Counter Trade Dubai

I wrote a piece on Wednesday evening that discussed my own experiences with market volatility over Thanksgiving. It ended with:

The rates on your screen Friday morning will be meaningfully different than the ones you are looking at today.

I got the Vol. right. But I had no clue that the source of the hiccup would be Dubai. The reason is, as many have pointed out, this is “old news”. To be sure, there have been some new and important developments. But I doubt that Dubai is the issue that sinks the ship.

The talk is of $80-90 b of exposure. Say half of that is lost money. Of that, 70% is deep pockets in Abu Dhabi. That gets to an ‘outside the Gulf’ loss of only $15 b. A few European Banks will get hit. There is very little US exposure to this mess. The numbers do not look that big to me.

How big of a surprise was this? I suspect not so big for those who have big stakes in Dubai. These were WSJ headlines from 11/23. Three days before before the Tday blowup.


If you are a big bondholder you keep an eye on whether the contractors are getting paid. If there is no money for the vendors then it is just a matter of time before the creditors get stuck. This comment from a gulf paper Six months ago:

Nakheel, for example, has asked its suppliers to take discounts of between 25 per cent and 35 per cent.

There are dozens of examples of press reports that Dubai was in arrears for a long time. So I do not buy that this is a nexus for the market.

I think that by next week market focus will again return to those of Wednesday. A weak dollar, strong gold and busted monetary policy. Dubai is a side show that was aggravated by our holiday and an overreaction in Asian markets. We will revert back to the main event.


Note: In looking at this I saw these comments. Someone has to say things like this. It still strikes me funny:

November 24, 2009 US Consul General Justin Siberell to “Emirates Business”.

"We are certainly bullish on Dubai.”

Micro and Macro Economics – “It Stinks”

I was talking to a friend who is a contractor. He’s been in business for a long time and has a good reputation. Renovations, additions, a custom built house now and then were his specialty. In the good times he had three crews working full time and a payroll of $20 grand a week. The good times are over. I asked him how is business was going. His response, “It stinks.”

I asked him, “What changed?”

He said something that rang a bell:

“90% of my business came from homeowners who re-fi’ed to pay for the work that I did. That is over now. No one has equity in their homes anymore and if they do have equity, the banks won’t lend against it .”

Jump from the micro to the macro economic impact of this. The following is a graph of total mortgages outstanding. Mortgages debt grew at a 10% pace up to 2008. Since then the total has declined.


This chart looks at the trajectory of mortgage growth based on prior years and compares it to the actual.


The gap is very significant. Of course the trend line of mortgage growth pre 2007 was unsustainable. Assume that instead of a crash we had a soft landing in 2008. This graph looks at a mortgage growth rate half of what we were experiencing. There is still a big ‘debt gap’.


These gaps are what hurt my contractor friend. His business (and a lot of others) lost the grist that made it all work. Money. The home equity ‘piggy bank’ is empty and busted. He has only one crew now. He is not buying any new equipment anytime soon. His business at the lumberyard is down 60%. The bank cut his line. His subs and suppliers want cash. The jobs that are out there are bid low because there are a lot of guys scrambling for work. A business that once paid payroll and income tax is now costing us. There are 15 people getting nine months of unemployment. As far as GDP impact goes, this company went from third gear to reverse.

I don’t know the relationship to mortgage debt creation and GDP. I would guess around 20%. Based on that, the gap I described above would translate into a $300b contribution to GDP. About 2%. We desperately need that 2% right now. We aren't going to get it. We are at least three years away from achieving growth in total mortgage debt.

Total residential mortgages outstanding today are at levels last seen in the 1st Q of 2007. By way of comparison the current GDP level is about where it was at the end of 2006. For me, this means that the economic recovery for the next few years will be anemic at best.


Note: The FRB data is from June 30, 2009, so it is stale. The monthly numbers from both Fannie Mae and Freddie Mac through October confirm that there is still no growth in mortgages. F/F’s combined books are in decline. FHA has picked up the slack, but I doubt that there is any net growth. FHA will have to reduce its lending in the near future. They can’t keep lending 96.5%, they will go broke. There is no soft landing for this segment of the economy.

Bernanke Vs. Gold - Getting Hostile

I was struck with Bernanke’s comment last week at the Economics Club regarding bubbles. He said:

”It is not obvious to me that there are any misalignments in the US financial system”.

This comment has already gotten the attention of the media. Two years from now the blogs will be quoting it along with other notable words from the Chairman. Remember the following? Mr. Bernanke regrets having said this:

“We (the Fed) do not expect significant spillovers from the subprime market to the rest of the economy or to the financial system.”

When Mr. Bernanke made those comments back in May of 2007 he was either misrepresenting the facts or he simply could not see the implications of the facts that were in front of him. I don’t think he was fibbing to us then. He called it as he saw it. He simply had no clue what the pieces meant. I am concerned that he is equally out of touch today.

How could Mr. Bernanke not see that zero interest rates are a misalignment?

Mr. Bernanke is a student of economic history. He knows that during the 30’s T Bill rates went negative. I am sure that he remembers the panic of 2008 when again Bill yields fell below zero. But those were panic situations. There is no panic today. But bill rates are at zero.

I am sure that Mr. Bernanke is smiling ear to ear as he sees the evidence that his plans are working. Zero interest rates were his objective. He has succeeded and even exceeded his goals.

What Mr. Bernanke has accomplished is making fiat money useless. It now costs you to own the stuff unless you want to gamble with it. Our whole system is based on the notion that money has value. The Fed has established that it has none.

I assume that Mr. Bernanke is acutely aware of day-to-day market movements. He knows that the comments by St. Louis Fed Governor James Bullard that “Maybe we should extend the Agency POMO buys” quickly resulted in a $20 pop in the gold price. You can’t ask for a better example of the market’s attitude towards America’s monetary stance. It is starting to get downright hostile.

It would be a kick in the pants to the entire financial system if the price of gold started to have a meaningful impact on monetary policy. I think that is exactly what is going to happen. It is just going to take a while. Bernanke continues to believe that nothing is misaligned. We are going to wake up and find out that things are horribly misaligned.

FDIC on REO Sales: Keep'em in the Dark!

In October the FDIC held a large auction of properties it had acquired as a result of failed banks in Georgia. I thought this was an interesting story and wrote about it before the auction took place. It was my intention to write about it again after the results of the auction were released. No such luck. The FDIC has decided to keep us in the dark on this one. The following is an email I got from JP King, the auction house who ran the Georgia auction:

“Unfortunately, FDIC has prohibited us from releasing any information regarding the auction. We've been trying to get them to let us release the results, but they have denied our requests. We aren't allowed to release any details.”

I would have thought that the results of a pubic auction of properties owned by FDIC would have to be publicly disclosed. So why is the FDIC trying to cover this up?

The answer is that the REO problem for the D.C. lenders and the FDIC is reaching a crisis level. In spite of every effort to avoid foreclosures the fact is that the number of properties owned by the Feds is rising on a daily basis.

There are approximately 55 million mortgages outstanding today. At least 10% will/have gone into default before this is over. Of those half will result in foreclosure. These numbers create an estimate of the Federal share of REO at about 1.5 mm homes. Depending on unemployment and the economy going forward that number could be much higher. Before this is over the Feds could own up to 5% of all residential RE.

D.C. is struggling with this. The Treasury Department has created HAMP and HARP, two programs designed to restructure bad mortgages and keep homeowners in the house at all costs. So far the results from these programs have been terrible. More than half of the restructured loans re-default within nine months.

Fannie and Freddie are going into the rental business with their REO. They are charging “market rates” of rent to defaulted owners who are willing to stay in the home. Given that market rents today are equal to the costs of ownership I doubt that the new ‘Renters’ are going to be able to make the payments. So this program is just delaying the recognition of the REO problem. At best they have pushed the problem forward by one year.

The FDIC, FHA, Fannie and Freddie all have their own web sites for the properties they own. I think they are doing a good job of advertising what they have to offer, but of course they can’t find buyers. Unless a property is being offered up in an auction or at a very distressed price it just does not sell. Ask anyone trying to sell a house in any section of the country. If you sell today you have to leave a lot of money on the table. What is clear is that when properties are marked down to distressed levels, or there is an auction, the demand is there. The buyers are vultures. You can’t blame them for that.

We are in a vicious cycle. Lower properties values create more underwater borrowers. Underwater borrowers have no incentive to pay so they don’t. Defaults/foreclosures follow. The liquidation of the resulting REO creates more downward pressure on property values. The drop in values just leads to more underwater borrowers and more defaults.

D.C. is well aware of these facts. A recent letter from the American Bankers Association (ABA) to the FDIC had the following to say on the topic. Read these words to say, “Stop the liquidations! You are killing us!”

“The prompt post-closing sale (auction) of real estate in depressed markets, while understandable from the perspective of wanting to conclude a resolution quickly, results in a lower price paid to the FDIC for the assets. This further depresses the market prices obtained by other banks trying to work through problem assets of their own.”

We have already spent trillions shoring up the banking system. They have a big REO problem too. Policies that hurt the banks and force them to compete with the likes of the FDIC are not constructive. We are shooting ourselves in the foot. So just this one time I have to agree with the ABA position.

In my prior post on the JP King/FDIC auction the comments were all in support of the FDIC. People wanted price discovery and a rapid wind down of the government’s ownership of residential RE. It’s hard to argue with that logic, except for the fact that if we go down that road RE is going to fall another 25% and we will be talking about the D word again.

With this as a backdrop it is easy to understand the thinking at the FDIC in withholding the results of the Georgia auction. They would be damned if it was determined that the liquidations resulted in drops in RE values in the communities where the auctioned homes were. (Trust me, that is what happened)

But they should be equally damned for not letting the public know what the results were. This policy is not in keeping with the, ‘new spirit of openness in government’ that we keep hearing about.

Secrecy is not going to work. The fact is we have four major Washington based entities that combined have over $8 Trillion in financial assets secured by real estate. There has to be a coordinated plan to deal with the individual Agency’s REO problem. Uncle Sam is already the largest property owner in the US; the holdings will double in the next twelve months. That is too big a problem to keep secret.

Oct. SSTF Report - We Are Now Living Off Of The Interest

The Social Security Trust Fund wracked up another monthly deficit for October. The shortfall was $4.2 billion. This is the 5th consecutive month of red ink for the Fund. The total for the period comes to $15bil. Blame the economy and the boomers for this problem. Some basic measures of the Fund's performance are rapidly deteriorating.

A critical measure is the ratio of Payroll Tax receipts to Benefits paid. The following chart looks at that ratio over time. That ratio will fall below 1.0 for the full year 2009. As of today we are living off of the interest.


In November the SSTF will pay out $56.9 billion. They will be lucky to take in $47 billion in tax income. The deficit will be near to $10 billion. Interest income, and other income add another $140b annually to the Fund’s top line. But with monthly deficits of $10b on an operating basis, the Fund is running very close to break even for 2010. That possibility is not on anyone’s radar screen.

My estimate for benefits in 2010 is $756 b. If we assume total GDP growth of 2% the resulting ratio is 5.75%. That is up from 4% just a few years ago. It is rising fast. The following is from a CBO report on the Fund from August 2009. These guys think it going to 6% in 2030? This train will arrive 18 years early.

“Both CBOE and SSTF project that Social Security’s outlays will rise from 4.8 percent of gross domestic product (GDP) this year to about 6 percent in 2030 and will stabilize thereafter.”

The US is struggling with health care legislation. Inside of this debate is a cost of about $1 Trillion. We can’t agree on this because of the question, “Who will pay?”

Health care is small beer compared to SS. My estimate on the current imbalance of the fund is close to $7 trillion on a NPV basis. We are on a ship traveling at high speed toward a rocky shoal. And it is foggy and no one has a clue.

SS is too hot a potato to come up for a resolution prior to next year’s elections. That would imply it comes up for discussion sometime in 2011. The Fund can’t wait that long. I just keep wondering when the MSM will wake up to this.

FDIC Decision Due Out Soon

On September 29th the FDIC announced a plan to bolster its reserves. There were three basic choices. A) Borrow from the Federal Financing Bank, B) Charge a large special assessment on the banks and C) Have the banks pre-pay three years of insurance premiums up front.

At the time, the FDIC gave the public a thirty-day comment period before the final determination. That time period is up. The letters are in. I would expect an announcement on this by Ms. Bair before the end of the week.

This is the link to the letters. There are a lot of them. The FDIC may choose to ignore all of the comments, but I think they will address some core issues raised in their final ruling.

The FDIC went after this with a carrot and a stick. They said to the banks,” If you pay up front we will make the accounting work for you”. “If you don’t, we will charge you a ‘Special Assessment’. That would go through your income statement”.

Bankers being bankers it is understandable why they would not want to recognize an expense up front if there was another way around it. Therefore almost all of the letters were in support of the pre-pay deferred recognition approach.

There was some support for the FDIC to tap its credit lines at the Federal Financing Bank. They have a blank check at the FFB for $100 billion. So the pre-pay option isn’t really necessary. But the easier FFB option had a significant cost. Ms. Bair is acutely aware of the ‘anti bailout’ mentality. Her words on the subject:

“It's clear that the American people would prefer to see an end to policies that look to the federal balance sheet as a remedy for every problem.”

This is why the FDIC made it easy for the banks to choose door (C). It’s cosmetics.

Not surprisingly the Banks all wanted a bone thrown to them. They made a good case. If they did not prepay they would have earned a spread on the cash. So in effect the proposal has a negative impact on income. We wouldn’t want that. A few examples:






Some thought of what may come:

-The $45 b prepay is a done deal.

-There will be exceptions in a number of cases and categories of banks. These banks will get a drawing from the FFB. That drawing will be guaranteed by the FDIC. This is small beer. Maybe $5b. It will look like the FDIC will have no borrowings however.

-There will be no special assessments.

-There will be a discount on the pre-payment. The banks will be allowed to take that as income. Top line benefit that has no substance.

-The assumption that deposits will grow by 5% will be reduced. This will have the impact of reducing the net amount that the FDIC takes in. (by just a few billion)

-The statement will reaffirm that deposits are safe and that the FFB (and this cash) is backstopping that promise.

-This will be made to look like a great success. A true private sector solution.

-The ‘system’ will have created another $45 billion of off balance/income statement funding. This will not show up anywhere.

-If a discount is awarded to the banks then that percentage should be compared to the cost of tapping the FFB for the shortfall. Any excess would be a measure of the Government's willingness to avoid the perception of a bailout.

Congressman Latta was very supportive of the proposal in his letter. I thought his side comments were interesting:


Also of interest was this comment by the ABA.

Fannie and Freddie Own Stuy Town?

Stuyvestant Town in NYC looks like a default about to happen. This was a $5.4 billion mega RE deal from November of 2006. There is a $3 billion 1st mortgage. I think that Fannie and Freddie own close to half of that.

The following is from a 2007 Wachovia prospectus. This shows that of the $3b mortgage $1.5 bil was taken down by ‘Watchoveryou” (AKA Wells Fargo) and later put into this $7 billion CDO. (garbage) The balance was structured as a bond that ranked par passu with this mortgage. Those bonds made it to the government mortgage agencies.



Bloomberg quoted a Freddie Mac spokesperson as saying, “Freddie Mac doesn’t expect to lose money on the bonds backed by the property.” Let’s hope so, but the following doesn’t make me feel good that a $3b mortgage is money good:Link


Two questions come to mind. The first is, “How is it that the GSE’s bought this paper in the first place? The second, more important issue, “How much more of this kind of stuff do they have?”

Stuyvestant Town does provide rent controlled housing, but the 2006 transaction had nothing to do with achieving the Country’s housing objectives. The business plan from the new owners (Speyer/Blackrock) was to get the old rent controlled tenants out as fast as possible and then raise the rents and condo-ize units to pay down the loans. There is no justification for Fannie and Freddie to have financed that process. The motive was to leverage up their balance sheets and generate fee-based revenue. There was never sufficient income to service the mortgage debt. A $400 mm reserve was set up to cover the shortfall. That account is now empty. This was a bad loan from the get-go.

On the issue of how much else is there? We don’t know. The following from F/F just raise questions.




The Administration will address the GSE’s in the coming months. The path for the mortgage agencies and the government’s future role in the mortgage market is up for discussion. Possibly the process should start with a list of what the GSE’s did that was not in the interest’s of the taxpayers.