FSO Editorials

Everyone is Writing Default Insurance!

by John Rubino, Dollar Collapse, November 29 , 2006

It’s easy to talk about the credit bubble, but a picture is still worth a thousand words, or in this case millions of dollars. Below are some charts created by Houston-based Bearing Asset Management that illustrate just how crazy (and familiar) today’s market has become. As Bearing’s Bill Laggner puts it, “Complacency is near an all-time high and mutual fund cash positions are near an all-time low. Bank loan loss reserves are falling due to the illusion of credit default swaps. Everyone is writing default insurance!”

Viewing these charts in sequence, a few things jump out:

The stocks that make up Bearing's credit bubble index (banks, brokers, homebuilders) didn't miss a beat when tech crashed in 2000; they kept on rising and have now, despite the homebuilders' recent weakness, hit levels comparable to the NASDAQ before its crash.
Subprime lending has driven the latest stage of the credit bubble, which puts it on very shaky ground indeed. From Bearing: "32.6% of new mortgages and home-equity loans in 2005 were interest only, up from 0.6% in 2000; 43% of first-time home buyers in 2005 put no money down; 15.2% of 2005 buyers owe at least 10% more than their home is worth (negative equity); 10% of all home owners with mortgages have no equity in their homes (zero equity); $2.7 trillion dollars in loans will adjust to higher rates in 2006 and 2007."
Instead of a single isolated bubble, there has been a series of rolling bubbles, with new ones forming to replace those that burst. Each, in other words, is part of one mega-bubble that's fueled by an ongoing flood of new dollars.

John Rubino is the author of The Coming Collapse of the Dollar (co-written with James Turk), How to Profit From the Coming Real Estate Bust (Rodale, 2003), and Main Street, Not Wall Street (William Morrow, 1998). A former Wall Street financial analyst and columnist with theStreet.com, he currently writes for Fidelity Magazine and CFA Magazine He lives in Moscow, Idaho. Contact by Email.