What a Tangled Web

It was Fall Break here in Tennessee, and this past week has been weird. Is it the disruption to schedule, the government shutdown, the Tricolor and First Brands fallout, trade war blues or the talk of insurrection? All of the above, I suppose. For those not familiar with Tricolor or the First Brands bankruptcy, the web is tangled and vast. Fifth Third Bank, JP Morgan Chase, Barclay’s, Western Alliance Bank, UBS and Jefferies all have exposure, and the list doesn’t stop there. Morgan Stanley is reported to have requested a withdrawal of its funds from Point Bonita Capital, a unit of Jefferies Leucadia Asset Managment, which had 25% of its $3 billion trade-finance portfolio invested in First Brands receivables. Apollo has also been caught in the fray with some shady dealings. In many ways this reminds me of when New Century filed bankruptcy in April 2007. That bankruptcy and trouble at Bear Stearns led to the rating agencies downgrading hundreds of mortgage bonds.

I remember the day this article came out in 2007 like it was yesterday. At my former company we were already under stress as the private equity company that purchased us sensed the shift in the market and wanted a purchase price adjustment. We knew though that day in July meant the world would know what we knew…those bonds were not worth what anyone thought they were worth. The emergency that would consume six years of my life began on that day.

I would walk in every morning to another hundred-million-dollar writedown which meant we were near to breaking covenants on our lending facilities at the big banks. My department was tasked with calculating our tangible net worth daily as executives flew to New York to beg. Although we had a small bank in Utah, we were not a bank, and those lending facilities were our lifeblood. In many ways GMAC ResCap is the poster child for what happens to a nonbank when the bezzle is uncovered. As I shared in a video this week with

Unicus Research

and Jack Gamble from Nobody Special what is likely happening behind the scenes at these banks and across the system is panic. You wouldn’t know it from many of the headlines in the US financial media.

To translate, “rethinking risks” really means they are desperately trying to understand their exposure, and it won’t stop with this initial list of impacted entities. Because much of the shenanigans were happening in the murky world of off-balance sheet financing, victims can take time to surface.

Who those investors are, and how far the chain of debt stretches into the mainstream banking system, is an open question. Jefferies says it has $715m in exposure to First Brands. An investigation has been set up in part to examine whether invoices were pledged more than once.

But it goes further, with concerns mounting that First Brands’ precarious arrangements could be found elsewhere.

Brett House, an economics professor at Columbia Business School, says concerns are primarily about unregulated private debt markets and the assets they hold that are often not marked-to-market, an accounting system that values a company’s assets and liabilities at their current fair market value.

‘When these assets become impaired, it’s a surprise to markets, because there hadn’t been a gradual updating of information,’ House says, ‘and because we don’t have great transparency on the location and concentration of where these assets are being held. And that can often have knock-on effects that are unanticipated.’

Insurers such as AIG, Allianz and Coface are also on the hook as they wrote policies that were meant to protect trading partners or investors from losses. This also reminds me of yesteryear when big private mortgage insurers got into hot water and stopped paying claims. The crazy thing is we received very few reimbursements for our claims which of course then exacerbated our liquidity issues. Somehow though most of those businesses continued to operate.

It’s getting real out there folks, and this all feels eerily familiar. Despite headlines to the contrary, yesterday’s stock market selloff in my opinion had more to do with this festering wound than tariffs with many banks ending deeply negative on the day. I believe my former company, which is now called Ally, will also be in the crosshairs of the distress in auto. Yesterday, Ally saw a -5.69% drawdown and is now down -17.09% from its recent high in September. The banks and private credit have been extending and pretending, masking the distress in auto and commercial real estate. While everyone could see the distress brewing it has not mattered as mania prevailed in the market. I believe we have reached the point where it is going to matter. The shadow banking system is much larger now than during the GFC.

No matter what Fed Governors may say, private credit poses deep risks to the system and no one knows just how big this genie will be when it is fully unleashed from its bottle in the shadows. In our hyperfinancialized markets where you can gamble on auto parts receivables (like seriously why?), the game is one of confidence. Chase lost confidence in Lehman to meet its commitments and the rest is history. Once faith is lost then gradually turns to suddenly very quickly.

We will likely see bank failures soon. Will this be a repeat of March 2023 with the Fed swooping in and juicing the market once more? I think we are on much more precarious footing now. As my buddy Jack discusses in the video linked above, Nvidia and the AI narrative became the last great hope to keep the money flowing. There is fraud written all over these AI companies who are using Enron-like accounting practices. For more details, please see the linked video or Jack’s video from August 2023.

I started writing this piece early yesterday. This morning’s articles are taking on a more serious tone. For someone who doesn’t scour financial media though, it may be easy to miss this story about a subprime auto shop that lent to immigrants and an auto parts company. I caution you to take it seriously and to watch. The tariff war does seem to be escalating but what happened on Friday is about much more than that. If we continue to see stock market weakness or an even greater drawdown, get ready to see home price declines accelerate. We know that confidence has already been rocked in housing as Redfin reports record cancellations for home sales, higher than any August since they started tracking in 2017.

The biggest reasons these home sales have been cancelled? Property inspections coming back with issues and additional repairs needed. FOMO-buying is no longer the order of the day, and property inspections are no longer being waived (never, never, never waive a property inspection).

As mentioned here several times, sellers are deluded, driven mad by their spurious zestimate. We have been taught to see housing as an investment - it’s even defined as such on the Census Bureau’s website. This indoctrination has been purposeful to drive the wealth effect and keep us spending even when we shouldn’t. I implore you not to fall for these tricks. Your financial future is at stake. Once larger awareness occurs, the confidence game that is housing will be shattered.

For today’s post I will be diving into an expat housing market at the request of a subscriber. Additionally, I will share Top 5 city summaries, an update on delinquency and lists of cities where I’m seeing motivated selling, distressed selling and a new category I’m now calling depressed selling where sales are down as well as home prices YOY. There are two cities in the Midwest that are blinking red, signaling what’s to come there. Early reports for September are pointing to slightly stronger sales than last year. For true price discovery, we need sales. Based on what’s happening with foreclosures, which I will discuss below, we will be getting sales one way or the other. The new FHA waterfall is in place and the jig there is up. That means foreclosures will start to accelerate, reaching critical mass next year.

Without further ado…