"U.S. stocks plunge to worst 1-day drop since 2001"

All the headlines are about stocks, but the real story is the increase in cost to insure bonds. Remember, U. S. Government bonds require no insurance. I just saw an article in Bloomberg that said that bonds in Mongolia only yielded 1.39% more than Treasuries. As the risk of default goes up, the cost of insurance will make risky bonds worth much less.

This could easily become a monumental vicious deflationary circle. The very instruments that have expanded credit on a global scale will contract it even more quickly by making risky debt very, very, very expensive to own or issue.

The Bond Market...

...tells a frightening story. Bloomberg reported today that "the Dow Jones CDX North America Crossover Index of 35 U.S. and Canadian companies surged $36,000 per $10 million in bonds to $151,000." That's 31%. That's a record high (since creation in 2004). That's the top of the page. The bottom of the page says that "the CDX index fell to $107,500 on Feb. 22" which was a "record low." Hmmmm... From record low to record high in just five days. Wow! Maybe that makes me nervous because I've never seen this before. Wait, no one has ever seen this before, because the index was created in 2004. If this doesn't scare the pants off of everyone, I'll be very surprised. It makes me consider selling everything...

DOW drops 500

Paying off big time today:

Treasury Call Options.
ITB, DSL, EEM shorts.

10 yr drops from 4.62 to 4.50.

Unfortunately, PIMCO's RCS didn't follow. It even lost a few cents.

I seem to have my best luck betting on swings in the 2 and 10-yr treasury yield.

How can I translate this success into my real money account where I can't buy CBOT options?

Ouch!

The subprimes were hit again today. Here's Bloomberg's report on the downgrades of BBB- bonds from Moody's. The simplicity of the math is frightening. Subprime mortgage bonds have yields of up to 9.25% If you bought the bonds a month and a half ago, you got 9.25% (max) and could insure against default for 3.89% for a net of 5.36% (max). That's a bit better than Treasuries. Now, however, insurance costs 11.2%.

Game over.

On paper at least, all future subprime mortgages are uninsurable. If they're uninsurable, they're unsellable. If they're unsellable, all the subprime lenders will go bankrupt.

Our economy has over $2,000,000,000,000 trillion worth of subprime mortgages. This drop is exactly what George Soros talks about in "The Alchemy of Finance." I feel pretty silly to have missed it completely. However, I still think this is in the baby stage.

When the loans go bad, the lending stops. Why don't the banks bail them out you say? It won't help, because it's cheaper for the bigger banks to cut their losses and run.

It's a slippery slope, it's very, very steep, and it's getting steeper. In the practice account, I'm going to position everything around this as aggressively as I possibly can.

NFI

From Marketwatch, this quote says it all:

NovaStar Chief Financial Officer Greg Metz said the company expects to recognize little, if any, taxable income in 2007 through 2011, so "management is currently evaluating whether it is in shareholders' best interest to retain the company's REIT status beyond 2007."

Unpaid dividends from 2006 equal $4.60 per share. It's hard to see anything else worth anything in the company.

The question is, what will happen to the rest of the credit bubble?

trades...

Short 1 Downey Savings and Loan (DSL) @ $71.00
Short 2 US Home Construction Index (ITB) @ $41.52

Trades

Closed NFI @ $17.14 - this was a disaster. If I had done my homework before buying it, I would have recognized the kind of self-reinforcing vicious circle that George Soros was always looking for.

Now I'm looking at a few to short. The homebuilder's index (ITB), Countrywide (CFC), and Downey Financial (DSL). Downey had 90% of their portfolio in negative amortization loans, which will get killed when prices fall, which will happen when foreclosures flood the market.

Closed QQQFX.X (June Nasdaq 100 Trust [QQQQ] call at $50) at $0.21 at open. It had been at $0.60 at one point. I bought it at $0.20.

With currency, I changed my shorts on EUR/USD and GBP/USD to long JPY/USD. I think that with deflation coming to the dollar (and therefore lower rates), the Yen will be comparatively stronger. I think the Yen has a larger chance of increasing rates than the Fed or the Bank of England.

Fabulous!

Fabulous analysis from the Wall Street Examiner. Russ Winter examines NEW and NFI from the bond investor's perspective.

long overdue update

Three developments have emerged the markets since my last blog. First, oil dropped from $60 to $50 to $60 in little more than a month. Second, news from China indicated that the Asian leader was a net exporter of zinc, as well as the world's largest consumer of the metal. Thirdly, the subprime mortgage market has suffered a deadly blow.

First, oil. Quoted in Barron's, Art Smith, head of energy research firm John S. Herold, said that he's amazed at the market reaction to a 100,000 barrel weekly inventory change. He points out that 100K is equivalent to a rounding error. As a weekly change it is insignificant in the face of the 85 million barrels consumed daily. My thought on oil is that global warming is a good thing to bet against short-term. Everyone was talking about how warm it was a month ago; now the Northeast is in an ice age. I must admit that while I love the logic, I only came up with it in hindsight. Another development in oil is that Venezuelan production has fallen apart faster than I had anticipated. I had thought that Chavez would pump oil like crazy, but he's already neglected maintenance enough for production to plummet. I know I predicted $40 oil, but global growth and lack of OPEC cheating may desroy that prediction.

Second, zinc. A major hedge fund revealed research that China was, shockingly, a net exporter of zinc last year. Zinc, one of the hottest metals last year, immediately underwent a 15% correction. Copper fell 5%. However, gold is up from $602 to $662. Talk about contradictory signals. If I had to pick one, I'd say the gold bugs were nuts. I know the Fed's been talking about inflation again, but they don't even have the employment report on their side this time.

Finally, the subprime mortgage market imploded with twin reports from HSBC (HBC) and New Century Financial (NEW) warning that bad loans were returning to cost them much more than anticipated. HSBC's losses were 20% greater than they were prepared for. NEW was down 36% on a suprise warning of 4th quarter losses and upcoming restatements of Q1-Q3 of '06. Novastar Financial (NFI) which I bought too soon at $21 was down to $16.36 on the sector hit. However, I think their downside is limited because they have $12 a share in cash. NEW also has $12/share.
I think NFI is a buy.