Even though the market is once again enjoying a delusion sandwich covered in toxic mortgage mustard, the reality on the ground continues to become grimmer. Wachovia, one of the nation’s largest banks announced an $8.9 billion quarterly loss and that they’ll be slashing over 6,000 from their workforce. Oh, and the dividend is getting slashed as well. So what happens? The market of course pushes the stock up by 27%! American Express, the uber credit card company also announced problems but the market is believing that the Federal Reserve and the U.S. Treasury have some mythical powers to create money out of thin air. They do only if you own an investment bank.

Yet back in the trenches of reality, Americans are feeling the massive pinch of the world’s biggest housing bubble being pricked by the sharpest needle of all, imploding debt. That is no hyperbole. In no time in our civilized history have we seen such speculation on a global scale stemming from real estate. California is the poster boy of this housing bubble. You would think that the market would be punishing lenders even harder who have created and own such financially destructive loans yet many see this as a time to jump in. Just look at the markets. Tread these waters at your own peril.

Today, the California foreclosure numbers for the second quarter were released and they are not a pretty site. First, let us take a look at the first sign of future wealth destruction, the notice of default:

As you can see from the chart, notice of defaults have gone sky high in that past few quarters. We went from a relatively mild 2006, to a quickly deteriorating 2007, to the current record breaking problems in 2008. The reason notice of defaults are so important for future predictions is that these are homes that have yet to be taken back by lenders. These are early signs of trouble. What this means is lenders in the upcoming months better gear up for a tsunami of REOs.

We already know that the short-sale option has been a marginal joke in California. Many are so deeply in negative territory that no lender would go for a short-sale and rather would take a foreclosure. They have too many problems trying to stay solvent and avoiding their own foreclosure ala IndyMac Bank. The vast divide between lenders and how loan modifications are being handled is an utter joke. There is no standard. Some lenders are willing to work with you while others are doing absolutely nothing in the area of loan modifications. They are all holding their breath and preparing their turd bucket of mortgages ready for release into the belly of Fannie Mae and Freddie Mac. Bank of America who recently acquired toxic mortgage producer Countrywide recently alluded to the fact that they may not be backing up Countrywide debt:

“(Global Trend Analysis) Bank of America Corp., the second- biggest U.S. bank, said it may not guarantee $38.1 billion of Countrywide Financial Corp.’s debt after taking over the mortgage lender, increasing the likelihood of a default.

“There is no assurance that any such debt would be redeemed, assumed or guaranteed,” the bank said in an April 30 regulatory filing, adding that no decision has been reached. Investors had grown more optimistic the bank would back Countrywide debt. Ratings firm Standard & Poor’s cut the mortgage-lender’s debt to junk today after saying it would raise the grade earlier this week.”

They basically are doing a “it wasn’t me” on the market. After all, would you back up Countrywide’s toxic debt?

Last quarter, there was an all time record of 121,341 notice of defaults filed in California. This is incredible. Only 3 years ago, the number was 12,408 for the second quarter of 2005. That is a ten-fold jump in 3 years! Yet the more distressing analysis is when we look at the notice of defaults and also combine the actual foreclosures that occurred in the second quarter:

We are now in uncharted waters. The notice of default numbers may look like they are plateauing but this is like arguing whether you are going to jump out of a 100 story or 102 story building. The number of foreclosures in the second quarter hit a stunning 63,031. If you look closely at the chart, even in 2006 many of the notice of defaults where resolved without a foreclosure actually taking place. Well of course this occurred because the massive speculation allowed those who over paid to sell to someone who over paid even more.

“(DQNews) Of the homeowners in default, an estimated 22 percent emerge from the foreclosure process by bringing their payments current, refinancing, or selling the home and paying off what they owe. A year ago it was about 52 percent. The increased portion of homes lost to foreclosure reflects the slow real estate market, as well as the number of homes bought during the height of the market with multiple-loan financing, which makes ‘work- outs’ difficult.”

This is not good and only reinforces the obvious which the overall market is ignoring at the moment. What this tells us is 78 percent of these notice of defaults will end up in foreclosure. Now the precipitous decline in prices is ensuring that many of those 121,341 notice of defaults will further add REO inventory for the remainder of the year and cause future losses to these banks and lenders. Now how is this going to be healthy for the market? If anything, it assures us that prices will be falling for the remainder of the year and will put a vast amount of inventory on the market during the worst selling times which are the fall and winter. This combined with the $300 billion in option ARM loans will be a destructive combination. We have yet to see the massive recasts in the pay Option ARM market. You can do the math and any lenders with large exposure in California are going to get hammered.

Paulson saying we are months away from a bottom is absurd. Senator Jim Bunning was right when he called him out and stated that Paulson will be out in a few months, but the rest of us will be here to deal with any of the consequences of hasty actions. The bottom is in…but for Paulson’s career.

We have just cut the umbilical cord of reality from Wall Street. Look at the action with WaMu announcing a $3.3 billion loss:

“SEATTLE—Washington Mutual says it swung to a loss in the second quarter as it increased to more than $8 billion its reserve to cover sour loans.For the April-to-June period, the Seattle-based bank says it lost $3.33 billion, or $6.58 per share, which compares with a profit of $830 million, or 92 cents per share in the year-ago period. Results include a previously disclosed, one-time reduction of $3.24 per share related to the company’s capital raising in April.

Thomson Financial says analysts, on average, were expecting a loss of $1.05 per share.

The bank says it increased its loan loss reserves by $3.74 billion to $8.46 billion during the quarter, as it continues to face mounting losses stemming from bad mortgages.”

Shares of WaMu went up and down in after hours trading as if there really is any doubt about the data. Not only did WaMu miss their target, they missed it by multiple times! Bwahahaha! And the freaking stock barely moves. Do you know where most of WaMu’s loans are? In California. Just let the above charts sink in with their vivid colors and try to take a guess what is going to happen. They’re going to need all those loss reserves for the army of Real Homes of Genius they have in their portfolio. Companies should just announce a $1 trillion dollar loss and you’ll see their stock rally by 50%. Apparently bad news is now good. Hello George Orwell!

What we are seeing on main street is not being reflected by what is occurring in the stock market, which should at least reflect what is going on in the real world (aka, look at the above charts). Yet what do we expect from a government that tells us we are not in a recession, unemployment is not bad, and inflation is contained? Their panacea of course is drilling for oil we won’t see for at least 5 years! I didn’t realize subprime mortgages ran on 89-octane. All you need to do to verify this reality is take a trip to your local grocery store, fill up your tank of gas, send your kid to college, look at your mortgage, and try booking a trip out of the country and you’ll quickly realize that something is rotten in Denmark.

Let us take a look at another data point that shows us how far we are from a bottom here in California:

The above is a look at subprime loans in the state. As you can see, there are still plenty out there to cause damage but take a look at the Alt-A products which most pay Option ARMs fall under:

And this should make you feel warm and fuzzy all around. The Congressional Budget Office came out saying that the rescue of Fannie Mae and Freddie Mac would cost approximately $25 billion but no one really knows how much. Heck, WaMu and Wachovia combined dished out losses of $12.2 billion in one quarter and they are peanuts to the issues confronting Fannie and Freddie. Yet they are also seeking in the legislation to increase the public debt limit by a stunning $800 billion from $9.8 trillion to $10.6 trillion:

“(WSJ) The $25 billion cost estimate from the CBO for the rescue plan was downplayed by Democratic and Republican lawmakers. “Everyone knows it’s just a wild guess,” said Sen. Jim DeMint, (R., S.C.). He called the plan a “huge gamble,” but added that, “it’s kind of: Guarantee a little now or pay a whole lot later.”

Lawmakers plan to raise the public-debt limit as part of the legislation to $10.6 trillion from $9.8 trillion. Congress must vote to increase the limit to account for additional borrowing, something it is loath to do, although it would have had to take that step this year even without the rescue plan for Fannie and Freddie, Democratic aides said.”

This is flat out absurd! What a disgrace. You need to get in contact with your Congressperson or Senator and say you will not stand for this absurdity:

Find your respresentative

Find your Senator

Give Senator Jim Bunning some support to filibuster this piece of toxic legislation

Can you see what is happening? You’ll also see in the legislation that they are trying to raise caps to $625,000 which of course will make it convenient to off load this crappy Alt-A California mortgage junk onto the public debt. If you needed any more evidence that Washington is trying to offload this entire mess on the U.S. taxpayer, you need not look any further than this piece of legislation. What a shame.

There are more Alt-A loans in California and these actually have a higher concentration of no-doc loans! Can you take a wild guess how these are going to do now that the state has a median price of $328,000, down 31.5% from the peak price of $479,000? If you look to Washington or Wall Street for your answer, don’t expect one that reflects the reality on the ground. We are living in two separate universes here. If you would have bought a median priced home in California last year at the peak, you would now be down $151,000. Is this really a reason for a rally especially in lenders that fed into that speculation that is now clearly bursting with an onslaught of foreclosures?

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■Foreclosed: Predicting Foreclosures in California. How Many Homes will Be Foreclosed in 2008?
■Foreclosures jump statewide by 40% in California in just one quarter! Welcome to California’s Gold!
■Foreclosures? Housing Bubble? In Southern California? Impossible!
■How Many People Overpaid for Their Home in Los Angeles County? Trying to get a Raw Number of Households Underwater.
■Foreclosure Nation: More Like Foreclosure States. 4 States Made up 50 Percent of all Foreclosures and Distressed Property Action.

I’m going to tell you something that you probably already know. Americans are horrible savers. In fact, this trait has provided the perfect breeding ground for credit products that provide the illusion of real wealth. I’ve been hammering away in article after article going after the big players on Wall Street and also going after unscrupulous lenders that have been the pushers of the credit products for this past decade that have led us to this current economic cliff. Yet there is sufficient blame to go around and one is the psychology of the American consumer.

As of 2008, the average household debt is $117,951 and this includes credit cards, installment loans, home equity loans, and mortgages. The New York Times has an excellent series regarding the “Debt Trap” and below is a graph that I will be talking about in great detail. If you are interested, click on the image to go to the New York Times interactive chart:

All in all Americans have over $2.5 trillion in consumer debt. This number is staggering. That is why during the first signs of any economic problems the first thing that came to mind to our financial politician wizards was an economic stimulus package. Of course the majority didn’t ask where the money came from but you can now thank higher consumer inflation for the byproduct of this action.

Yet this mentality is still guiding much of our economic and political policies. People have become addicted to credit as if it were some form of drug. Recently, many lenders especially those with high concentration loan portfolios in California have started closing off many consumers’ home equity line of credits. The reaction is very telling since it gives us an insight into how people view credit.

Many believe that this home equity line was similar to you having access to your regular savings account. That is, whenever you needed the money it would be there for you. This was one of the inventions that started in the 1990s and has exploded recently. As you can see in the interactive chart above, home equity loans really had no place in the market prior to the 1990s. The concept was that the equity was your ultimate safety net, not some modified credit card that would put your biggest asset at risk. Recently with the run-up in the housing bubble, American consumers with their lack of savings decided to tap into this resource to continue spending. So when many people realized that their home equity lines have been shut down, they felt as if they had their savings stripped away. This idea that access to debt is equivalent to access to wealth demonstrates the profound lack of financial knowledge from many in our country.

Why would people be so willing to spend money that they don’t have? This is where the discussion veers off from economics and begins to look at consumer behavior and psychology. People want to be loved and accepted. Just watch MTV or VH-1 for a few hours and you’ll see this for yourself through their advertising. What you’ll see are ads about looking a certain way or buying a certain fragrance and with this simple act, you will be loved or accepted (normally by a very attractive member of the opposite sex). Of course you’ll have to spend money on a certain product which is probably over priced.

You also see this in many of the local clubs and night spots here in Southern California. Pick anytime, if you go out on a single night, you’ll typically see a guy trying to impress his friends with a round of the most expensive spirits not because of the taste, but because of the price of the drink. The group like a Pavlovian experiment responds as, “wow, you are the [best, greatest, coolest, hottest, funniest] person alive!” So the condition is imprinted on the mind. That is, if you spend on an expensive item you will get recognition from the group. The fact that many of these clubs accept credit cards is a perfect place to watch this social experiment unfold. Watch how many people use cash.

Now carry this psychology over to home purchases and automobile purchases which are the two largest consumer debt items around. Buying that home was about being secure and having a place for your family. After all, who doesn’t want this? It’s not like someone is going to respond, “no, I actually don’t want my family to be secure and rather live under the San Gabriel River.” So many either feel the pressure directly from family and friends or indirectly from media campaigns and those in the industry. The idea of owning a home is deeply imbedded in the American psyche. It is a cultural archetype that even as a kid, many start drawing a home with a picket white fence and a dog as a reference to what home is.

Those in advertising produced excellent (meaning they got people to do a desired action) marketing campaigns that exploited this insecurity which many carry deeply. Some of you may have seen this Century 21 ad where a couple is debating over real estate:

*Click to watch full ad on YouTube (warning, you may become financially ill)

Think about what this ad is telling us. What does your gut tell you when you watch this? Try finding an ad that has a more financially prudent debate where the couple is sitting down with their accountant and going over the ratios on a conventional 30 year fixed mortgage. We didn’t see any of this because the entire industry would have halted! Hello! $397 average savings per year and people were going zero down on $500,000 starter homes? No wonder why our economy has placed a multi-year debt albatross that is slowly drowning us.

Amazingly, six in 10 Americans oppose Wall Street Bailouts but the majority do support the government keeping people in their homes:

*Source: Gallup

So why did the Bear Stearns bailout go through so quickly without going to the public? The answer is, many people simply do not care enough to cause an uproar about what occurred. They rather focus on saving 10 cents a gallon on oil while their mortgage payment just went up $500, $1,000, or even $2,000. The talking heads told us that if Bear Stearns wasn’t bailed out, the dark clouds of financial ruin would sweep over the nation and cover us in fire and brimstone. Guess what? We still ended up flying into a bear market and people are still losing their homes. We are getting this same rhetoric with Fannie Mae and Freddie Mac. A quick solution is nationalize the entities, split them up, and let the shareholders eat their risk. Enough with this implicit guarantee when we all know the taxpayer is on the hook.

The problem with Wall Street and bailing certain institutions out and this uttering of a second stimulus from politicians is they still believe that we are living in a world where people are willing to sacrifice their lives to go deeper into debt. They miscalculated on how people view housing. When the archetype dream of a picket white fence home came with a $4,000 a month mortgage payment, the sudden reality hit and many realized that the dream wasn’t worth the actual price tag. That is why the zero down craze was so utterly incompetent. Buyers had no skin in the game.

In places like California, buyers were effectively given a put option. The mortgage itself is non-recourse, meaning if there is a foreclosure the home goes back to the lender or bank and the buyer walks away with a foreclosure on their record. Many are electing to go down this route. Some by choice and many because they cannot afford the recasting payment or have seen a decrease in their income. Amazingly, the person that rents with a zero net worth now has a stronger financial position than the person that bought at peak levels and actually has a negative net worth of $100,000 or even $200,000.

The obsession with credit and the ultimate sign of debt the McMansion is now crumbling on its weak edifice. Our economy has been so dependent on debt and real estate for the past decade that we have fallen behind in many crucial areas like biotechnology and engineering because much of our capital and resources were diverted to non-productive sectors like building bigger and bigger homes accompanied by cars that are bigger and less fuel efficient. Slowly this is changing at least with the auto industry.

Many rational Americans looked around their neighborhood and saw what was a once in a lifetime spending binge. A boat, Hummer, and McMansion for all. The only problem is, it was on a temporary lease. The problem with this is that 70 percent of Americans were living like the top 1%:

*Source: Wikipedia

Many had to deal with cognitive dissonance of knowing incomes didn’t justify the spending they were seeing in the real world. The majority however decided to capitulate and get into unbelievable amounts of debt. It was a façade. The government is simply feeding into this cultural delusion that all the consumption items of debt reflected the actual income of our country but it did not as you can clearly see. No politician has the courage to say what needs to be said, “my fellow Americans, we have spent way beyond our means and need to change the way we live our lives.” Not during an election year. They will keep feeding into this myth that you can save nothing and sacrifice little and enjoy everything today even if you don’t actually have the savings to pay for it. Until we see some CEOs doing the perp walk instead of going to them for advice on saving the housing market (much of the problems created by them), then we will know that times are changing at the top. People need to demand this from their government or at the minimum, not buy into this financial myth.

We have $500 billion in Pay Option ARMs that are set to recast in the next few months. These are the absolute most toxic mortgages out there. I would put them on the same level as subprime loans and we are going to quickly realize that they too will be defaulting in high rates. Banks and lenders are artificially counting that these loans will still remain current once they do recast. If you look at their bottom line, they are actually counting much of the deferred interest as income. Many are current but not for long. They are betting that owners will exercise their put option but many will simply allow it to expire worthless.

I notice that parts of our cultural consumer psychology are changing. There was one commercial this weekend on a show that was targeted to the teen crowd that had a girl fixing up her dorm room. The room looked trendy and had all the knacks that someone could possibly need for college. She looks at the camera and tells us, “I got this all for a discount. After all, I am a math major.” It will now be cool to save if not for any other reason then there is no other option. There was also a segment on a show poking fun at those who waited in lines for the new iPhone. One of the actors was showing a new feature of, “using the phone to navigate for places for cheaper rent since I can’t afford my current place with this phone.” Time for the wake up call folks. Things are not going back to how they were.

Did You Enjoy The Post? Subscribe to Dr. Housing Bubble’s Blog to get updated housing commentary, analysis, and information

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Related Posts:

■Are you a Debt Slave?
■Cultural Spending Neurosis: How a Nation Went From Prudence to Financial Decadence.
■Stop Saving Now and Spend Those Rebates! The Home Refinancing Well Has Run Dry.
■You Can Kiss $2.84 Trillion in Housing Equity Goodbye: The Continued Decline in Real Estate.
■The Plague of Housing: Why we Will Feel and Be Poorer Because of the Housing Bust.