The Global Housing Crash

I am a believer in the global housing crash scenario. Normally, I don't put much faith in economic forecasts. I think it is almost impossible to do it well. Alan Greenspan agrees by the way. He recently said on the John Stewert Show (of all places) that he hadn't seen any improvement in economic forecasting over his entire life. However, the housing situation is different. It is a matter of common sense. Logically, real housing prices should not change very much. Houses and the land they sit on are stagnant things like commodities. They do not produce cashflows other than by renting them out. But renting them out for an amount that doesn't cover the mortgage payment is a negative carry. They are clearly overvalued and must come down one way or the other. I won't go over the argument why they are overpriced and why they must come down. Rather, I want to focus on the consequences.

Lets assume that the following dire scenario happens:

House sales and prices continue to drop over the next two years. The subprime buyers cannot be kept in their houses despite much government interference. It simply isn't in their interest to stay. They foreclose and/or declare bankruptcy. However they aren't the only ones. Other "prime" homeowners with negative equity, negative net worth but otherwise good credit realize that they also have no incentive to stay in their homes. Many of them also join the subprime crowd. The negative feedback is obvious. More foreclosures lead to more inventory which puts more pressure on prices. The deflationary psychology sets in. People put off buying because prices are dropping so quickly. The Fed will do its best but can't force people to buy houses. Washington will do its best to pass legislation with incentives to slow the crash but with only mild effects. Prices drop by 10% per year for four years, a total of 35% and then start to decline another 2% for the next six years. The total 10 year decline is 42%. With 2% inflation, real prices have dropped by a factor of 2.

What would the consequences be?

I don't really know. But I think this would lead to many different crises, certainly a long recession if not a depression. Some of the milestones would probably include

• Lender failures
  
• Home builder bankruptcies
  
• Financial company impairments
  
• Credit crunch
  
• Failure of leveraged speculators
  
• Major bank balance sheet impairments
  
• Recession in countries with housing crashes
  
• Recession spreads to most other countries
  
• Failure of mortgage insurance companies requiring Government bailout
  
• Near or complete insolvency of Fannie Mae, Freddy mac requiring Government bailout
  
• Investment bank failures
  
• Major bank failures
  
• Currency devaluation arms race
  
• Rise of protectionism
  
• Major inventory/capacity overhang in manufacturing/export countries like China
  
• Deflation in all major asset classes
  
• Flight to safety, US dollar?, blue-chips, health care, high cash-flow, recession resistant companies, Treasuries
  
• International goverment intervention in mortgage market and banking
  
• Panic, crises, unforseeable events and eventually resolution and recovery
  

In the end (whenever that is), houses are no longer sexy "investments". They become more affordable and necessary "expenses". They are just the place where you live.

As I mention above. I don't know how it will end or what will go right or wrong along the way but many of these things could happen. Many will only happen if house price declines cross certain thresholds. A 10% decline will be manageable. A 20% decline will be major pain. Beyond that, my above scenario is (I think) quite likely and I don't see what could cause prices to stop decling at only 20%. They will still be very expensive for most people and still a negative carry for renting out in most markets. I don't think most companies have a plan for 30% price declines.

Westernbank versus Inyx Timeline

This is a timeline to keep track of developments concerning the Inyx , Westernbank interaction

Feb 2005, Irish High Court bars Kachkar and Carrigan from investment and directorship positions in Ireland. (source: Carrigan testimony doc 191)

March 31, 2005, Inyx and its wholly-owned subsidiary, Inyx USA Ltd. (“Inyx USA”), entered into a Loan and Security Agreement (as amended, the “USA Loan Agreement”) (attached Exhibit 1) with Westernbank. Fraud guarantees signed by "Inyx Operators" (source: RICO complaint)

May, 2005, Inyx Pharma Ltd. (“Inyx Pharma”), which is also a wholly owned subsidiary of Inyx, signed an amendment to the USA Loan Agreement (attached Exhibit 2), and became a co-borrower under that Agreement. Inyx, Inyx Pharma and Inyx USA are referred to hereinafter as the “USA Borrowers.” loan $46M ($10M revolving and $36M in 4 term loans) secured by all assets (source: RICO complaint).

July 2005 Jose Biaggi appointed CEO and President of Westernbank.

August 30, 2005, Kachkar, Green and Goldshmidt each executed similar guarantees covering fraud, deceit or criminal acts by Inyx, the EU Borrowers, or any officer, employee or agent of Inyx or the EU Borrowers. (source: RICO complaint).

On August 31, 2005, Inyx Europe Limited (“Inyx EU”) and Ashton Pharmaceuticals Limited, f/k/a Celltech Manufacturing Services Limited (“Ashton”), entered into a Loan and Security Agreement (as amended, the “EU Loan Agreement”) with Westernbank (attached Exhibit 9). Inyx EU and Ashton are referred to hereinafter as the “EU Borrowers.” Under the EU Loan Agreement, Westernbank agreed to lend up to $35.5 million, consisting of a revolving credit line of up to $11.7 million and term loans to Inyx EU in the aggregate amount of $24.8 million, pursuant to four promissory notes. Loans are now about $82M (source: RICO complaint also Montanez testimony).

October 24, 2005, Inyx sought and received a $5 million Secured Over Formula Advance Loan from WBC for working capital to purchase new inventory. The loan was to be guaranteed by inventory one of the Inyx Companies was to purchase pursuant to existing purchase orders. The Inyx Companies, however, never reported such inventory to WBC, and the underlying purchase orders were fraudulent. In addition, while the loan has long since been due and owing, the loan has never been repaid. Loans now $87M (source: RICO complaint).

Nov 2005, Another $10M in loans for revolver at Inyx Pharama Loans now $97.5M (source: Montanez).

On or about August 1, 2006, a conference call was conducted among Westernbank employees and Handley and Hunter. During this call, Handley and/or Hunter falsely represented to Westernbank that most of the Inyx past due accounts receivable discussed on the call would be collected over the coming months even though they knew that most of these accounts receivable were fraudulent. This conference call took place over international wires (source: RICO complaint).

On or about August 11, 2006, Kachkar, Green, Goldshmidt and other Inyx Companies employees traveled to Puerto Rico to meet in person with Westernbank employees. Among the topics discussed were Inyx’s aging accounts receivable. Kachkar, Green and/or Goldshmidt told the Westernbank employees that they should direct their questions to Handley and Hunter because they were the ones knowledgeable about the accounts receivable (source: RICO complaint).

Sep 2006, Loans are up to $110M. Accounts receivables increasing, need more working capital. Added to revolver (source: Montanez).

Starting in September 2006 and continuing through at least May 2007, the Inyx Operators repeatedly, misled Westernbank by advising it that the Inyx Companies and/or the Inyx Operators were finalizing arrangements with other sources of funding either to buy out or significantly pay down the Inyx Companies’ debt to Westernbank (source: RICO complaint).

Oct 2006, Auditors cannot complete audit in UK.

November, 10 2006 Jay Green says final stages of due dilligence with Goldman Sachs, Wachovia, Credit Suisse. Jay Green requests a waiver of financial covenants. They are writing off $37M in receivables and that they are pre-billings. "Raised a red flag". Contacted Kachkar who claims this is only GAAP accounting and that receivable are good (source: Montanez)

November 17, 2006 personal guarantee from Kachkar and Benkovitch in the amount of $10 million (source: RICO complaint).

November 20, 2006 Mike Vasquez sends letter acknowledging the $37M in pre-billings. (source: Montanez)

Jan 2007 Last WHI Conference call. Stipes says Inyx is current and that it is not a bad loan. Might be acquired.

Jan 17, 2007 Jack Kachkar offers $148.6 million to buy Marseille soccer team.

Feb 21, 2007, Skepticism grows over Kachkar's funds Money laundering worries. . French Press says he has 386M Euros (same link).

Mar 2, 2007 Jay Green sends Westernbank a letter of commitment for financing from Pareto Securities. The letter turns out to be a forgery.

Mar 5, 2007 French Paper reveals that TRACFIN, the French agency that investigates money laudering is investigating Kachkar and Benkovitch.

March 7, 2007 personal guarantee from Kachkar and Benkovitch in the amount of $8 million (source: RICO complaint). Loans at $120M (source: Montanez).

Mar 14, 2007 Kachkar's claims to have purchased Grimaldi Castle exposed in Provence Paper .

Mar 24, 2007 Robert Louis-Dreyfus decided not to extend a payment deadline for Kachkar to buy Marseille team.

Apr 11, 2007 Jose Biaggi tenders his resignation as CEO and President of Westernbank and member of the BOD.

In May 2007, Westernbank learned of a collateral deficiency under the Loan Agreements in excess of $80 million because of uncollectible accounts receivable. Various Inyx officers, including Kachkar, Green and Goldshmidt, thereafter gave false assurances to Case 3:07-cv-01606-ADC Document 3 Filed 08/23/2007 Page 32 of 54 33 Westernbank in June 2006 that the collateral deficiency was substantially less than this sum, the accounts receivable identified as uncollectible were in fact collectible, and/or that the collateral deficiency would be covered by other assets (source: RICO complaint).

May 2007, David Zinn says receivables probably not collectable (source Montanez).

May 14, 2007, Sahara Bank replies by SWIFT saying that it has no letter of credit from Qadahfi for Westernbank.

May 31, 2007 Meeting with Kachkar. He says receivables are good (source Montanez).

June 7, 2007, Kachkar and Benkovitch executed an Amended and Restated Limited Guarantee (the “First Personal Guarantee”) (attached Exhibit 14) guaranteeing, with certain limits as detailed in the First Personal Guarantee, all obligations of the USA Borrowers and the EU Borrowers to Westernbank under both the USA and EU Loan Agreements (collectively, the “Loan Agreements”), up to $30.1 million. The First Personal Guarantee was given “in substitution” of earlier guarantees (source: RICO complaint).

June 19, 2007 According to 8-K filed June 25, 2007, WB decides that the Inyx loan is impaired.

June 20, 2007, Kachkar and Benkovitch executed an additional Limited Guarantee (the “Second Personal Guarantee”) (attached Exhibit 15) guaranteeing, with certain limits as detailed in the Second Personal Guarantee, all obligations of the USA and EU Borrowers to Westernbank under the Loan Agreements in an amount equal to the sum of $70 million plus the amount that the repayment obligations under the Loan Agreements exceeded $142.4 million. This Guarantee was “in addition to and not in substitution of” the First Personal Guarantee for $30.1 million, which remained “continuously in effect.” (source: RICO complaint).

June 20, 2007, Kachkar and Benkovitch executed a Collateral Deficiency Letter (attached Exhibit 16), through which Kachkar and Benkovitch agreed to Case 3:07-cv-01606-ADC Document 3 Filed 08/23/2007 Page 12 of 54 13 provide certain collateral (the “Mining Collateral,” as defined in the Collateral Deficiency Letter) sufficient to cover the amount of the collateral deficiency under the Loan Agreements (source: RICO complaint).

June 22, 2007 Montanez says "We became concerned on approximately June 22nd." because David Zinn reports missing $4.1M in receivables at Inyx USA and 28M sterling missing at Inyx Pharma and 51M sterling missing at Ashton. They contact Zinn who says they will never be collected. Zinn also says $14M in funds have been diverted from lock box (source: Montanez).

June 25,2007 WB files the 8-K reporting the impairment. WHI stock falls.

As of June 28, 2007, Westernbank had made loans to the USA and EU Borrowers in the amount of $142,778,299.77 under the Loan Agreements. As of that date, numerous Events of Default under the Loan Agreements had occurred (source: RICO complaint).

June 28, 2007, administrators were appointed for Inyx Pharma and the EU Borrowers (source: RICO complaint).

June 29, 2007, Westernbank sent a demand letter to the USA Borrowers (attached Exhibit 17). In that demand letter, Westernbank informed the USA Borrowers that (i) the amount of the outstanding loans exceeded the amounts available under the lending formulas and (ii) Westernbank was demanding, as entitled under the Loan Agreements and the Cross-Default Agreement, for the immediate payment of such excess amounts, totaling $87,282,422. The demand letter also informed the USA Borrowers that all other “Obligations” as defined under the Loan Agreements had become due and payable (source: RICO complaint).

June 29, 2007, Westernbank sent a separate demand letter to Inyx Pharma and the EU Borrowers making the same demand as in the demand letter sent to the USA Borrowers but referring to the Obligations under the EU Loan Agreement that had become due and payable as a result of Event of Defaults under the EU Loan Agreement (attached Exhibit 18) (source: RICO complaint).

July 2, 2007, Inyx USA, as well as another Inyx subsidiary named Exearis, Inc., filed voluntary petitions for relief under chapter 11 of title 11 of the United States Code in the United States Bankruptcy Court for the District of Delaware (source: RICO complaint).

On or about July 3, 2007, Westernbank sent to Inyx, Inyx Pharma, Inyx EU and Ashton a “Notice of Default and Demand” (attached Exhibit 19). The Notice of Default and Demand stated that numerous defaults had occurred under the Loan Agreements (source: RICO complaint).

On or about July 3, 2007, Westernbank also issued letters to the Inyx Operators demanding payment under the Fraud Guarantees (attached Exhibit 20). By these letters, Westernbank demanded payment from the Inyx Operators of at least $80 million (source: RICO complaint).

On or about July 3, 2007 and on or about July 10, 2007, Westernbanki ssued letters to Kachkar and Benkovitch demanding payment under the Personal Guarantees and the furnishing of the Mining Collateral under the Collateral Deficiency Letter (attached Exhibits 21 and 22). Westernbank demanded from Kachkar and Benkovitch (a) payment in the amount of $30.1 million under the First Personal Guarantee, (b) payment in the amount of and $70,378,299.77 under the Second Personal Guarantee, (c) the furnishing of the Mining Collateral sufficient to cover the collateral deficiency under the Loan Agreements, and (d) compliance with and performance of their covenants under the Collateral Deficiency Letter (source: RICO complaint).

July 26,2007 The Stipes Fights Back article published in Caribbean Business

A house is NOT an investment

People often get caught up in prevailing myths which provide a basis of belief which leads them to make poor financial decsisions. One of the biggest myths is the idea that buying a house is an investment. The way we talk about things often dictates the decisions we make. Investing money always seems more prudent than simply buying. Often it is said that buying a house is an investment. Is this true? That of course depends on what we mean by investment.

I think the best definition of investing is using ones savings to buy an asset which will provide real future returns in excess of the invested capital.

For example buying a factory with which you will produce marketable products is an investment. Even if you borrow most of the capital, you can pay the interest payments with the operating cash flows. If it is a good investment, you will have profits left over which you can put into savings. Over the long term, it is likely that you can pay off the mortgage and collect these cash profits. After say 30 years, you will have paid off the loan so that you own the factory, the cash flows that were produced as well as the future cash flows that will come in the future. If the real value of these things are greater than the real value of the invested capital, you have made a profitable investment.

I will use the term real value to mean inflation adjusted value. We can compare dollar amounts at different times by discounting them by the risk free return.

Other examples of investments are buying stock in a company, buying CDs from a bank, buying an apartment building which is producing cash flows in excess of the mortgage payment interest rates.

So, what about buying a house? Well, we all need a place to live. Our main choices are renting an apartment or buying a house (or condo). A similar decision to this is choosing what to eat. We all need food but we seldom talk about investing in our food. We consider it a necessary purchase not an investment. Buying a house should be considered the same.

It is possible to think of buying houses as investing. For example, if you buy a house for the purpose of renting it out, it can be an investment. If the rental payments are large enough to pay for the mortgage and also build equity in the house, this can be an investment. However this shows that it is only possible to make housing an investment if mortgage payments to rent are a low enough ratio. In fact this is the best way to value the price of houses. The price to rent ratio is similar to the price to earnings ratio for a stock.

During times of a speculative housing mania, the price of houses will be increasing. People buy houses with borrowed money and hope to make money simply from the increase in house price. If the house price is increasing faster than the interest rate of the borrowed funds then it may be the case that the rent is below the required mortgage payment but the appreciation of the house makes up for this negative cashflow.

However, this situation is unstable and cannot last for long. Eventually the house price will stop appreciating at these high rates and may even start deceasing. These people with negative cashflow will have to sell. This wave of selling will lead to higher inventories of houses for sale which will lower prices further. This kind of "investing" is better thought of as speculation. The profits depend on price appreciation and not positive cashflow. It is no different than speculating on the prices of gold, currencies or pork bellies.

Whether or not such housing speculators make money depends on when they got into the game. People who started early may come out with a profit. Those who started late will come out with a loss.

The housing industry is constantly promoting the idea that buying a house is an investment when this usually is not true. When you are buying a house to live in, this is simply a purchase to satisfy your housing needs. It is the main alternative to renting and often makes sense for people. If the payments on a traditional 30-year fixed mortgage are comparable to the payments that you would pay to rent the same house, then buying is probably a good idea. That is because you are paying a similar amount and are building equity in the house.

The housing prices in Los Angeles these days are so high that buying a house can only be thought of as irrational. Prices are way above any amount that is justifiable by rental cash flows. You will pay more on a interest only mortgage than you would pay to rent the same place. With an interest only mortgage, you are building no equity in the house. The no-money-down, interest-only-loan, which was so common these past few years can be thought of as renting money to speculate with infinite leverage on house prices. Most people would never borrow $20K and then buy pork belly futures but they actually undertaking something even riskier when they use these interest-only motgage products to buy a house. They are not actually buying a house- i.e they don't build equity-they are merely speculating on rates of appreciation. The only benefit over renting is that you get to profit from any appreciation of the house. However in a climate of falling home prices, this can only be a negative. Plus you need to pay all of the expenses associated with buying such as taxes, repairs and insurance. In such an environment prices have to go down since there is practically no financial incentive to buy at current prices. People who got in late may forclose and these forclosed homes will add to the inventory driving prices down further.