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The investigations and recriminations begin.  Remember when "subprime" lending was hailed as an egalitarian financial innovation providing housing to low income homeowners.  Now it is blamed for the advent of the bear market with the usual investigations and scapegoats as predicted in these very pages.
--S. Osborne

Right, the forecast from our May issue is available in the Additional References section below. As we noted in this month’s issue of The Elliott Wave Financial Forecast, the debacle has been slow to ripen, which has been a source of encouragement to the bulls. But as the March issue also noted, “the durability” of the peaking process “actually relates to the size of the implosion and its eventual extension across the depth and breadth of the credit universe.” The article shows that the real estate sectors burgeoning recriminations phase is adhering very closely to the mania model. One of the attributes EWI first associated with bubble-era financial fraud, for instance, is a tendency for illicit accounting tricks and swindles to escalate in the initial phase of a downturn. In the case of New Century, this appears to have happened. The NY Times article goes on to reveal, for instance, that New Century’s latest problems were preceded by a forced buy back of $469 million in loans, up from $240 million for the same period in 2005. The company was able to sell half of those loans by discounting them by more than 25%, but “How it handled the remainder - about $227 million - is now under scrutiny. According to accounting rules the company should have valued the loans on its books for what they were worth today, not their previous face value. But it did not. If it had, the company would have seen its earnings fall by about $60 million before taxes, wiping out most of its profit in the third quarter.”  In other words, as the worm turned, New Century appears to have made a common post-mania blunder of trying to wiggle off the hook by manipulating its books. It’s a classic mistake.

And don’t look now, but the housing rebound is not going in the right direction. Here’s the very latest forecast from the head of the nation’s largest homebuilder:
D.R. Horton CEO: 2007 Will ‘Suck’

Considering how far off many people are about an anticipated bottom in the housing market, is it possible that it’s also a mistake to say it won’t spread to other areas. A host of burgeoning scandals certainly suggest that the slump is likely already on the verge of a rapid expansion to other sectors. Here’s just two stories that show the needle on the scandal meter pointing to trouble dead ahead for brokerage firms, hedge funds and the speculative forces that  underpinned the boom in everything from Netscape to Shanghai shares over the last dozen years:
A Big Splash on Wall Street
Regulators ratcheted up their ongoing investigation into insider trading on Wall Street Thursday. The SEC and U.S. attorney in Manhatttan announced charges againt 14 individuals including current and former employees of (three brokerage firms) and three hedge funds.
                              Forbes, March 2, 2007

SEC Probes Stock ‘Spam’
The U.S. Securities and Exchange commission froze the shares of 35 companies whose stocks trade over the counter as it examines whether promoters used e-mails to mislead investors and inflate stock prices.

“Operation Spamalot” questions the accuracy of statements made about the companies’ assets, financial condition, business operations and financing arrangements, the SEC said at a press conference today.
                         Bloomberg, March 8, 2007

To paraphrase Captain Renault in Casablanca, the SEC is “shocked, shocked” to find that gambling going on and its decision to do something about it is tantamount to a proclamation that the bust phase of the boom-bust cycle is underway. 

Postscript from Chuck: LISTEN UP!! Your swindle perspective is profound. The next Enron and S&L crisis may be upon us. I just witnessed a prime contractor, building a major custom home, suffer a huge loss by the default of the owner and a lender to the property. Contractual "safeguards" were in place but an alliance (fraud) between the Agent and homeowner seemed to enabled them to extract huge money advances out of the lending company with no relation to the value or work in place. Example: Roof/pool/landscape money gone at foundation stage and now defaulting payment after frame up. Follow up has been a nightmare for said contractor.

 Long story short, as lending institutions default others are enriched and all is lost in the paper work, reminding me of the S&L scams of the late '80's. It appears, a lending agent/ broker just needs a 'willing' accomplice to get access to the coffers. The loans are already labeled high risk and are accepted as losses.

May 2006, EWFF
There are some benefits to the ripple effect that keeps the churn of the great asset mania pushing through one asset class after another, from Beanie Babies to tech stocks and most recently through real estate. One big benefit is that, at this point, it’s not hard to clearly envision where the post-peak stress fractures are going to show up. In real estate, for instance, one of the potential problem areas that EWFF cited last summer was all the new forms of “creative’ financing that were springing up. When “60-year, no-interest terms” and the “sub-prime adjustable-rate, no-interest/nothing-down” loans became mainstream offerings and home buyers started “asking what is the lowest possible payment I have to make over the next 12-months so I can get in,” EWFF said the top had to be close at hand. This headline from the April 20, 2006 issue of the San Antonio Express confirms that it is now in place:
Real Trouble In Real Estate
Local mortgage brokers have a warning for people already struggling to make their adjustable rate mortgage payments: get out of them now.

Of course, now it’s too late. Rates are up and mortgage bankers are increasingly at a loss when it comes to creative refinancing solutions. The September issue showed a chart of banks’ mortgage-related assets and said that they seemed “blind to the danger as they continue to stuff their balance sheets with mortgaged assets.” Bloomberg columnist Caroline Baum reveals in a recent article that the truth can now be told—banks are in deeper than almost anyone thought. “Every time the subject of banks making risky home loans to bad credit risks—no money down, no questions asked—the usual retort is that banks sell the mortgages. They aren’t at risk. That’s not exactly true.” Baum places the exposure at 44%, but even that understates the problem because banks still derive significant origination fees from mortgages they sell, and those fees are drying up. With the national foreclosure rate jumping 63% in the first quarter of the year (according to RealtyTrac.com), real estate, is suddenly a dicey proposition for bankers.

Another aspect of the reversal that no one ever counts on in the midst of a mania is the high level of fraud that invariably attaches itself to the hottest sectors. The next wave of scandals is probably still growing, but its outline is clearly visible in articles like this one from MarketWatch on April 9:
Home Is Where the Fraud Is
Mortgage scams cost billions
Once a nuisance to a handful of lenders, mortgage fraud has blossomed into one of the fastest-growing white collar crimes in the country.

The fulfillment of these 2005 forecasts about the housing market confirms that a Grand Supercycle version of the Supercycle real estate busts of the 1830s and 1930s is underway. These are just the warm-up acts. If there is a banker out there who took this advice from Conquer the Crash, “Sell off your largest-percentage mortgages and get into safer investments,” it’s time to sit back and enjoy the show.