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Doom And Gloom Rehab

By Tobin Smith

Click here to watch a video of the rant.

I want to thank Britney Spears and Isaiah Washington for being the inspirations behind my rant today.

Poor Britney, God bless her, checked into rehab on Tuesday -- I hear she's out now. That didn't take long.

"Grey's Anatomy" actor Isaiah Washington had to go to rehab because he said some unkind things about gay people.

If you ask me, I think we're keeping this rehab thing too small -- it should be a lot bigger. And I think the first new rehab program should be for the bad news bears and perma-doom-and-gloomers -- and I volunteer to run it.

These are the guys that we see forecasting disaster on television every day -- we have them on Fox News Channel and you can see them on CNBC, too. They make good TV and you know why they're on -- because they scare the crap out of people.

Here's their basic line: These sub-prime mortgages are going to blow up and when they blow up they're going to take the entire U.S. economy with them. It's going to be a recession just like 1989 or 1990.

And that's why they're bearish. They'll tell anyone who listens that -- oh my God! -- you've got to sell your stocks, you need to buy gold and you need to buy all sorts of crazy things.

Listen, these guys need to be in rehab to get reacquainted with modern economics. In essence, they're telling a story as if nothing in the world has changed since the '80s. And let me tell you, in terms of financial terms, in terms of global financial economy, in terms of how we spread risk around the rest of the world, everything has changed. Everything.

So to come to the same conclusion that something that happened in the late '80s is going to cause the same thing to happen in 2007 is insane. It is so far off the mark.

SUB-PRIME THINKING

Let's go through this sub-prime blowup thing.

In the old days, if we went out and we lent a bunch of money out to people who are less than creditworthy, and maybe we gave them 100% loans or maybe 110% loans. In the old days (what I'm calling the '80s now) this happened. And guess what? If interest rates started going up, or the economy really slowed down, you'd get a high default rate.

And that would be somewhat of a contagion because maybe at that time a lot of those loans were made by savings and loans that had no insurance and there was no way or securitizing via credit derivatives.

Let's fast forward to 2007. Today, we've got a whole bunch of guys making these sub-prime loans to low credit people or with low documentation loans and pretty much everyone could get approved.

Now some of these questionable practices are coming home to roost because they were adjustable-rate loans. And as interest rates rose over the last couple of years, they now have a 7% and 8% rate instead of a 5% rate.

But guess what? This is not going to take down our entire economy. As a matter of fact, it's not even taking down the mortgage industry. Here's what it's doing:

First off, the companies that bought or made these loans, packaged them together and sold them off in pieces in what's known as trusts. Now these trusts were purchased by millions of investors out there through their money managers, hedge funds or corporate bond funds.

But instead of just buying these things, they also are buying what's known as credit derivatives (i.e., insurance), particularly on the hedge fund side. So if the loans blow up, they've already bought insurance.

When they bought these high-yielding loans, they paid for that insurance all up front. That wasn't available in the '80s.

So the idea that if these loans go bad that means the rest of the world is going to go bad is nuts. It's nuts because these loans have been split up and sold to literally millions of different investment pools all over the world, not just in the United States.

So when you spread the risk like that, it completely changes the risk parameters.

BIGGER IS BETTER

Here's the second thing that the doom-and-gloomers don't understand: We have a $13 trillion economy that's almost $14 trillion if you add everything up including imports/exports and the whole schmozzle.

So at that level, a $200 billion meltdown in mortgages doesn't get on the radar screen of our economy. We are a gigantic aircraft carrier powered by the incredible buying power of the American consumer, the incredible productivity of the American corporation.

$200 billion hiccups just don't get it anymore.

I mean, 15 to 20 years ago it was a different story. But these guys, these professional doom and gloomers in my personal economic rehab program, are going to learn how the world is different today.

1) Because of global capital, we have this tremendous diffusion of investment capital from all over the world in these various investments, so they're spread out. No one country or single place is going to take a hit if they have problems.

2) When they do have problems we have a huge, multi-trillion dollar credit derivative industry, which is a fancy phrase for people who buy insurance when they purchase these riskier assets. They've already insured most of this.

3) If you look at where the defaults are coming in this sub-prime market, you'll find out that a lot of the defaults are coming from speculators in places like Miami.

So I think these people bought these condos probably on the day we said the real estate market is at the top in March 2005. That was the day when we saw facing full-page ads in every major newspaper in the United States saying, "make $50,000 every 90 days."

That was the top, ladies and gentlemen. We called it, and we were right.

But guess what? A lot of people didn't see our warning and went out and bought condos at the top of the market and got an adjustable-rate mortgage. So when the thing scooted up in two years or a year and a half, they said, "Forget it. That condo's going away, I'm giving it back to the bank."

Or they bought a house because residential real estate "can't fail." Well guess what? They're giving it back, too.

Now these people are not bankrupt. I mean there are certainly people at the low end of the economic scale who have a mortgage that's too big and they give them to the bank in foreclosures because they can't make the payments.

Guess what folks? That's how the mortgage market works. But the thing these guys are missing is that this is just the speculation being pulled out of the market. We've got an unemployment rate of 4.7%. We'll probably top out in this cycle at 4.9%, maybe 5%.

REMEMBER THE SUPER SPENDERS?

Here's one more thing people don't understand about this economy. We have what I would call the super spenders -- the top 10%-20% earners in the United States. This group accounts for almost 90% of our economic activity when you talk about anything related to discretionary spending.

We're talking about spending on a second home, new TVs, putting the kids through college, etc. If you study that group -- people over the age of 30 with some college -- the unemployment rate is about 1%.

And the fact of the matter is that at the low end of economic spectrum, if they're having financial difficulty because their mortgage rates have gone up to the point where they can't make them, I mean, you know, as dreadful and heartbreaking a story as that is, from a pure economic standpoint, it really doesn't matter as much to the overall economy.

So what you really want to worry about in 2007 is how the super spenders are doing in the American economy. And if you look at those numbers, you'll see they're doing great, and that's why this economy continues to grow and continues to have this soft lading -- and is getting ready to rebound again.

So if you add all those points together, you'll see a brighter future. That's what I'm going to teach in the doom-and-gloomer rehab.

We'll even take Britney Spears -- though I don't know if we can get her to last for more than a day.

But I really think there's a group of doom and gloomers out there that need to come to my rehab center and get adjusted to current reality in the global economy, and not keep overlaying what happened in 1985 and making that comparison.

From an economic standpoint, that argument really doesn't hold water.

Remember, we also have about 2 billion more consumers in the world than we had at that time. Thank you, China. Thank you, Russia. Thank you, India.

We have a huge amount of capital -- I mean the world is literally twice, almost three times as wealthy as it was then.

And we are just so much bigger, so much more powerful, so much more insulated from these specific shocks, that we just don't have that down risk. And that reality has really not been priced into stocks because I think when people understand how much safer from an economic standpoint this overall global economy is, they'll probably do one thing -- and that's price stocks even higher.

So, doom and gloomers, there's plenty of room in my rehab program. You guys are out of touch with reality, and you can use my help.

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Tobin Smith is the founder of ChangeWave Research, the editor of ChangeWave Investing and ChangeWave Microcap Investor and a contributing market analyst for Fox News Channel. His market commentary can be found twice weekly in the ChangeWave WaveWire and he provides more specific recommendations and advice through his ChangeWave Investing service. Click here to learn more about ChangeWave Investing.