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Wanted: Prime Suspect of
Housing Market Murder
By Susan C. Walker,
Elliott Wave International
October 8, 2007
Helen Mirren accepted her Emmy award for best
actress in the mini-series, "Prime Suspect" with elegance and grace. Just the
opposite of the tough detective superintendent character she plays who tracks
down murder suspects in England. Who would Jane Tennison pick out as the prime
suspect for the murder of the U.S. housing market and the resulting gruesome
Suspect No. 1 – Phil Spector
No – sorry, wrong case, wrong suspect. Spector has been on trial for the murder
of a guest at his home (the judge declared a mistrial this week), but Spector
has nothing to do with the subprime mortgage fallout and ensuing credit crunch.
O.J. Simpson, who stands accused of trying to "recover" his sports memorabilia,
is not the prime suspect either. If the crime doesn't fit, you must acquit.
Suspect No. 2 – Alan Greenspan
Says that he didn't catch on for a few years that subprime mortgages could
create a problem for the economy. As chairman of the Federal Reserve, he let
easy credit ride, which facilitated the housing bubble and the subsequent
implosion. Could liken his behavior to supplying the gun to a rampaging
murderer. Guilty of aiding and abetting, but he's not necessarily the prime
Suspect No. 3 – Angelo Mozilo
Angelo Mozilo, CEO of Countrywide Financial (largest mortgage company in the
United States), says he kept his staff writing subprime mortgages day and night,
because if they didn't, then home purchasers would just find someone else to
give them a low-quality mortgage. Company went from writing 4.6% of its overall
mortgages as subprimes and low-documentation loans in 2004 to 8.7% in 2006.
Guilty of greed and a poor business plan but not murder.
Suspect No. 4 – S. & P. and
Oh, whoops, say these rating agencies, we thought that once you sliced up a BBB
security thinly enough and packaged it with other more desirable collateralized
debt obligations that we could call it AAA. Did we mislead anybody? Again,
aiding and abetting but not a prime suspect.
Suspect No. 5 – Goldman Sachs and
other investment banks
Says that their investors wanted higher returns and that collateralized debt
obligations spiced up with subprime mortgages served the purpose. And besides,
they say, the rating agencies gave them an excellent rating. Guilty of acting
like a fence but not the prime murder suspect.
The True Prime Suspect
All of these are worth a look as suspects, but the true prime suspect has
neither a first name nor a last. It's known as "social mood," and its m.o. is
"herding behavior." That's our real murderer, the one that quashed the hopes and
dreams of those who believed that house prices would always go up. Social mood
changed, and with it changed the idea of what were smart financing moves to
purchase a house. Suddenly, as house prices began to fall and subprime
mortgagees began to default on their loans, the stick house built on low-quality
mortgages seemed like a really bad idea.
Who knew? When social mood was positive,
mortgage writers pushed people who couldn't really afford a mortgage into
believing they could. Then they sold the mortgages to eager investment bankers
who sliced them up into small packages of risk and re-packaged them with less
risky securities. Then the ratings agencies gave their stamp of approval: AA?
Why not AAA? And eager investors who wanted higher returns bought them up.
But now the game is up. When social mood
turns from positive to negative, fear replaces greed, and people begin to see
the riskiness for what it is. When social mood changes from positive to
negative, markets turn from bullish to bearish. And no one can stop it – not
even the Fed.
This is how Bob Prechter, president of
Elliott Wave International, describes the phenomenon:
"Like credit inflation, credit deflation is
in fact an intricate, interwoven process, whose initial impetus is a change in
social mood from optimism toward pessimism. If you are still on the fence
about this idea, ask yourself: What changed in the so-called
“fundamentals” between June and August? The answer is: absolutely nothing.
Interest rates did not budge; there were no indications of recession; there
were no changes in bank lending policies; there were no chilling government
"The only thing that changed was people’s
minds. One day sub-prime mortgages were a fine investment, and the next day
they were toxic waste. There was no external cause of the change.… According
to socionomic theory, the stock market is a sensitive indicator of such
changes in mood. This is why The Elliott Wave Theorist has
continually said that the financial structure will hold up as long as the
stock market rises. A downturn occurred in mid-July, and its consequences in
terms of negative social mood are becoming swiftly evident. Remember, C waves
(see Elliott Wave Principle, Chapter 2) are when optimistic illusions
finally disappear and fear takes over. Sounds like now." [Elliott Wave
Theorist, September 2007]
How To Protect Yourself from the
Prime Suspect Who is Still on the Loose
Social mood has turned ugly and is likely to
continue its murderous rampage, leaving the policymakers helpless. As analysts
Steve Hochberg and Pete Kendall write in The Elliott Wave Financial Forecast:
"The Fed does not "inject" liquidity; it only offers it. If nobody wants it, the
inflation game is over. The determinant of that matter is the market. When bull
markets turn to bear, confidence turns to fear, and a fearful people do not lend
or borrow at the same rates as confident ones. The ultimate drivers of inflation
and deflation are human mental states that the Fed cannot manipulate."
What should you do to protect yourself in
this time of falling home prices, a powerless Fed and a contracting economy? Bob
Prechter wrote one of the best how-to books. It's his business best-seller,
titled, Conquer the Crash, How To Survive and Prosper in a Deflationary
Depression. You might want to start there.
Editor's Note: You can read
FREE 9-page chapter from Conquer the Crash –
You will learn the implications of the massive credit expansion, what triggers
the change from boom times to recession, and more.
Susan C. Walker writes for
Elliott Wave International, a market forecasting and technical analysis
company. She has been an associate editor with Inc. magazine, a newspaper writer
and editor, an investor relations executive and a speechwriter for the Federal
Reserve Bank of Atlanta. Her columns also appear regularly on FoxNews.com.