UN sanctions and deadlines already past. But it appears the Security Council is set to initiate a stronger set of sanctions, including the ordering of an international freeze on assets of 13 Iranian companies, including the country's fifth-largest bank, Bank Sepah. Plus the resolutions would impose an embargo on all Iranian arms exports. The U.S. hopes this would help curb the flow of weapons into Lebanon. Especially pleasing to the White House are sanctions against three companies aligned with Iraq's Revolutionary Guards. The full 15-member Security Council should vote sometime this coming week.

One sidelight to the whole Iran issue has been Russia's sudden loss of patience with regards to their work on the Bushehr nuclear reactor. Russia now says the September launch date will not be met and it won't deliver needed shipments of nuclear fuel, claiming Iran is still running behind on payments.

Iraq: Iran and the United States exchanged harsh words at last weekend's meeting in Baghdad, but at least they were talking. Meanwhile, the Senate voted down another Democratic attempt to force the withdrawal of U.S. combat troops in 2008.

On the ground, U.S. commanders are seeing some cooperation from Moqtada al-Sadr's Mahdi Army in Sadr City. 700 of the more extreme elements, who for the time being posed a threat to Sadr as he makes himself over yet again, have been arrested but at any moment the relative calm could evaporate. [As in Sadr has now called for new protests against the U.S. occupation.]

In the end, however, it's still about a political settlement and for all his talk, Prime Minister Nouri al-Maliki is worthless. The White House keeps extending the timeline because Maliki talks reform and then does nothing. For starters, the critical oil revenue-sharing measure has yet to be passed by parliament.

Early in the "surge," it would appear the U.S. military is beginning to assert itself in Baghdad, despite the ever present IEDs that continue to claim the lives of our soldiers. Gen. David Petraeus is just trying to buy the government time to get its act together. Now it's also time to tell Maliki "Put up or shut up" and give him a tight deadline to get key measures passed or send him packing.

Israel: Hamas and Fatah supposedly agreed to another power- sharing agreement, but Hamas still won't recognize Israel so no one outside the Palestinian territories gives a damn. Separately, another report shows that over 30% of Israeli settlers in the West Bank are living on property illegally seized.

Two other items. Israel is claiming Syria has been positioning thousands of medium- and long-range rockets capable of striking major towns across northern Israel, with many hidden underground in new installations. And the plot thickens regarding the high-level Iranian "defector," Ali Reza Asghari, a former leader of the Revolutionary Guards. Last week I wrote of how he was spirited out with his family and was presumed to be in the United States. This week, however, his wife, brother, two daughters and a son surfaced in Tehran. They insisted their father was abducted by the U.S. and Israel.

Rami G. Khouri, in an op-ed for the Daily Star, summed up the recent action in the region.

"It is not a coincidence that serious political talks are taking place simultaneously these days between top Lebanese political foes, Saudi Arabia and Iran, the United States and each of Syria and Iran, Israelis and Palestinians, the Europeans and Syria, and, directly or indirectly, Israel and Saudi Arabia.

"For the past three years, since the situations in Iraq, Iran, Syria, Lebanon and Palestine-Israel have all been conflated into a consortium of conflicts, there has been frequent talk that one way out of the region's stressed conditions is to strike a Grand Bargain that resolves all these disputes simultaneously. That has always been a long shot. It is also obvious that these simmering conflicts and active battles are all linked to one another to some extent - especially as Syria, Iran, the U.S. and Israel have their fingers in every one of these disputes. Therefore progress on any of these disputes could trigger movement on the others?.

"If talking is a small but important sign of possible progress, more significant is the simultaneity of all these discussions, for several reasons. It forces all concerned to clarify their positions and thus construct a possible negotiating framework, especially by identifying one's minimum needs and most important demands from the other side. It generates new possibilities to push for reasonable negotiated agreements rather than savage battlefield legacies. It increases the possibility that reasonable tradeoffs and compromises can be made on more than one front (in other words Iran and Syria might ease off in Lebanon if their regimes were no longer threatened with removal by force, and Israel might concede more to Syria and the Palestinians if it were confident about Iran's, Hizbullah's and Hamas' willingness to coexist with it)?..

"Sampsons abound in the Middle East. On the other hand, antagonists who discern the potential dangers of their macho attitudes and militarism are also capable of acting more humbly and reasonably, by exploring possible peaceful resolutions of their conflicts.

"We shall soon discover if our decision-makers are the irresponsible killers they often seem to be, or still have enough sense and humanity left in them to pull back from the brink of their own extremism. For the first time in many years, they have the opportunity to choose from both options that are on the table before them."

Zimbabwe: Last Sunday, the Movement for Democratic Change (MDC), the chief opposition for almost a decade to President Robert Mugabe, staged a "Save Zimbabwe" prayer meeting. Riot police then attacked the gathering and 50 MDC officials were arrested and savagely beaten with rubber truncheons and iron rods. The MDC's leader, Morgan Tsvangirai, suffered a fractured skull and broken wrist yet days after he made a court appearance.

Even ally South Africa finally scolded Mugabe (that's as harsh as the South Africans get when it comes to their neighbor), while the 83-year-old dictator told his critics to "go hang." What's increasingly apparent to me, however, is that it will soon be Mugabe himself who is strung up like Mussolini.

North Korea: The International Atomic Energy Agency's Mohamed ElBaradei made his first visit to North Korea and Kim Jong-il's top nuclear negotiator called in sick and refused to meet with him. Kind of early in the year to be thinking of using up your sick days, isn't it? ElBaradei, though, said his other meetings were productive and he fully expects North Korea to comply with the six-party agreement and shut down the Yongbyon nuclear reactor by the April 14 deadline. At that point the North would receive energy aid and political concessions.

But with exactly four weeks to go, South Korean intelligence is saying there are absolutely no signs of activity around Yongbyon, yet Seoul is reinstituting some aid programs.

Earlier, the U.S. Treasury Dept. ended an 18 month investigation into a Macau bank that had been accused of being used by North Korea for counterfeiting and money laundering, but it wasn't clear if Kim would have access to the $25 million in deposits. As of Friday, the U.S. acted as if he would. But on Saturday, North Korea announced the issue wasn't settled to its satisfaction.

China: Staying in the region, following is an excerpt from a story by Ken Fireman and Allen T. Cheng of Bloomberg News.

"Last July, as North Korea prepared for ballistic missile tests, Admiral William Fallon picked up the telephone to warn his Chinese military counterparts of the U.S.'s deep concern, and urge them to weigh in against the launches.

"There was just one problem: The commander of all U.S. forces in the Pacific, who had spent two years cultivating ties with Chinese leaders, couldn't reach anyone to deliver his message: 'I just couldn't get somebody to answer the phone,' Fallon said. 'Nobody wanted to talk.'

"His experience shows what analysts and security officials in Japan, India, Taiwan and the U.S. say is China's lack of openness about its military plans, decision-making and actions during crises. Those traits compound international concerns created by its long-term military buildup?.

"Says General Tetsuya Nishimoto, Japan's former military chief of staff: 'We should consider the buildup as a threat, because their goals and intentions are unclear.'"

On Friday, Prime Minister Wen Jiabao, in his annual press conference, didn't exactly allay any fears on the military front, claiming the firing of an anti-satellite missile that successfully destroyed one of China's aging satellites in space was "an experiment in outer space," not the firing of a ground-based ballistic missile into space. Wen also obfuscated on a number of other issues, including China's growing role in global warming and soaring levels of greenhouse gas emissions.

Japan: Prime Minister Shinzo Abe's approval rating dipped below 40% for the first time since taking office in September. Abe and Australian Prime Minister John Howard did sign a defense cooperation pact this week, focusing on counterterrorism, border and maritime security, and disaster relief. It is Japan's first defense pact with a country other than the United States, but not a mutual defense treaty like with Washington. Both Abe and Howard played down concerns the agreement was directed at China?.but of course it was.

Pakistan: There is a developing crisis here with a growing backlash against President Musharraf's suspension of the country's top judge, the chief justice of the Supreme Court, Iftikhar Chaudhary. An official with Human Rights Watch proclaimed "By brazenly and unlawfully dismissing, detaining and humiliating the chief justice?President Musharraf has created a constitutional crisis?.Musharraf has undermined judicial independence before and nothing could make that more clear than his arrest of the Chief Justice."

There is a real possibility that the growing protest, which turned violent on Friday, could topple Musharraf unless it is immediately resolved. Hundreds of lawyers continue to rally outside the Supreme Court, supported by high-profile opposition figures.

Chaudhry was suspended for alleged "misconduct," though no details have been released to the public.

India: 49 policemen were killed by Maoist rebels in the center of the country. I have to admit I didn't know this group had attacked interests in 13 of India's 28 states over the past few years. Someone needs to tell them Mao is dead.

Thailand: The Islamic insurgency here is increasingly brutal. This week rebels killed nine Buddhists riding in a commuter van in the restive south of the country, execution-style.

Germany: Chancellor Angela Merkel, who President Bush once massaged, has turned on her boyfriend as she vehemently opposes Washington's efforts to place components of a U.S. missile shield into Poland and Czech Republic. "We?prefer a solution within NATO and also an open discussion with Russia," she said. But then a NATO spokesman said the organization would not interfere with any negotiations the United States may be involved in.

This follows a pattern, as Gerard Baker points out in The Weekly Standard. When Vladimir Putin "flipped a frosty Moscow finger at the assembled Europeans and Americans" at a recent speech in Munich:

"He attacked the United States as a bullying unilateralist that was tearing up international law. But just as the Europeans in the audience were nodding in approval, the Russian president turned on them too. He denounced NATO's expansion to Russia's borders and even found time to insult the Organization for Security Cooperation in Europe, the stately body that has been aiding and promoting democratic reform in the former Soviet bloc, as a 'vulgar' institution.

"The initial reaction, even from Europeans, was hostile. But on reflection, they seemed to decide that a supportive cringe would be more appropriate. A senior German official told me that there was much in what Putin had said that would resonate in Europe. The Suddeutsche Zeitung, a supposedly sober newspaper, blamed the United States for the new Cold War atmosphere, saying it had created 'the opportunity for Putin to set himself up as the powerful voice of the growing number of countries and peoples who are stricken by doubt in the wisdom of Western policies.' This, sadly, for all the continent's boastful claims of a new transatlantic partnership, is the true voice of modern Europe: a Europe that refuses to fight a war, to which it has pledged itself, against terrorists in Afghanistan; a Europe that declines to stand up to a Russian president who condemns its efforts to spread democracy even as his KGB friends eliminate their critics in European capitals. The transatlantic partnership may be together again [compared to four years ago and the debate over Iraq]. Whether it stands for anything is much less clear."

Britain: Prime Minister Tony Blair, as one of his last acts, implored the members of parliament to approve a plan for a new set of nuclear submarines that carry Britain's existing Trident missile force. "I think that is essential for our security in an uncertain world."

Ironically, this caused a major flap in his Labour Party but he won the vote, 409-161, thanks to support from the opposition Conservatives. Their leader, William Hague, said not renewing nuclear defenses would force Britain to depend on France and the U.S. "We should not think for a moment that if we were to divest ourselves altogether of that arsenal, other nations would be likely to follow suit," Hague said.

But I have to laugh at a comment from Nigel Griffiths - who resigned from the Blair government as deputy Commons leader so he could vote against the project.

"We have led the world in decommissioning land mines, and nuclear warheads, and the world is watching us now. Let us lead the world for peace."

Earth to Mr. Griffiths. "Can you say China? Or haven't you heard they are ramping up their own nuclear weapons production at lightspeed?"

And this is almost comical. Britain's Middle East minister, Kim Howells, referred to former Israeli prime minister Ariel Sharon as dead - and then tried to explain himself by saying it was "an easy mistake to make."

Mexico: Good for President Felipe Calderon for none too subtly blasting President Bush upon the latter's arrival into the country, telling him basically that it was about time the Gringo paid attention to his country. [OK, he didn't use the term Gringo, Venezuela's Hugo Chavez did; but Calderon could have.] As for Bush's trip to the region, truly little was accomplished.

Venezuela: President Chavez, in an interview with ABC's Barbara Walters, said "There is no intention to reduce or eliminate (the supply of oil to the U.S.), but we have said, in case of any other aggression by the U.S. administration, we would cut this oil supply, but we expect this is not [going] to happen."

---

Pray for the men and women of our armed forces.

God bless America.

---

Gold closed at $653
Oil, $57.11

Returns for the week 3/12-3/16

Dow Jones -1.4% [12110]
S&P 500 -1.1% [1386]
S&P MidCap -1.1%
Russell 2000 -0.8%
Nasdaq -0.6% [2372]

Returns for the period 1/1/07-3/16/07

Dow Jones -2.8%
S&P 500 -2.2%
S&P MidCap +2.4%
Russell 2000 -1.1%
Nasdaq -1.8%

Bulls 45.5
Bears 28.9 [Source: Chartcraft / Investors Intelligence]

Have a great week.

Happy St. Patrick's Day!

May the road rise to meet you.
May the wind be always at your back.
May the sun shine warm upon your face,
the rain fall soft upon your fields and, until
we meet again, may God hold you in the palm
of His hand.

Brian Trumbore

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