Dallas Fed President Richard Fisher spoke Tuesday. His words echoed those of Fed Governor Kevin Warsh who recently wrote an important Op-Ed in the WSJ. On the issue of withdrawing the monetary stimulus that is now in the system Fisher said:
"I have faith my colleagues on the Federal Open Market Committee will stand and deliver (monetary tightening) in a timely way."
Mr. Fisher and his colleagues recently voted to extend the Fed’s zero interest rate policy, “for the foreseeable future”. In his speech Mr. Fisher affirmed that the balance of the $1.25 trillion of Agency POMO intervention will continue through the end of March, 2010: As of 9/23 the Fed had purchased $700 b of MBS, they have another $550 billion to go.
(“T)he FOMC expects we will complete the execution of our $1.25 trillion intervention in the mortgage-backed securities market by the end of the first quarter of next year.” (Finally the word intervention, thanks Mr. Fisher)
Of interest to me was that Mr. Fisher had strong words to say regarding the Feds future tightening efforts:
“I expect that when it comes time to tightening monetary policy, my colleagues and I will move with an alacrity that, if needed, will be equal in speed and intensity to that with which we pursued monetary accommodation.”
Really? Mr. Fisher has said he would ‘stand and deliver’ a reversal of monetary easing at a torrid pace. When the time is right. If it is needed. But not at anytime in the foreseeable future. If ever.
At this point I would assume that the term “foreseeable future” means “not until after January”. That dovetails with March as being the target for the ending of the Agency MBS POMO intervention. So ‘foreseeable future’ could be as far away as six months.
For me the idea that we are going to continue stepping on the gas for anther half year is scary. By that time there will bubbles all over the place. If you take Mr. Fisher at his word you would think that on April 1st the Funds rate would go to something crazy like 3%. Some April Fool joke that would be. That is not going to happen. This is a very big ship. It has go into neutral for some period before the engines can be reversed.
A more reasonable interpretation would be: Sometime after the first quarter 2010 the Fed will raise rates two times. The first will be in May, an increase of 1.5%. Later in the year it will be raised another big notch to 3%. The average for the full year will be less than 2%. There is no meaningful tightening in that scenario.
The tough talk by the Fed members is coordinated. Other Fed Governors have speaking engagements this week. Bernanke is talking as well. Look for all of them to pound the table on this issue. They know that the dollar has been getting dangerously weak of late. They know that the general distrust of the QE process is a part of that. It is no coincidence that the ‘market talk’ on the dollar has been more constructive over the past few days. Behind that recent thinking is the belief the Fed will, ‘do the right thing’.
However, if in three months the Fed is still buying $20b of long duration coupons each week and the bill rate is still at 9bp all this tough ‘Fed speak’ will be forgotten. It would be better for the Fed to act tough versus talk tough. They have a lousy reputation for backing talk with action.
Consider this from the other side. Say Mr. Fisher and his colleagues do deliver on their words. Assume the Fed funds rate is 4% by 12/31/10. This creates a monster headache for Mr. Geithner. In a year from now the debt level will be +/-$13 Trillion. About 30% or $4t is short term. This scenario would increase the cost of just the short-term debt by $150b.
I don’t see that either of these possibilities adds up to a strong dollar medium term. In my view it is nearly certain that the Fed will go too far with the QE process. The fact that they want to continue for another six months at this juncture is proof enough for me. It will be interesting to watch the cat and mouse game evolve. At some point over the next three months words alone are not going to be sufficient.
Tuesday, September 29, 2009
Sunday, September 27, 2009
Biz Booming at Geithner's Private Bank
Tim Geithner hit the ground running in January when he took over as Treas. Sec. He had a lot on his plate. One of his smaller responsibilities was the Federal Financing Bank (FFB). Mr. Geithner has knocked the cover off with this one. So far this year the FFB has increased its portfolio by 50%. By asset size, FFB would have ranked 35th in the USA at the end of 2008. Today it would be ranked about 25th. Clearly a job well done.
The FFB is a child of the 70’s. It appears to have been a doghouse lender for years. The following looks at the FFB loan book. The numbers involved are peanuts compared to the big numbers that are being tossed around D.C. However there is a window into the thinking of Treasury in their lending activity.
The FFB business model is simple. They borrow money from Treasury and lend it to government Agencies. They take a small spread on the loans to cover administrative costs. Because all these loans are to ‘family’ members there is supposed to be no credit risk. On this issue FFB says:
The Bank has not incurred and does not expect to incur any credit-related losses on its loans.
Well, that sounds good. It is not clear to me that this is the case. The following is a description/discussion of the loan book at the end of July. You tell me if all this is money good.
-The $18+ billion outstanding to the National Credit Union Association jumps out. NCUA is the FDIC for America’s Credit Unions. They provide the insurance guarantee (up to $250,000) on the deposits of these entities. There are a total of 9,369 CUs. They have assets in excess of $600 billion. So this is a big deal.
The CUs bought big into “investment” grade MBS and got killed. Several of the big CUs have folded this year. An interesting discussion on this mess comes from a 5/15/09 statement to Congress, “The Credit Union Share Insurance Stabilization Act’.
This from the report:
"Both external and internal analyses have consistently shown that the projected MBS credit losses in the corporate system are real, highly likely, and relatively large."
That does not sound so good. The NCUA is a bailout to be. To assume that there is no potential for losses here is wrong.
Note: This may be a blueprint for a fix of the FDIC. Sheila Bair has said the problem with her Agency is “liquidity” not “solvency”. She could make use of the cheap money from FFB, as does NCUA. Note that there is already a line open on the report for the FDIC. Call this a blank check.
-I am reasonably sure that the Post Office will make good on its $6.5 billion of loans outstanding. The PO is an Agency of the US Government, but Uncle Sam does not guarantee their debts. This would appear to be outside of the scope of FFB. I assume there is a ‘carve out’ to allow this advance.
The folks at the PO must drive a hard bargain. Look at the rates that were set in July. Sweet deal!
-The FFB has a total of $20 billion outstanding to rural utilities. I am not sure that all of these borrowers are money good. The following is a description of the July 09 activity. Note that loans are being made for 32 years in a number of cases. The lending rates are at a fraction above Treasury’s cost to issue debt for similar maturities. This looks like cheap Preferred Stock pricing, not debt. This is a subsidy.
-The $492mm of HOPE bonds that the FFB purchased are being held at cost. That might be because very little of this money has been spent. The WSJ wrote on this recently. The HOPE money from Treasury was supposed to be used to help troubled borrowers restructure underwater mortgages. This is the grist for debt relief. When it is spent (it will be) it will be lost. The FFB is fooling itself and us by keeping this ‘investment’ on the books at par. Check out the reset rates. 18BP for three-month money. Thank Bernanke for that.
-The $2 billion to the GSA, the $600mm for Financing for Foreign Military Sales and the $600 mm of HUD notes are just a mystery. This is off balance sheet financing. That makes the FFB a SPIV for the government.
-The FFB will not lose money on its loan book, but future taxpayers will be obligated to fund the Agencies who are the borrowers so those loans can be repaid. Cheap money with no payback plan just creates bad borrowers. We have seen that. At a minimum, the FFB should revise its loan terms. Borrowers should be obligated to repay in a reasonable period of time. There should be a source of repayment defined in advance. The interest rates on these loans should be at market rates. The intent of this would be to make it more difficult for Government Agencys to finance themselves outside of budgets they are allotted. Exactly the opposite of the way it is has always been done.
The FFB is a child of the 70’s. It appears to have been a doghouse lender for years. The following looks at the FFB loan book. The numbers involved are peanuts compared to the big numbers that are being tossed around D.C. However there is a window into the thinking of Treasury in their lending activity.
The FFB business model is simple. They borrow money from Treasury and lend it to government Agencies. They take a small spread on the loans to cover administrative costs. Because all these loans are to ‘family’ members there is supposed to be no credit risk. On this issue FFB says:
The Bank has not incurred and does not expect to incur any credit-related losses on its loans.
Well, that sounds good. It is not clear to me that this is the case. The following is a description/discussion of the loan book at the end of July. You tell me if all this is money good.
-The $18+ billion outstanding to the National Credit Union Association jumps out. NCUA is the FDIC for America’s Credit Unions. They provide the insurance guarantee (up to $250,000) on the deposits of these entities. There are a total of 9,369 CUs. They have assets in excess of $600 billion. So this is a big deal.
The CUs bought big into “investment” grade MBS and got killed. Several of the big CUs have folded this year. An interesting discussion on this mess comes from a 5/15/09 statement to Congress, “The Credit Union Share Insurance Stabilization Act’.
This from the report:
"Both external and internal analyses have consistently shown that the projected MBS credit losses in the corporate system are real, highly likely, and relatively large."
That does not sound so good. The NCUA is a bailout to be. To assume that there is no potential for losses here is wrong.
Note: This may be a blueprint for a fix of the FDIC. Sheila Bair has said the problem with her Agency is “liquidity” not “solvency”. She could make use of the cheap money from FFB, as does NCUA. Note that there is already a line open on the report for the FDIC. Call this a blank check.
-I am reasonably sure that the Post Office will make good on its $6.5 billion of loans outstanding. The PO is an Agency of the US Government, but Uncle Sam does not guarantee their debts. This would appear to be outside of the scope of FFB. I assume there is a ‘carve out’ to allow this advance.
The folks at the PO must drive a hard bargain. Look at the rates that were set in July. Sweet deal!
-The FFB has a total of $20 billion outstanding to rural utilities. I am not sure that all of these borrowers are money good. The following is a description of the July 09 activity. Note that loans are being made for 32 years in a number of cases. The lending rates are at a fraction above Treasury’s cost to issue debt for similar maturities. This looks like cheap Preferred Stock pricing, not debt. This is a subsidy.
-The $492mm of HOPE bonds that the FFB purchased are being held at cost. That might be because very little of this money has been spent. The WSJ wrote on this recently. The HOPE money from Treasury was supposed to be used to help troubled borrowers restructure underwater mortgages. This is the grist for debt relief. When it is spent (it will be) it will be lost. The FFB is fooling itself and us by keeping this ‘investment’ on the books at par. Check out the reset rates. 18BP for three-month money. Thank Bernanke for that.
-The $2 billion to the GSA, the $600mm for Financing for Foreign Military Sales and the $600 mm of HUD notes are just a mystery. This is off balance sheet financing. That makes the FFB a SPIV for the government.
-The FFB will not lose money on its loan book, but future taxpayers will be obligated to fund the Agencies who are the borrowers so those loans can be repaid. Cheap money with no payback plan just creates bad borrowers. We have seen that. At a minimum, the FFB should revise its loan terms. Borrowers should be obligated to repay in a reasonable period of time. There should be a source of repayment defined in advance. The interest rates on these loans should be at market rates. The intent of this would be to make it more difficult for Government Agencys to finance themselves outside of budgets they are allotted. Exactly the opposite of the way it is has always been done.
Saturday, September 26, 2009
Fed's Warsh on QE- Form Over Substance
Fed Governor Kevin Warsh made a splash on Friday with an Op-Ed piece in the WSJ. The essence of this was that the Fed would have to move to eliminate the massive monetary stimulus quickly and aggressively at some point in the future when, “The timing is right”.
This sounded good to me at first. I hate the QE process. I think it will ruin us. Mr. Warsh’s comments were addressed to people like me. My thoughts after re-reading his words:
-Mr. Warsh is a ‘close confident’ of Mr. Bernanke according to the WSJ. Anyone who thinks that Mr. Bernanke did not have something to do with the Op-Ed piece and the follow on speech by Warsh is just wrong. While Warsh wrote this column, I will bet that Bernanke reviewed it before it was delivered to the WSJ. Fed Governors do not speak publicly unless there is a specific reason. Everything they do is orchestrated. Including articles in the WSJ.
-The timing of this writing is very suspect. It follows by just days the Fed’s announcement that they will keep rates at zero for, “the foreseeable future”. My guess is that after the last announcement Bernanke got phone calls from foreign central banks that said, “I am holding your paper and I do not like your actions. What you are doing is devaluing my holdings. Change your ways or I will change my holdings!”
-Why would any central bank willingly hold the vast quantities of Treasury IOUs when the return adjusted for inflation is negative? They have to account to their citizens as well. From China and now Japan and from many other traditional holders of our debt are coming words and actions that they have had enough. While they are not selling Treasury paper yet, there is little evidence that they are increasing their holdings net of Agency debt.
-Foreigners have expressed their concerns, but more significantly the American people are increasingly looking at the Fed's policies with disdain. People are aware that for the first time in our history the US is monetizing the debt. Large deficits have always been an issue. But we are in a new and dangerous place with the deficits in 2009. In prior years, holders of dollars purchased all of the debt. This time it is different. Now we are just printing the money. Depending on what is included in the calculation of QE that printing has/will reach a minimum of $1.75 trillion. Mr. Bernanke has to be aware at this point that many citizens are actively comparing our economic policies to that of post WWI Germany, Argentina and even comically Zimbabwe. There is nothing comical about this. We are doing what those countries did.
-Mr. Warsh suggests that at sometime in the future the Fed will react and remove the stimulus. These are empty words while the Fed buys $25 billion of Federal IOU’s each week. There is no substance behind Mr. Warsh’s comments when interest rates are negative 2% versus inflation. The Fed's credibility is not reestablished by an Op-Ed piece. It will be re-established by action.
-It is possible that the delay in reversing the QE program will have a negative effect in the short term. At this point everyone is thinking, “It is going to end soon and when it does there will be another big leg down in the economy, I am not going to plan an expansion based on that”.
-Do not assume that Mr. Bernanke is unaware that the dollar is at a low for the past year. He knows that this movement in capital is a function of the increased distrust in his policies outside of the USA. Mr. Bernake’s only job is to, “maintain price stability”. There is no confidence he will deliver on this promise.
-The words by Warsh coupled with the Fed’s unanimous vote to extend zero interest rates this week leads me to believe that the Fed will continue the QE process until the 1st quarter of 2010. Mr. Bernanke has said recently that the recession is over. The emergency monetary and fiscal steps that have been undertaken over the past year and a half have worked. The economy is now benefiting from a significant inventory correction. The real economy has some legs. They may be wobbly legs, but they are real. The inventory correction will be completed by the first quarter 2010, precisely the time that the Fed will be withdrawing its stimulus. The downturn in the 2nd quarter of 2010 will be significant as a result of these combined factors. It would be far wiser to reverse the monetary stimulus while the economy has legs of its own. Failure to do so will leave the Fed with no policy options nine months from now.
-In the Journal piece Mr. Warsh stated:
“If policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal–and the economy has returned to self-sustaining trend growth–they will almost certainly have waited too long.”
Mr. Warsh and Mr. Bernanke already know they have extended the emergency steps too far. They know that there is very little chance that the US will return to trend line growth of 3% on a sustained basis. Too much damage has been done to expect that to happen. It is more likely that we will have just a quarter or two of real economic expansion before the next slowdown.
This Op-Ed would not have appeared if that were not the case. The Fed is in a policy dilemma at this point. They know what they are doing is wrong, but they are afraid of the consequences of, “Doing the right thing”. So they are doing nothing. They write letters to leading newspapers saying they are aware of the problem, and will act in a timely manner. But they know that the longer the emergency steps are extended the harder the fall will be when they remove them.
This sounded good to me at first. I hate the QE process. I think it will ruin us. Mr. Warsh’s comments were addressed to people like me. My thoughts after re-reading his words:
-Mr. Warsh is a ‘close confident’ of Mr. Bernanke according to the WSJ. Anyone who thinks that Mr. Bernanke did not have something to do with the Op-Ed piece and the follow on speech by Warsh is just wrong. While Warsh wrote this column, I will bet that Bernanke reviewed it before it was delivered to the WSJ. Fed Governors do not speak publicly unless there is a specific reason. Everything they do is orchestrated. Including articles in the WSJ.
-The timing of this writing is very suspect. It follows by just days the Fed’s announcement that they will keep rates at zero for, “the foreseeable future”. My guess is that after the last announcement Bernanke got phone calls from foreign central banks that said, “I am holding your paper and I do not like your actions. What you are doing is devaluing my holdings. Change your ways or I will change my holdings!”
-Why would any central bank willingly hold the vast quantities of Treasury IOUs when the return adjusted for inflation is negative? They have to account to their citizens as well. From China and now Japan and from many other traditional holders of our debt are coming words and actions that they have had enough. While they are not selling Treasury paper yet, there is little evidence that they are increasing their holdings net of Agency debt.
-Foreigners have expressed their concerns, but more significantly the American people are increasingly looking at the Fed's policies with disdain. People are aware that for the first time in our history the US is monetizing the debt. Large deficits have always been an issue. But we are in a new and dangerous place with the deficits in 2009. In prior years, holders of dollars purchased all of the debt. This time it is different. Now we are just printing the money. Depending on what is included in the calculation of QE that printing has/will reach a minimum of $1.75 trillion. Mr. Bernanke has to be aware at this point that many citizens are actively comparing our economic policies to that of post WWI Germany, Argentina and even comically Zimbabwe. There is nothing comical about this. We are doing what those countries did.
-Mr. Warsh suggests that at sometime in the future the Fed will react and remove the stimulus. These are empty words while the Fed buys $25 billion of Federal IOU’s each week. There is no substance behind Mr. Warsh’s comments when interest rates are negative 2% versus inflation. The Fed's credibility is not reestablished by an Op-Ed piece. It will be re-established by action.
-It is possible that the delay in reversing the QE program will have a negative effect in the short term. At this point everyone is thinking, “It is going to end soon and when it does there will be another big leg down in the economy, I am not going to plan an expansion based on that”.
-Do not assume that Mr. Bernanke is unaware that the dollar is at a low for the past year. He knows that this movement in capital is a function of the increased distrust in his policies outside of the USA. Mr. Bernake’s only job is to, “maintain price stability”. There is no confidence he will deliver on this promise.
-The words by Warsh coupled with the Fed’s unanimous vote to extend zero interest rates this week leads me to believe that the Fed will continue the QE process until the 1st quarter of 2010. Mr. Bernanke has said recently that the recession is over. The emergency monetary and fiscal steps that have been undertaken over the past year and a half have worked. The economy is now benefiting from a significant inventory correction. The real economy has some legs. They may be wobbly legs, but they are real. The inventory correction will be completed by the first quarter 2010, precisely the time that the Fed will be withdrawing its stimulus. The downturn in the 2nd quarter of 2010 will be significant as a result of these combined factors. It would be far wiser to reverse the monetary stimulus while the economy has legs of its own. Failure to do so will leave the Fed with no policy options nine months from now.
-In the Journal piece Mr. Warsh stated:
“If policymakers insist on waiting until the level of real activity has plainly and substantially returned to normal–and the economy has returned to self-sustaining trend growth–they will almost certainly have waited too long.”
Mr. Warsh and Mr. Bernanke already know they have extended the emergency steps too far. They know that there is very little chance that the US will return to trend line growth of 3% on a sustained basis. Too much damage has been done to expect that to happen. It is more likely that we will have just a quarter or two of real economic expansion before the next slowdown.
This Op-Ed would not have appeared if that were not the case. The Fed is in a policy dilemma at this point. They know what they are doing is wrong, but they are afraid of the consequences of, “Doing the right thing”. So they are doing nothing. They write letters to leading newspapers saying they are aware of the problem, and will act in a timely manner. But they know that the longer the emergency steps are extended the harder the fall will be when they remove them.
Thursday, September 24, 2009
Freddie Pays Big For New CFO
Mr. Ross Kari has been appointed as CFO of Freddie Mac. He is getting a big paycheck.
Freddie Mac does not need a CFO. What is Mr. Kari going to do with his time? Freddie is in conservatorship. It is a ward of the state. He is not going to be doing any special transactions that justify this big nut for the taxpayers. Freddie borrows short term from Treasury to fund their portfolio; they sell their MBS and unsecured bonds to the Fed. What’s so complicated about that?
The whisper from D.C. is that something will be on the table for all of the Agencies by next March. Mr. Kari is likely to be out of a job by then. For his sake I hope he has a big parachute. On the flip side, if he does, there will be hell to pay.
Freddie is no longer a public company that has a big stock float or a presence on Wall Street. It has no earnings, only losses. It should be de-listed. This is not a Citi where there is a remote hope of a soft landing. Freddie is toast. There will be no stockholders meetings where Mr. Kari will be called on to report the success and progress at Freddie. It is unlikely that Freddie can even pay the dividend it owes to Treasury. They are losing $2+ billion a month. That number would be higher, but they are burying their losses by providing ReFi loans at 125% LTV. Half of these new loans go into default in less than one-year.
Freddie hired Mr. Kari to bring someone solid on board. That cost them. Freddie has plenty of talented people who can operate this ship for the next six months. This thing is on autopilot. The only reason Freddie did this (with the blessing of FHFA) is that they wanted to try to demonstrate that they had the right “team” to be the survivor Agency. This hire was about optics, not substance.
Mr. Kari is ex CFO of Fifth Third Bank. That makes him a player, but let's not forget that Fifth Third took $3.4 billion in TARP money. This is what he had to say about repaying that loan back in July:
Fifth Third Bancorp's Chief Financial Officer Ross Kari said the Cincinnati bank would wait until the economy improves until it would repay cash from the government.
Freddie needs to be absorbed by HUD. I think they will be. There is not much room for this pay grade at HUD. The President makes $400k, Senators $174k, Bernanke and Geither get $191k.
Who is making these choices? Who is approving them? Is anyone watching the store?
Freddie Mac does not need a CFO. What is Mr. Kari going to do with his time? Freddie is in conservatorship. It is a ward of the state. He is not going to be doing any special transactions that justify this big nut for the taxpayers. Freddie borrows short term from Treasury to fund their portfolio; they sell their MBS and unsecured bonds to the Fed. What’s so complicated about that?
The whisper from D.C. is that something will be on the table for all of the Agencies by next March. Mr. Kari is likely to be out of a job by then. For his sake I hope he has a big parachute. On the flip side, if he does, there will be hell to pay.
Freddie is no longer a public company that has a big stock float or a presence on Wall Street. It has no earnings, only losses. It should be de-listed. This is not a Citi where there is a remote hope of a soft landing. Freddie is toast. There will be no stockholders meetings where Mr. Kari will be called on to report the success and progress at Freddie. It is unlikely that Freddie can even pay the dividend it owes to Treasury. They are losing $2+ billion a month. That number would be higher, but they are burying their losses by providing ReFi loans at 125% LTV. Half of these new loans go into default in less than one-year.
Freddie hired Mr. Kari to bring someone solid on board. That cost them. Freddie has plenty of talented people who can operate this ship for the next six months. This thing is on autopilot. The only reason Freddie did this (with the blessing of FHFA) is that they wanted to try to demonstrate that they had the right “team” to be the survivor Agency. This hire was about optics, not substance.
Mr. Kari is ex CFO of Fifth Third Bank. That makes him a player, but let's not forget that Fifth Third took $3.4 billion in TARP money. This is what he had to say about repaying that loan back in July:
Fifth Third Bancorp's Chief Financial Officer Ross Kari said the Cincinnati bank would wait until the economy improves until it would repay cash from the government.
Freddie needs to be absorbed by HUD. I think they will be. There is not much room for this pay grade at HUD. The President makes $400k, Senators $174k, Bernanke and Geither get $191k.
Who is making these choices? Who is approving them? Is anyone watching the store?
Monday, September 21, 2009
Deficits and Funding Gap - Two Different Things
The imponderable that most troubles me today is the amount of debt that the Federal Government is signing up for. In an effort to keep the US economy from plunging the Keynesian response was to ramp up the deficit and spend Federal dollars. It is clearly working. It looks likely that the next six months will show positive GDP growth. It is possible that one or more of these quarters could be above the 3% trend line we need to put a dent in unemployment. The question is can this recovery be sustained?
To a significant extent, the sustainability of the recovery will be dependant on the Fed’s ability to keep interest rates at historically low levels. That will be a very tall order. The Fed is facing the strongest laws of economics: supply and demand. At some point that basic law will exert itself. The only question is when.
There can be little confidence in the forecasts of future deficits. A few short years ago the prevailing estimates for deficits was in the $400b range. Then 08 happened and an extra $1 trillion of borrowing was required to plug the hole. The current estimates for the deficit is $1 trillion for each of the next nine years. Assume for the sake of discussion that were to prove correct.
Total debt outstanding is $12t. Of this, $2.5t is held by the Social Security Trust fund, the public holds the balance of $9.5t. The Trust Fund will not be significantly increasing its holdings of Treasury IOUs over the next five-years, they will be net sellers by 2014. This means that 100% of the new money requirement will have to be sold to public investors.
The following chart looks at Treasury debt issuance for the nine months from October 08 through June of 09. During that period Treasury raised New Money totaling $1.4t. But in order to do that they had to issue a total of $6.7t in new securities. The difference of $5.3t was rolling over of securities that matured during the period. The majority of this refinancing activity was maturing Treasury bills with short-term maturities. However a significant (and growing) amount is longer term securities.
Some time ago Treasury produced estimates of the average life of the country’s debt. The following shows that they are projecting an average life of public debt of 55 months for the next few years. It is unlikely that they will achieve these goals, but lets give them the benefit of doubt and call the average life of 60 months, or five years.
The five-year average life implies that one half of the debt will mature during that period. Straight arithmetic suggests that $6 trillion will need to be refinanced over the next five years. Round that down and call it $1 trillion per year. On average, the old money roll over and the new money requirement total an average of $2 trillion per year, for the foreseeable future.
Quantitative easing is not a solution to this problem. The Fed will monetize at least $1.75 trillion before it is done with its POMO purchases. There can be no doubt that the Fed purchases allowed Treasury to sell the vast amount of paper that it did. Without the Fed’s constant intervention we would have already had a failed auction.
The inflation adjusted return on Treasury paper with a maturity less than two-years is currently -1%. For ten-year maturities the return is at best 1.5% pretax. For foreign holders who also face a risk of a decline in the dollar, the returns are negative for the entire thirty-year investment horizon.
If the Fed responds to this by extending and expanding its QE purchases of existing public sector debt (either Treasuries or Agency MBS) the dollar will fall like a stone. No one in the global financial community likes this program any longer. If it is allowed to continue there will be a very swift market reaction. There is a lot of dumb money around, but there is not $2 trillion of dumb money to support this.
Bernanke has said that he will end the QE policy. He has also said that he will maintain the current zero interest rate monetary policy for, “the foreseeable future”. If you believe what he is saying then you have to assume that failed Treasury auctions will be in our future. When a ten-year bid to cover ratio falls to 1.05 the Black Swan will swim up the Hudson and attack Wall Street once again.
The most likely outcome is that Bernanke will try to finesse this problem. He will maintain zero interest rates until the market forces him to react. At that point a rapid increase in the Fed Funds rate will be required. This has happened before. Greenspan did the same thing before he left the helm at the Fed. He engineered 17 increases in the Funds rate over a 24-month period. The following chart shows that ramp up. Those increases ended the cheap money from ARMs. That led to a correction in housing demand. A small portion of the mortgage market, Sub Prime, took a predictable hit. But then the unpredictable happened and we had the economic collapse of 2008. It probably would have happened at some time in the future, the excesses were there. However, the 08 mess was directly correlated to these rapid rate increases:
Mr. Bernanke is a scholar of the Depression. That knowledge has served us well the past eighteen-months. It is time for Mr. Bernanke to look at a different historical period. He needs to review how successfully the Fed withdrew monetary stimulus in 2006. If he fails to focus on this period of history it is likely that the results will be the same. The soft landing of sustained low interest rates and multi-trillion dollar funding requirements would appear to be the least probable outcome of them all.
Look for talk along these lines in Pittsburgh this week.
To a significant extent, the sustainability of the recovery will be dependant on the Fed’s ability to keep interest rates at historically low levels. That will be a very tall order. The Fed is facing the strongest laws of economics: supply and demand. At some point that basic law will exert itself. The only question is when.
There can be little confidence in the forecasts of future deficits. A few short years ago the prevailing estimates for deficits was in the $400b range. Then 08 happened and an extra $1 trillion of borrowing was required to plug the hole. The current estimates for the deficit is $1 trillion for each of the next nine years. Assume for the sake of discussion that were to prove correct.
Total debt outstanding is $12t. Of this, $2.5t is held by the Social Security Trust fund, the public holds the balance of $9.5t. The Trust Fund will not be significantly increasing its holdings of Treasury IOUs over the next five-years, they will be net sellers by 2014. This means that 100% of the new money requirement will have to be sold to public investors.
The following chart looks at Treasury debt issuance for the nine months from October 08 through June of 09. During that period Treasury raised New Money totaling $1.4t. But in order to do that they had to issue a total of $6.7t in new securities. The difference of $5.3t was rolling over of securities that matured during the period. The majority of this refinancing activity was maturing Treasury bills with short-term maturities. However a significant (and growing) amount is longer term securities.
Some time ago Treasury produced estimates of the average life of the country’s debt. The following shows that they are projecting an average life of public debt of 55 months for the next few years. It is unlikely that they will achieve these goals, but lets give them the benefit of doubt and call the average life of 60 months, or five years.
The five-year average life implies that one half of the debt will mature during that period. Straight arithmetic suggests that $6 trillion will need to be refinanced over the next five years. Round that down and call it $1 trillion per year. On average, the old money roll over and the new money requirement total an average of $2 trillion per year, for the foreseeable future.
Quantitative easing is not a solution to this problem. The Fed will monetize at least $1.75 trillion before it is done with its POMO purchases. There can be no doubt that the Fed purchases allowed Treasury to sell the vast amount of paper that it did. Without the Fed’s constant intervention we would have already had a failed auction.
The inflation adjusted return on Treasury paper with a maturity less than two-years is currently -1%. For ten-year maturities the return is at best 1.5% pretax. For foreign holders who also face a risk of a decline in the dollar, the returns are negative for the entire thirty-year investment horizon.
If the Fed responds to this by extending and expanding its QE purchases of existing public sector debt (either Treasuries or Agency MBS) the dollar will fall like a stone. No one in the global financial community likes this program any longer. If it is allowed to continue there will be a very swift market reaction. There is a lot of dumb money around, but there is not $2 trillion of dumb money to support this.
Bernanke has said that he will end the QE policy. He has also said that he will maintain the current zero interest rate monetary policy for, “the foreseeable future”. If you believe what he is saying then you have to assume that failed Treasury auctions will be in our future. When a ten-year bid to cover ratio falls to 1.05 the Black Swan will swim up the Hudson and attack Wall Street once again.
The most likely outcome is that Bernanke will try to finesse this problem. He will maintain zero interest rates until the market forces him to react. At that point a rapid increase in the Fed Funds rate will be required. This has happened before. Greenspan did the same thing before he left the helm at the Fed. He engineered 17 increases in the Funds rate over a 24-month period. The following chart shows that ramp up. Those increases ended the cheap money from ARMs. That led to a correction in housing demand. A small portion of the mortgage market, Sub Prime, took a predictable hit. But then the unpredictable happened and we had the economic collapse of 2008. It probably would have happened at some time in the future, the excesses were there. However, the 08 mess was directly correlated to these rapid rate increases:
Mr. Bernanke is a scholar of the Depression. That knowledge has served us well the past eighteen-months. It is time for Mr. Bernanke to look at a different historical period. He needs to review how successfully the Fed withdrew monetary stimulus in 2006. If he fails to focus on this period of history it is likely that the results will be the same. The soft landing of sustained low interest rates and multi-trillion dollar funding requirements would appear to be the least probable outcome of them all.
Look for talk along these lines in Pittsburgh this week.
Saturday, September 19, 2009
FHA - The Other Troubled D.C. Lender
FHA Director David Stevens came out last week with a statement that their 2% minimum capital rule will be broached this fall. Mr. Stevens swore that this was not going to be a problem and no federal bailout was going to be required. He came forward with a list of things to address the problem. As near as I could tell none of these changes will have a significant impact on the results. The proposed measures will not be implemented until after 1/1/2010. By then it will be too late. In my view FHA will most likely require a federal support package sometime in the 1st quarter of 2010.
FHA is on a tear to provide new mortgages. One needs only to watch cable TV and see their endless ads to confirm that. FHA makes high LTV loans. They lend as much as 96.5% of a purchase price. This coupled with the first time buyer credit of $8,000 makes them a provider of 100% financing. The history of this type of lending shows very high default rates in the first eighteen months of a loan. Between now and January their capital cushion will be eroded and we will have another Fannie and Freddie story to deal with.
FHA is not a public company, it is owned by Congress. They do not publish the wealth of information that F/F does. It is therefore difficult to determine just how sick they are. Rummaging through their web site I did come across something that I thought was interesting. FHA sets ceilings on its credit extensions based on geography. This make sense as RE values vary across the country.
There are some predictable results and a few surprises. The major East/West Coast cities have the highest limits:
But if you live in one of the Nation’s other Cities you are not so lucky:
And if one lives in some not so expense (but still very nice) parts of the country you have been red lined by the Feds:
One has to wonder if RE prices drove these limits or if these limits drove RE prices. An example: The FHA has set very high loan limits for a number of major ski resorts. It is certain that the availability of cheap FHA loans with 96.5% LTV has been a boon to the development of these areas. I have to wonder as to the social implications of this. These are Federal dollars being spent in support of a rich man’s sport in rich man’s Counties.
Other FHA factoids:
-The highest advance rate for FHA is in Maui, Hawaii. There you can borrow up to $790,000. While I understand that RE is pricey in this beautiful spot I am not convinced that Uncle Sam should be supporting those high prices.
-In San Juan, Vermont the limit is $271,050, In San Juan, Puerto Rico the limit is more than double that; $606,500.
-In Saipan you can get an FHA mortgage for up to $613,000. In Guam the limit is $651,000. In St. John, Virgin Islands you can get a 96.5% mortgage for up to $623,000.
-In three important counties in S. Florida the limits are as follows:
Miami-Dade – $423,750
Palm Beach- $423,750
Collier- $531,250
By way of comparison the following twenty-seven counties in Puerto Rico have FHA limits of $606,250. Go figure that one out.
Guaynabo, Gurabo, Hatillo, Humacao, Juncos, Florida, Tao Alta, Tao Baja, Trujillo Alo, Vega Baja, Vega Ala, Yabucoa, Yauco, Loiza, Maniti, Maunabo, Morivis, Naguabo, Naranjito, Orocovis, Quebradillas, Rio Grand, San Juan and San Lorenzo.
-Ann Arbor Michigan is a nice place. The FHA limit there is $345,000. It would be an interesting experiment to increase this limit to $700,000 and monitor what happens over a ten-year period. My guess is that as a direct consequence Ann Arbor would grow, its citizens would prosper, the local economy would improve, tax receipts for the community would increase and population would expand. It worked pretty well at the Ski resorts in Colorado; it probably would be as effective in Ann Arbor. I don’t think you need a mountain to get a high limit, but a few friends back at the FHA wouldn’t hurt.
FHA is on a tear to provide new mortgages. One needs only to watch cable TV and see their endless ads to confirm that. FHA makes high LTV loans. They lend as much as 96.5% of a purchase price. This coupled with the first time buyer credit of $8,000 makes them a provider of 100% financing. The history of this type of lending shows very high default rates in the first eighteen months of a loan. Between now and January their capital cushion will be eroded and we will have another Fannie and Freddie story to deal with.
FHA is not a public company, it is owned by Congress. They do not publish the wealth of information that F/F does. It is therefore difficult to determine just how sick they are. Rummaging through their web site I did come across something that I thought was interesting. FHA sets ceilings on its credit extensions based on geography. This make sense as RE values vary across the country.
There are some predictable results and a few surprises. The major East/West Coast cities have the highest limits:
But if you live in one of the Nation’s other Cities you are not so lucky:
And if one lives in some not so expense (but still very nice) parts of the country you have been red lined by the Feds:
One has to wonder if RE prices drove these limits or if these limits drove RE prices. An example: The FHA has set very high loan limits for a number of major ski resorts. It is certain that the availability of cheap FHA loans with 96.5% LTV has been a boon to the development of these areas. I have to wonder as to the social implications of this. These are Federal dollars being spent in support of a rich man’s sport in rich man’s Counties.
Other FHA factoids:
-The highest advance rate for FHA is in Maui, Hawaii. There you can borrow up to $790,000. While I understand that RE is pricey in this beautiful spot I am not convinced that Uncle Sam should be supporting those high prices.
-In San Juan, Vermont the limit is $271,050, In San Juan, Puerto Rico the limit is more than double that; $606,500.
-In Saipan you can get an FHA mortgage for up to $613,000. In Guam the limit is $651,000. In St. John, Virgin Islands you can get a 96.5% mortgage for up to $623,000.
-In three important counties in S. Florida the limits are as follows:
Miami-Dade – $423,750
Palm Beach- $423,750
Collier- $531,250
By way of comparison the following twenty-seven counties in Puerto Rico have FHA limits of $606,250. Go figure that one out.
Guaynabo, Gurabo, Hatillo, Humacao, Juncos, Florida, Tao Alta, Tao Baja, Trujillo Alo, Vega Baja, Vega Ala, Yabucoa, Yauco, Loiza, Maniti, Maunabo, Morivis, Naguabo, Naranjito, Orocovis, Quebradillas, Rio Grand, San Juan and San Lorenzo.
-Ann Arbor Michigan is a nice place. The FHA limit there is $345,000. It would be an interesting experiment to increase this limit to $700,000 and monitor what happens over a ten-year period. My guess is that as a direct consequence Ann Arbor would grow, its citizens would prosper, the local economy would improve, tax receipts for the community would increase and population would expand. It worked pretty well at the Ski resorts in Colorado; it probably would be as effective in Ann Arbor. I don’t think you need a mountain to get a high limit, but a few friends back at the FHA wouldn’t hurt.
Thursday, September 17, 2009
Fed Clarifies QE Policy - Sort Of
I was involved with a blog debate a month ago. The broad topic was the Fed’s quantitative easing policy (QE). More specifically there was a question of what types of Fed actions should be included in the QE definition. At the time I made some assertions and a number of folks took issue with me. I was left wondering who was right. So I wrote to the Fed. My note to them and their response:
From:BK
Can you please help resolve a misunderstanding?
On 8/12/09 the Fed put out the following report.
This report described the POMO purchases that have/will be made. It included $1.25 t of Agency MBS, $300b of Treasury obligations and $200b of Agency Bonds.
Should all of this be included in the definition of Quantitative Easing? I have put forward an argument that the $200b of Agency debt should be excluded from the total of QE purchases.
Can you clarify this for me please?
Thank you,
Bruce Krasting
From Fed:
Thank you for your inquiry.
Regarding your question if the New York Fed's operations create reserves, the Federal Reserve is the owners/definers of "reserves". That said, the Federal Reserve has developed several programs in response to current economic conditions. Information on these programs is available on our website at this link.
Information is also available from the Board of Governors website at:
From this information you may choose which programs embody your own definition of quantitative easing. I hope this information is useful to you.
Regards,
Kimberly Hooks
Media Relations and Public Affairs
Federal Reserve Bank of New York
While I am thankful to Ms. Hooks for her response I must confess that I am still confused. I did look through the information in the links provided and they do contain some clarifying information. But I felt it also opened the door for even more questions about the QE policy.
I was struck by the response: ”you may choose which programs embody your own definitions of quantitative easing”. I get to choose? I have no vote in this matter. Maybe 20-30 people in the whole country have a voice in this that counts. My view on what is and isn’t QE is irrelevant. I just wanted the facts. A Yes or No was what I was hoping for.
The following chart can also be found here. It is from this list of Fed activities I am to choose from. Possibly Ms. Hooks provides a clue in this with her words, “If the New York Fed's operations create reserves, the Federal Reserve is the owners/definers of "reserves". I take this to mean that if the action creates Reserves then it should be considered as part of the QE program. When she says: “the Federal Reserve has developed several programs in response to current economic conditions”, I assume that to be a ‘hint’ that the programs that have been created in direct response to the current economic crisis should be the ones included in the definition of QE. Of course this could be completely wrong. I am still left guessing on this. This is as clear as mud. In my simplistic view the Reserves are borrowed, not owned and I am not sure what a “definer” is. The chart:
The first category on this list, OMO (Open Market Operations), does create reserves and it does include agencies. I think this answers the question of a month ago. The Fed's purchases of direct agency debt securities (different from Agency MBS) should be included in the definition of QE.
But if you define QE as an action that creates Reserves and it is new, then there are nine additional categories that can be included as part of the QE effort. My conclusion on this is that if the market believes that the Fed is limited to purchases of Treasury coupons, agency direct debt obligations or Agency MBS to achieve their QE policy objectives they are wrong. There are no bounds on this policy.
By any definition the QE policy launched by the Fed to address the economic crisis is the largest single financial choice that has ever been made. It is having a dramatic effect on our economy today. Its impact both positive and negative will be felt for the next decade. And I can’t get a straight answer on how to define it or how big it is.
From:BK
Can you please help resolve a misunderstanding?
On 8/12/09 the Fed put out the following report.
This report described the POMO purchases that have/will be made. It included $1.25 t of Agency MBS, $300b of Treasury obligations and $200b of Agency Bonds.
Should all of this be included in the definition of Quantitative Easing? I have put forward an argument that the $200b of Agency debt should be excluded from the total of QE purchases.
Can you clarify this for me please?
Thank you,
Bruce Krasting
From Fed:
Thank you for your inquiry.
Regarding your question if the New York Fed's operations create reserves, the Federal Reserve is the owners/definers of "reserves". That said, the Federal Reserve has developed several programs in response to current economic conditions. Information on these programs is available on our website at this link.
Information is also available from the Board of Governors website at:
From this information you may choose which programs embody your own definition of quantitative easing. I hope this information is useful to you.
Regards,
Kimberly Hooks
Media Relations and Public Affairs
Federal Reserve Bank of New York
While I am thankful to Ms. Hooks for her response I must confess that I am still confused. I did look through the information in the links provided and they do contain some clarifying information. But I felt it also opened the door for even more questions about the QE policy.
I was struck by the response: ”you may choose which programs embody your own definitions of quantitative easing”. I get to choose? I have no vote in this matter. Maybe 20-30 people in the whole country have a voice in this that counts. My view on what is and isn’t QE is irrelevant. I just wanted the facts. A Yes or No was what I was hoping for.
The following chart can also be found here. It is from this list of Fed activities I am to choose from. Possibly Ms. Hooks provides a clue in this with her words, “If the New York Fed's operations create reserves, the Federal Reserve is the owners/definers of "reserves". I take this to mean that if the action creates Reserves then it should be considered as part of the QE program. When she says: “the Federal Reserve has developed several programs in response to current economic conditions”, I assume that to be a ‘hint’ that the programs that have been created in direct response to the current economic crisis should be the ones included in the definition of QE. Of course this could be completely wrong. I am still left guessing on this. This is as clear as mud. In my simplistic view the Reserves are borrowed, not owned and I am not sure what a “definer” is. The chart:
The first category on this list, OMO (Open Market Operations), does create reserves and it does include agencies. I think this answers the question of a month ago. The Fed's purchases of direct agency debt securities (different from Agency MBS) should be included in the definition of QE.
But if you define QE as an action that creates Reserves and it is new, then there are nine additional categories that can be included as part of the QE effort. My conclusion on this is that if the market believes that the Fed is limited to purchases of Treasury coupons, agency direct debt obligations or Agency MBS to achieve their QE policy objectives they are wrong. There are no bounds on this policy.
By any definition the QE policy launched by the Fed to address the economic crisis is the largest single financial choice that has ever been made. It is having a dramatic effect on our economy today. Its impact both positive and negative will be felt for the next decade. And I can’t get a straight answer on how to define it or how big it is.
Wednesday, September 16, 2009
Senator Isakson on RE: We Need More Gas!
Senator John Isakson (R. Ga.) knows how to sell real estate. For twenty years he built up Northside Realty outside of Atlanta. His company is one of the largest independent RE brokerages in the country. With that much experience he knows full well that when you provide 95% LTV loans and a tax rebate that allows the buyer to put up net-net zero money down on a home purchase you can move real estate again. The Senator is pushing hard to extend the existing first time home buyer program. He wants to dramatically expand the scope (and cost) of the program as well. From the Senator’s web page:
“Specifically, my legislation would increase the maximum amount of the credit from $8,000 to $15,000 and expand the current tax credit so that it applies to any buyer of any home, not just first-time buyers. My legislation also would eliminate the income caps of $75,000 for an individual and $150,000 for a couple under the current tax credit so that there is no income limit for eligibility. Finally, the legislation would extend the tax credit for one year from date of enactment and would still allow home buyers to claim the credit on their 2009 tax return for purchases made in 2010.”
This proposal would double the size of the program and it would change it from ‘first time buyer’ to ‘anyone goes’. Bloomberg interviewed the Senator. From the article:
Sept. 16 (Bloomberg) -- An extension of the $8,000 U.S. home buyer tax credit is gaining support in the Senate as bill sponsor John Isakson said he is rallying lawmakers to continue a program that helped boost home sales by more than 1 million.
I hope that this statement is a misquote. Possibly an error by Bloomberg. But if this is a correct statement, then it is very significant. Some implications:
-The existing Tax Credit for home buyers is a product of the American Recovery and Reinvestment Act of 2/17/2009. The cost of this incentive was estimated to be $3 billion. If the Senator were correct that the number of home sales attributable to the program is 1mm, then the cost would already be in excess of $8 billion. That would imply that this program is already 250% over budget and we still have until Halloween before it ends.
-Recent data puts annual sales of exiting homes at +/-5mm and new homes at +/-500k. The rebate program has been in place for six months; approximately 3mm homes were sold during that period. The conclusion by the Senator is that one-third of all homes sold are the result of the subsidy and the cheap money from FHA. No wonder the Senator wants to keep this ball rolling. Without it sales would tumble. Not so good for the family business.
-As a RE pro Senator Isakson know that when you mix high LTV loans with a no money down borrower you get big defaults. The Senator also knows that the default rate is what is killing us. Yet he proposes to pour more gas on the problem. He also knows that when these loans do default the ultimate cost will be born by the taxpayers.
-Assume a more realistic scenario: 20% of the 7mm homes to be sold in the year following implementation of the Senators proposal are a result of the program. That would be a conservative assumption. This would put the cost of Senator Isakson’s bill at $21 billion. That does not include the credit losses that would surely come from this. Call it $30 billion. Whose money is this that the Senator is spending?
The worst of the economic crisis is behind us. Bernanke says so. We need to stop the economic interference. The Senator’s proposal will certainly stimulate home sales while it is in place. All that does is create more debt, more defaults and more bubbles.
Senator Isakson reports that he has eleven grandchildren. I am sure that he is a loving and proud grandfather. He needs to think of the consequences of his proposed legislation. He is robbing his grandchildren (and everyone else under twenty-five in America today) of their future.
“Specifically, my legislation would increase the maximum amount of the credit from $8,000 to $15,000 and expand the current tax credit so that it applies to any buyer of any home, not just first-time buyers. My legislation also would eliminate the income caps of $75,000 for an individual and $150,000 for a couple under the current tax credit so that there is no income limit for eligibility. Finally, the legislation would extend the tax credit for one year from date of enactment and would still allow home buyers to claim the credit on their 2009 tax return for purchases made in 2010.”
This proposal would double the size of the program and it would change it from ‘first time buyer’ to ‘anyone goes’. Bloomberg interviewed the Senator. From the article:
Sept. 16 (Bloomberg) -- An extension of the $8,000 U.S. home buyer tax credit is gaining support in the Senate as bill sponsor John Isakson said he is rallying lawmakers to continue a program that helped boost home sales by more than 1 million.
I hope that this statement is a misquote. Possibly an error by Bloomberg. But if this is a correct statement, then it is very significant. Some implications:
-The existing Tax Credit for home buyers is a product of the American Recovery and Reinvestment Act of 2/17/2009. The cost of this incentive was estimated to be $3 billion. If the Senator were correct that the number of home sales attributable to the program is 1mm, then the cost would already be in excess of $8 billion. That would imply that this program is already 250% over budget and we still have until Halloween before it ends.
-Recent data puts annual sales of exiting homes at +/-5mm and new homes at +/-500k. The rebate program has been in place for six months; approximately 3mm homes were sold during that period. The conclusion by the Senator is that one-third of all homes sold are the result of the subsidy and the cheap money from FHA. No wonder the Senator wants to keep this ball rolling. Without it sales would tumble. Not so good for the family business.
-As a RE pro Senator Isakson know that when you mix high LTV loans with a no money down borrower you get big defaults. The Senator also knows that the default rate is what is killing us. Yet he proposes to pour more gas on the problem. He also knows that when these loans do default the ultimate cost will be born by the taxpayers.
-Assume a more realistic scenario: 20% of the 7mm homes to be sold in the year following implementation of the Senators proposal are a result of the program. That would be a conservative assumption. This would put the cost of Senator Isakson’s bill at $21 billion. That does not include the credit losses that would surely come from this. Call it $30 billion. Whose money is this that the Senator is spending?
The worst of the economic crisis is behind us. Bernanke says so. We need to stop the economic interference. The Senator’s proposal will certainly stimulate home sales while it is in place. All that does is create more debt, more defaults and more bubbles.
Senator Isakson reports that he has eleven grandchildren. I am sure that he is a loving and proud grandfather. He needs to think of the consequences of his proposed legislation. He is robbing his grandchildren (and everyone else under twenty-five in America today) of their future.
Monday, September 14, 2009
You Can't Do Good and Do Well on Wall St.
The Wall Street motto that I knew was: Monday through Friday you did well, On Sunday you did good. In this case doing ‘well’ was making money, doing ‘good’ is something you did that benefited someone else or the community in general. Mixing the two was bad mojo.
If you look at the amount of charitable donations by the big hitters (and the not so big) on Wall Street in 2007 you will see that nothing has changed since I was on the dance floor. They we coining money like mad Monday through Friday and giving a big chunk back over the weekend. Think of it like confession. It cleanses the soul.
In his speech today President Obama asked the big banks to “Do the right thing”. To be fair with their customers, tell them up front what the fees are, to open up their vaults and start lending again. He urged the lenders to change their ways and to cooperate with the new laws that are coming. Basically he asked them to do Good.
You can be certain that the banks will give lip service to these lofty ideals and they will continue to do good things in the communities that they operate in. But the idea that they are actually going to deliver on this is just silly. Wall Street does well, not good. 09 is no different than any other year. The President better have a big stick available because the carrot he is offering to Wall Street is not going to work.
He’s a terrible story about what happens when you try to mix doing good with doing well. This story took place a long time ago in a far off land.
Some native people had the rights to forest some land. Some big interests wanted that lumber. The deal needed money and I got involved. It was sold as a “do good” deal.
The locals wanted work and there were big transportation problems. The solution was to build a processing facility on site. That made everyone happy. Part of the deal required the enterprise to fund a school and a clinic. There was also profit sharing. These bells and whistles made it look good.
But there was a snag. In these woods there was an endangered animal. No one had seen one for years. Environmentalists protested. Since this was a “good’ deal a compromise was reached. People were allowed into the forest to search for the animal in question. If they found the animal the plans to harvest the lumber would be scrubbed.
They stayed in the woods for months looking. They lived in tents. They never saw a thing. So the project went forward.
Several years later I learned that before the observers were allowed into the forest the natives killed all of the animals that needed the protection. It was money, jobs and greed that did them in. Bad mojo.
If you look at the amount of charitable donations by the big hitters (and the not so big) on Wall Street in 2007 you will see that nothing has changed since I was on the dance floor. They we coining money like mad Monday through Friday and giving a big chunk back over the weekend. Think of it like confession. It cleanses the soul.
In his speech today President Obama asked the big banks to “Do the right thing”. To be fair with their customers, tell them up front what the fees are, to open up their vaults and start lending again. He urged the lenders to change their ways and to cooperate with the new laws that are coming. Basically he asked them to do Good.
You can be certain that the banks will give lip service to these lofty ideals and they will continue to do good things in the communities that they operate in. But the idea that they are actually going to deliver on this is just silly. Wall Street does well, not good. 09 is no different than any other year. The President better have a big stick available because the carrot he is offering to Wall Street is not going to work.
He’s a terrible story about what happens when you try to mix doing good with doing well. This story took place a long time ago in a far off land.
Some native people had the rights to forest some land. Some big interests wanted that lumber. The deal needed money and I got involved. It was sold as a “do good” deal.
The locals wanted work and there were big transportation problems. The solution was to build a processing facility on site. That made everyone happy. Part of the deal required the enterprise to fund a school and a clinic. There was also profit sharing. These bells and whistles made it look good.
But there was a snag. In these woods there was an endangered animal. No one had seen one for years. Environmentalists protested. Since this was a “good’ deal a compromise was reached. People were allowed into the forest to search for the animal in question. If they found the animal the plans to harvest the lumber would be scrubbed.
They stayed in the woods for months looking. They lived in tents. They never saw a thing. So the project went forward.
Several years later I learned that before the observers were allowed into the forest the natives killed all of the animals that needed the protection. It was money, jobs and greed that did them in. Bad mojo.
Sunday, September 13, 2009
SSTF - Their Proposals
A recent post on August cash flow losses at the Social Security Trust Fund got me an email from the Fund that pointed to their thinking on the potential approaches that will be considered when and if the problems at Social Security come on the table.
The full list of the Fund’s proposals can be found here. Each proposal has a discussion of the results over time. In my review there are two areas that appear to produce favorable results. Reducing COLA and raising payroll taxes have the most significant impact.
To have a meaningful affect on the outcome it is necessary that payroll taxes are increased by a combined 2.2%. This graph shows the impact of this change.
Raising taxes clearly fixes the problem. However to do so requires an increase in payroll taxes of $110 B in 2010 and each year thereafter (indexed higher). This is not an option that should be seriously considered. Any proposal that results in increased taxation on workers is just not going to fly. It would have a significant drag on the real economy. To stimulate growth and sustain the weak recovery requires tax decreases not increases.
To demonstrate the magnitude of the problem consider the following graphs. The first looks at the impact of raising the retirement age to 70 over a period of time. The second looks at raising the ceiling on taxable income from the current level. As you can see there is very little change. These approaches address the political issues behind the problem. Increase tax on high earners while old people would get benefits later in life. A grand compromise that will result in more divisions in our society and achieve next to nothing by way of fixing the underlying problem.
Adjusting the COLA formula has a significant impact. Reducing the COLA by 1% annually significantly extends the life and health of the Fund. This is just a cheap way to reduce benefits for future beneficiaries. While this approach shows promise it will result in future retirees that depend on SS income to starve. This just creates a future problem, the numbers look better but the social consequences will be a disaster.
However, this fix is the most likely one to be seriously considered as it addresses the present and pushes the problems of an aging population to the next generation. I hate this approach. It encourages inflation as a government tool to reduce costs. Reducing or eliminating COLA is a fix not a solution.
The Fund provides a significant range of alternatives for the public to look at. The summary of these alternatives can be found at this site. For each alternative go to the summary and then the graph on the right that looks like those above. If the graph shows meaningful extension of the viable life of the Fund it is a tool that can/will be seriously considered. While there are a number of proposals that achieve the desired results those same approaches run counter to the current macro economic/social picture we face and should not be considered.
In my view the Fund has done both an excellent and a terrible job in defining and analyzing the range of options we face. I think they have omitted the only choice that makes sense on a long-term basis. We have to have a means test for Social Security.
The American people and their lawmakers should be able to look at a proposal that means tests availability of retirement benefits. There are a lot of Lloyd Blankfeins, Larry Finks, Steve Jobs, Bill Gates’s and yes, maybe me too who could do without the extra $15k a year that we are currently entitled to get.
I would propose a means test on availability of $100,000 (indexed over time) in taxable income starting in 2010. If you make that much in a given year you simply do not get the retirement benefits. This is taxing the rich. While that is undesirable, it is a far better alternative than raising payroll taxes on current workers or cutting benefits across the board to all retirees. The impact on those with incomes greater than $100k would be negligible.
To the Fund: Please provide this information. We need to consider this approach. Trust me; Blankfein, Fink, Jobs, Gates and even I will back that option. In the long run it is the best alternative for our children, our society and us.
The proposals that you have put forward that are effective are at the same time flawed. That flaw is that they will be broadly unpopular. Washington is about to hit its citizens over the head with health care. And then you are going to come up for discussion. By that time people will be very angry. Those folks who came to visit your city this weekend are part of something much bigger and troubling. The means test narrows the scope of the hit that must come.
Saturday, September 12, 2009
What's a Home Worth These Days?
This is a vexing question for millions of Americans. There was a time when most people had a reasonably good idea of what they could sell a property for. There were enough purchases and sales to create comps. Not any longer. Homes that have been foreclosed on come to the market at distressed prices. This is happening in every neighborhood across the country. When one property sells at a distressed price it influences all the properties around it.
So what is residential real estate worth today? The answer to that question is, “About 15 times the annual rent”.
RE professionals are going to write me and say that this simple calculation is wrong. They will say that the number is lower. Possibly as low as 12 times rent. They might be right. However in areas of the country that I watch the 15 times rent number is a pretty good indication of value.
Based on this calculation the following rent/price guidelines can be determined:
It is still difficult for a homeowner to make a reasonable estimate on what the rental value of a property will be. But I have found that most people have a better handle on this number than they do on what their home can be successfully marketed for. There are regional considerations for rental values, by and large this formula works well for metro versus rural properties as a valuation tool.
This analysis creates a tremendous problem. There are very few homes for sale at 15 times rent. The only ones that come up for sale in that price range are those that are in foreclosure and are being sold by bank lenders. We know that there is demand for properties when those conditions are met. That has been proven in just about every area of the country.
In my view the bulk of unsold homes on the market today are trying to get sold at a multiple of rent that is at least 20 times. That is why these homes are not selling. The implication is that on balance RE is still 25% overvalued. The bad news is that rental values are dropping across the country as homeowners are forced to rent properties that can’t be sold.
I would be interested to get comments on this. I would like to hear from people around the country if they thought this pricing mechanism was in the ballpark for their area. I would be particularly interested to get comments from folks who live outside the US to get a look on how that stacks up as well.
If my sense of this is correct we are in for a very rude awakening. Those with $1MM+ homes will be particularly depressed by this calculation. My sense is that high end RE is in the process of a massive correction. The sheet rock palaces that were built with cheap money from 2002 to 2006 are worth half of what was paid for them. We just haven’t figured that out yet. The impact on consumption will be very significant when that reality sets in.
A back of the envelope analysis of the rental values of American homes produces a capitalized value of $9 trillion at 15 times rent. The mortgages on these same homes is equal to $12 trillion. We are missing $3 trillion in value based on this. That might be a decent estimate on how much the RE mess is going to cost us.
Thursday, September 10, 2009
Sugar - A Sweet Story
Sugar has been on a tear since last October. By the end of August it had doubled in price. It has given back 10% so far in September.
This appears to be a supply and demand issue. Global production is down due to weather, while demand is increasing. This chart tells that story.
Like with most things, it is never just visible conditions that influence prices. There is always a side story. For example on August 13th the WSJ revealed a letter from some of the big sugar players. No doubt but that this had something to do with the late August spike in the price. From the article:
"Some of America's biggest food companies say the U.S. could "virtually run out of sugar" if the Obama administration doesn't ease import restrictions amid soaring prices for the key commodity. In a letter to Agriculture Secretary Thomas Vilsack, the big brands -- including Kraft, General Mills, Hershey. and Mars -- bluntly raised the prospect of a severe shortage of sugar used in chocolate bars, breakfast cereal, cookies, chewing gum and thousands of other products."
This kind of talk from credible players encourages hot money. But when it started to rain in India at the beginning of the month the sugar market was overbought and ripe for a correction. One can only hope that the folks at KFT, GIS and HSY were able to buy low and sell high. They certainly were in the catbird's seat on this one.
There is a wild card in the sugar story. It is called STEVIA. My nose tells me that there is money to be made with this. I haven’t figured out how.
This is an old and interesting story. In the late 70’s none other than Donald “Rummy” Rumsfeld was the CEO of G. D. Searle. Shortly after the inauguration of Ronald Reagan the new FDA head approved Aspartame.This decision made NutraSweet. It made G.D.Searle. It gets better.
Stevia is a plant that is also a sugar source. It has been used in Japan for the past fifty years. Of interest is that while the US FDA was banning stevia and approving Aspartame the Japanese were taking precisely opposite path.
The FDA banned stevia in 1991. One year after Bush I got into office. That decision was controversial. The argument was put forth that the designation violated the FDA's own guidelines under which natural substances used prior to 1958, with no reported adverse effects, should be generally regarded as safe as long as the substance was being used in the same way and format as prior to 1958. The FDA has allowed stevia as a dietary supplement but not as an additive. One would think that it was either safe or not safe. Either way the domestic sugar industry got a free lift. +2 for G.D. Searle/ their new owner, Monsanto.
The interesting part about this was that the FDA determination was generated in response to an anonymous letter. There have been several FOI suits. We still don’t know who wrote that letter. Any guesses? It gets better.
In December of 2008, in the last months of the Bush II administration what does the FDA do? It reverses the 91 ruling and allows stevia to become a food additive. Is this a big deal? You bettcha it is. Look who is playing in this ballpark now:
-In 2007, Coke announced plans to obtain approval for rebiana for use as a food additive within the United States by 2009, as well as plans to market rebiana-sweetened products in 12 countries that allow stevia's use as a food additive.
-In May 2008, Coke and Cargill announced the availability of Truvia, a consumer brand stevia sweetener containing erythritol and Rebiana, which the FDA permitted as a food additive in December 2008.
-Coca-Cola announced intentions to release stevia-sweetened beverages in late December 2008.
-Pepsi and Pure Circle announced PureVia, their brand of stevia-based sweetener, but withheld release of beverages sweetened with reb-A until receipt of FDA confirmation. Since the FDA permitted Truvia and PureVia, both Coca Cola and PepsiCo have announced products that will contain their new sweetener.
So the fat cats are in this in a very big way. If Pepsi, Coke and Cargill are making investments it is a pretty sure bet that stevia is coming to America.
The stevia story is not likely to influence the price of London White Sugar any time soon. But the sugar story is a window into how things get done in this country. That widow is smudged with dirt.
Over the years there has been many questions raised regarding the safety of Aspartame. I am not smart enough to understand the facts on that. Monsanto bought Searle and later sold Aspartame. This is what Monsanto has to say about it today. Not exactly a "ringing product endorsement".
This appears to be a supply and demand issue. Global production is down due to weather, while demand is increasing. This chart tells that story.
Like with most things, it is never just visible conditions that influence prices. There is always a side story. For example on August 13th the WSJ revealed a letter from some of the big sugar players. No doubt but that this had something to do with the late August spike in the price. From the article:
"Some of America's biggest food companies say the U.S. could "virtually run out of sugar" if the Obama administration doesn't ease import restrictions amid soaring prices for the key commodity. In a letter to Agriculture Secretary Thomas Vilsack, the big brands -- including Kraft, General Mills, Hershey. and Mars -- bluntly raised the prospect of a severe shortage of sugar used in chocolate bars, breakfast cereal, cookies, chewing gum and thousands of other products."
This kind of talk from credible players encourages hot money. But when it started to rain in India at the beginning of the month the sugar market was overbought and ripe for a correction. One can only hope that the folks at KFT, GIS and HSY were able to buy low and sell high. They certainly were in the catbird's seat on this one.
There is a wild card in the sugar story. It is called STEVIA. My nose tells me that there is money to be made with this. I haven’t figured out how.
This is an old and interesting story. In the late 70’s none other than Donald “Rummy” Rumsfeld was the CEO of G. D. Searle. Shortly after the inauguration of Ronald Reagan the new FDA head approved Aspartame.This decision made NutraSweet. It made G.D.Searle. It gets better.Stevia is a plant that is also a sugar source. It has been used in Japan for the past fifty years. Of interest is that while the US FDA was banning stevia and approving Aspartame the Japanese were taking precisely opposite path.
The FDA banned stevia in 1991. One year after Bush I got into office. That decision was controversial. The argument was put forth that the designation violated the FDA's own guidelines under which natural substances used prior to 1958, with no reported adverse effects, should be generally regarded as safe as long as the substance was being used in the same way and format as prior to 1958. The FDA has allowed stevia as a dietary supplement but not as an additive. One would think that it was either safe or not safe. Either way the domestic sugar industry got a free lift. +2 for G.D. Searle/ their new owner, Monsanto.
The interesting part about this was that the FDA determination was generated in response to an anonymous letter. There have been several FOI suits. We still don’t know who wrote that letter. Any guesses? It gets better.
In December of 2008, in the last months of the Bush II administration what does the FDA do? It reverses the 91 ruling and allows stevia to become a food additive. Is this a big deal? You bettcha it is. Look who is playing in this ballpark now:
-In 2007, Coke announced plans to obtain approval for rebiana for use as a food additive within the United States by 2009, as well as plans to market rebiana-sweetened products in 12 countries that allow stevia's use as a food additive.
-In May 2008, Coke and Cargill announced the availability of Truvia, a consumer brand stevia sweetener containing erythritol and Rebiana, which the FDA permitted as a food additive in December 2008.
-Coca-Cola announced intentions to release stevia-sweetened beverages in late December 2008.
-Pepsi and Pure Circle announced PureVia, their brand of stevia-based sweetener, but withheld release of beverages sweetened with reb-A until receipt of FDA confirmation. Since the FDA permitted Truvia and PureVia, both Coca Cola and PepsiCo have announced products that will contain their new sweetener.
So the fat cats are in this in a very big way. If Pepsi, Coke and Cargill are making investments it is a pretty sure bet that stevia is coming to America.
The stevia story is not likely to influence the price of London White Sugar any time soon. But the sugar story is a window into how things get done in this country. That widow is smudged with dirt.
Over the years there has been many questions raised regarding the safety of Aspartame. I am not smart enough to understand the facts on that. Monsanto bought Searle and later sold Aspartame. This is what Monsanto has to say about it today. Not exactly a "ringing product endorsement".
Tuesday, September 8, 2009
SSTF Shocker - $6B August Deficit
The Social Security Trust Fund reported an August net deficit of $5.865 Billion. This is the largest monthly deficit in nineteen years. Base on recent years data it was not surprising the Fund ran a deficit in August. But the magnitude of the shortfall was a surprise to me. This deficit is now the seventh in the past twelve months. That pace has never been seen before.
We deal with very big numbers these days. 100rds of billions and trillions are how we measure things. So a $6b monthly deficit for the Fund would appear to be a ho-hum. That is not correct. This is an important number.
The Actuarial analysis of the Fund is misdirected. Their focus is based on the future value. It should be focused on the here and now. In the June annual report the Trustees concluded that the Fund would be broke in 2037. This conclusion is so far into the future that it is easy for everyone involved to say, “this is a next year problem, health care comes first”. Stephen Goss the Fund’s head honcho said as much in a recent interview.
While there is a political case that we have to prioritize health care as an issue, it is wrong on a purely economic basis to ignore the exploding problems at the Fund. Every month that the status quo is allowed to continue makes the cost of the ‘fix’ that much larger. Based on the past twelve months performance I now estimate that the Net Present Value of future committed liabilities is in deficit by $7 trillion. To plug this sized hole would require a significant increase in payroll taxes. That isn’t going to happen. Raising payroll taxes by 4% would kill the economy. No White House economist would advocate that. The alternative of cutting benefits would be very unpopular. There are currently 52 million beneficiaries of the system. A lot of them vote. To shore up the fund would require across the board cuts greater than 20%. While that may not be a hardship for some it most certainly will be for others. The only way to address this inequity will be a means test.
The August deficit reconfirms that the Funds foundations are wobbly. Some observations:
-In August the US Treasury had to borrow an additional $6 billion in the public market to finance the cash shortfall of Social Security. We already have too much paper for sale to fund the budget deficit. SS added to the supply problem last month.
-The 2037 Future Value of the August deficit is -$17b based on a 4% return. What this means is that there will be a very significant revision in the 2037 drop-dead date. Based on current trends the go broke date is closer to 2025.
-This is not just a bad month. The net decline in the Funds assets for June/July/August comes to $7 billion. In 08 that period was in surplus by $5 billion, In 07 it was +$7b and in 06 it was +$13b.
-The decline in payrolls is hurting the Funds’ top line. January-July 2009 payroll tax receipts were down from 2008 by $5 billion or 1%. While the monthly declines in payrolls will fall over the next six months it is unlikely that there will be much net increase either. It will be a very long time before we see monthly gains of 250k. Without that kind of growth the Fund will quickly fall into annual deficits.
-The expense side is exploding. The September monthly benefits cost will be $56.6b up from $51.5 in 2008, a 10% increase.
-In 2007 the SSTF produced a surplus of $191b that it invested in the US economy. This year it will be closer to $100b. Based on the current trends that surplus will be gone by 2012. Six years earlier than the Trustees forecast in June of this year.
SS is the mother of all systemic risks. Even the debate on this topic brings risk. It will expose an additional $7trillion unfunded liability. Another reason for holders of dollars to worry.
There is no fix to this. Raising taxes is a dead end. Age warfare is a possible social consequence. The really bad news is that no one will touch this for another year. By then it might be too late.
We deal with very big numbers these days. 100rds of billions and trillions are how we measure things. So a $6b monthly deficit for the Fund would appear to be a ho-hum. That is not correct. This is an important number.
The Actuarial analysis of the Fund is misdirected. Their focus is based on the future value. It should be focused on the here and now. In the June annual report the Trustees concluded that the Fund would be broke in 2037. This conclusion is so far into the future that it is easy for everyone involved to say, “this is a next year problem, health care comes first”. Stephen Goss the Fund’s head honcho said as much in a recent interview.
While there is a political case that we have to prioritize health care as an issue, it is wrong on a purely economic basis to ignore the exploding problems at the Fund. Every month that the status quo is allowed to continue makes the cost of the ‘fix’ that much larger. Based on the past twelve months performance I now estimate that the Net Present Value of future committed liabilities is in deficit by $7 trillion. To plug this sized hole would require a significant increase in payroll taxes. That isn’t going to happen. Raising payroll taxes by 4% would kill the economy. No White House economist would advocate that. The alternative of cutting benefits would be very unpopular. There are currently 52 million beneficiaries of the system. A lot of them vote. To shore up the fund would require across the board cuts greater than 20%. While that may not be a hardship for some it most certainly will be for others. The only way to address this inequity will be a means test.
The August deficit reconfirms that the Funds foundations are wobbly. Some observations:
-In August the US Treasury had to borrow an additional $6 billion in the public market to finance the cash shortfall of Social Security. We already have too much paper for sale to fund the budget deficit. SS added to the supply problem last month.
-The 2037 Future Value of the August deficit is -$17b based on a 4% return. What this means is that there will be a very significant revision in the 2037 drop-dead date. Based on current trends the go broke date is closer to 2025.
-This is not just a bad month. The net decline in the Funds assets for June/July/August comes to $7 billion. In 08 that period was in surplus by $5 billion, In 07 it was +$7b and in 06 it was +$13b.
-The decline in payrolls is hurting the Funds’ top line. January-July 2009 payroll tax receipts were down from 2008 by $5 billion or 1%. While the monthly declines in payrolls will fall over the next six months it is unlikely that there will be much net increase either. It will be a very long time before we see monthly gains of 250k. Without that kind of growth the Fund will quickly fall into annual deficits.
-The expense side is exploding. The September monthly benefits cost will be $56.6b up from $51.5 in 2008, a 10% increase.
-In 2007 the SSTF produced a surplus of $191b that it invested in the US economy. This year it will be closer to $100b. Based on the current trends that surplus will be gone by 2012. Six years earlier than the Trustees forecast in June of this year.
SS is the mother of all systemic risks. Even the debate on this topic brings risk. It will expose an additional $7trillion unfunded liability. Another reason for holders of dollars to worry.
There is no fix to this. Raising taxes is a dead end. Age warfare is a possible social consequence. The really bad news is that no one will touch this for another year. By then it might be too late.
Friday, September 4, 2009
An Insider look at Ginnie Mae MBS
As a result of my postings I get a fair amount of off the grid emails. They run the gamut. On a recent piece re: the Agency’s stock price I got, “You could not find your behind with your own two hands”. The note was sent to me in Cyrillic. Google translate gave me the gist of the message. Apparently they are trading the Agencies from the Long side in Kazakhstan.
I also get comments from people who are more knowledgeable than I am on a topic that I write about. I got the following analysis of a Ginnie Mae security from someone who has given me his or her permission to post it. This person works on Wall Street and does not want their name revealed. This analysis jives with recent reports that FHA is suffering losses and may need a bailout(WSJ 9/4). Enjoy. Hat Tip Jswede.
I’m continually astounded by a lot in this market, but perhaps nothing has been as jaw-dropping as the performance of the GNMA MJM (multi-jumbo mortgage) wrapped loans made starting about 1 year ago. These were the ‘mod’ loans made especially for ‘problem zip codes’ (read: high-priced, low equity and free-falling CA, AZ and FL) to support those markets. To make these high priced homes eligible for FHA, the max loan amount was stretched to over $700k. As there were ‘problems’ in these properties to begin with, the LTV averaged around 95%....
here’s a look at a random GNMA MJM 6%cpn (G2 4216) collateral issued in Aug 2008 – around 1300 loans to start, original principal $1b, median 95% LTV, WAOLS ~$466k… 94 loans paid off (how many short sales do you think?)… another ~225 30+ days delinquent… reminder, this is ONE YEAR LATER and July numbers….
Here’s a GNMA MJM 7%cpn (G2 4218) from Aug 2008 – only 26 loans in this one, $12mil at issue, 95% median LTV, WAOLS ~$498k…. 15 of those loans are delinquent. 7 loans are 90+ days – several probably never made a payment.
According to your Tuesday, July 21, 2009 entry, “Fed Mortgage Report – What’s Ginnie Mae Up To?”, GNMA gtd loan amount outstanding has expanded by close to 50% from 2Q 08 to 2Q 09….. if these MJM’s are any sign, in my estimation, we (tax-payers) will be taking losses with 20-40% severities on those new loans…
The more traditional GNMA securities made up of ‘conforming loan amounts’ are likely not much better: mostly bought with 3.5% down to 1st time buyers – oh, and they also got to monetize their tax-credit, so really have no skin in the game at all….
Here’s a random conforming loan size GNMA pool (G2 4170) from June 2008 – 12,224 loans, $199k WAOLS, 97% median LTV, $2.46bil original pool size:
These conforming loans don’t look too much better, huh? These losses will be just huge…. I mean, these numbers are just 1yr later… this will be perhaps a more massive transfer of losses to the upper income tax-payer than anything else we’ve seen so far….
I also get comments from people who are more knowledgeable than I am on a topic that I write about. I got the following analysis of a Ginnie Mae security from someone who has given me his or her permission to post it. This person works on Wall Street and does not want their name revealed. This analysis jives with recent reports that FHA is suffering losses and may need a bailout(WSJ 9/4). Enjoy. Hat Tip Jswede.
I’m continually astounded by a lot in this market, but perhaps nothing has been as jaw-dropping as the performance of the GNMA MJM (multi-jumbo mortgage) wrapped loans made starting about 1 year ago. These were the ‘mod’ loans made especially for ‘problem zip codes’ (read: high-priced, low equity and free-falling CA, AZ and FL) to support those markets. To make these high priced homes eligible for FHA, the max loan amount was stretched to over $700k. As there were ‘problems’ in these properties to begin with, the LTV averaged around 95%....
here’s a look at a random GNMA MJM 6%cpn (G2 4216) collateral issued in Aug 2008 – around 1300 loans to start, original principal $1b, median 95% LTV, WAOLS ~$466k… 94 loans paid off (how many short sales do you think?)… another ~225 30+ days delinquent… reminder, this is ONE YEAR LATER and July numbers….
Here’s a GNMA MJM 7%cpn (G2 4218) from Aug 2008 – only 26 loans in this one, $12mil at issue, 95% median LTV, WAOLS ~$498k…. 15 of those loans are delinquent. 7 loans are 90+ days – several probably never made a payment.
According to your Tuesday, July 21, 2009 entry, “Fed Mortgage Report – What’s Ginnie Mae Up To?”, GNMA gtd loan amount outstanding has expanded by close to 50% from 2Q 08 to 2Q 09….. if these MJM’s are any sign, in my estimation, we (tax-payers) will be taking losses with 20-40% severities on those new loans…
The more traditional GNMA securities made up of ‘conforming loan amounts’ are likely not much better: mostly bought with 3.5% down to 1st time buyers – oh, and they also got to monetize their tax-credit, so really have no skin in the game at all….
Here’s a random conforming loan size GNMA pool (G2 4170) from June 2008 – 12,224 loans, $199k WAOLS, 97% median LTV, $2.46bil original pool size:
These conforming loans don’t look too much better, huh? These losses will be just huge…. I mean, these numbers are just 1yr later… this will be perhaps a more massive transfer of losses to the upper income tax-payer than anything else we’ve seen so far….
Thursday, September 3, 2009
Ten-Year Note: A Terrible Investment
If you believe Mr. Bernanke, he will soon stop his purchases of under priced debt. Foreign holders have shown only modest interest in new US sovereign exposure of late. Their increases are only in short-term debt instruments. Central Bank holdings of coupon debt has increased by only $50b (June 08 vs. June 09). During the same period the CBs sold $90b in fixed rate Agency paper. If the Fed isn’t buying and foreigners aren’t either it means that Americans are going to have to come to the rescue and buy a great deal of bonds starting at some time in the near future. I can’t imagine why anyone would do that. Treasury coupons are a terrible investment.
If you subtract the current 10-year yield from the ten-year TIP you get an indication of how the market is pricing future inflation. The current difference is 1.66%. I think that is a ridiculous assumption for the next ten years. It will be higher than that. But these are big markets and we have to use what these markets tell us.
This estimate of inflation is also a discount rate to determine future values. For example, if the actual inflation rate over the next decade is 1.66%, then $100 today will be worth only $85.43 when the bond matures. Similarly the interest that is received is worth less. The $3.30 one would get in the tenth year is worth only $2.75. It gets worse.
The Treasury has its hand out when it pays interest. The average marginal tax on unearned income is 30%. So if you buy Treasury paper you only get 70% of the income net of taxes. When taking into consideration the tax impact and the rate of inflation the adjusted return to an investor is just .43% for the current ten-year bond.
If your expectations for inflation are closer to 2% versus the TIPS pricing then you really have to stay away from Government bonds. At a 2% inflation rate the return goes to zero. At 2.5% average inflation the return is negative. For an investor who puts up $100 today they will receive a TOTAL of only $94 in return over the ten-year period.
If one was wondering why junk stocks have a bid, or why PEs are so high, or why gold is pushing $1,000 you just have to look at this calculation. The inescapable conclusion is that for a ‘buy and hold’ investor the very worst place to put your money today is in Treasury bonds. It is just plain stupid.
Mr. Bernanke’s effort to keep rates low through open market purchases has worked. It is hard to imagine what would be happening in the real economy were it not for the QE program. As/when QE ends Mr. Bernanke will learn that no one wants to play in his sandbox any longer. It is difficult to ponder what market conditions will be like when that realization takes hold.
If you subtract the current 10-year yield from the ten-year TIP you get an indication of how the market is pricing future inflation. The current difference is 1.66%. I think that is a ridiculous assumption for the next ten years. It will be higher than that. But these are big markets and we have to use what these markets tell us.
This estimate of inflation is also a discount rate to determine future values. For example, if the actual inflation rate over the next decade is 1.66%, then $100 today will be worth only $85.43 when the bond matures. Similarly the interest that is received is worth less. The $3.30 one would get in the tenth year is worth only $2.75. It gets worse.
The Treasury has its hand out when it pays interest. The average marginal tax on unearned income is 30%. So if you buy Treasury paper you only get 70% of the income net of taxes. When taking into consideration the tax impact and the rate of inflation the adjusted return to an investor is just .43% for the current ten-year bond.
If your expectations for inflation are closer to 2% versus the TIPS pricing then you really have to stay away from Government bonds. At a 2% inflation rate the return goes to zero. At 2.5% average inflation the return is negative. For an investor who puts up $100 today they will receive a TOTAL of only $94 in return over the ten-year period.
If one was wondering why junk stocks have a bid, or why PEs are so high, or why gold is pushing $1,000 you just have to look at this calculation. The inescapable conclusion is that for a ‘buy and hold’ investor the very worst place to put your money today is in Treasury bonds. It is just plain stupid.
Mr. Bernanke’s effort to keep rates low through open market purchases has worked. It is hard to imagine what would be happening in the real economy were it not for the QE program. As/when QE ends Mr. Bernanke will learn that no one wants to play in his sandbox any longer. It is difficult to ponder what market conditions will be like when that realization takes hold.
Wednesday, September 2, 2009
Mtg.Bankers Assn. Proposal: D.O.A.
Talk about foxes guarding the hen house. The Mortgage Bankers Association came out with its recommendations for the future role of the US AAA in the mortgage market. Not surprisingly, they want to continue to use and abuse the privilege of the AAA guaranty. They want to recreate the GSE structure.
In an introductory letter Chairman Courson has this to say about the people who were behind the plan:
“Our Council, featuring some of the best minds in our industry, has spent significant time looking at the secondary market – what worked and what didn’t -- and came up with these recommendations,” said MBA’s President and CEO.
I am certain that Chairman Courson is correct. The people behind this are some of the smartest, most knowledgeable and are the best connected in the industry. They are the Foxes. The list follows. These names want to have the US AAA. Again.
The essence of the MBA proposal is to create new private companies, the securities of which would by guaranteed by Uncle Sam. Their words:
The centerpiece of MBA’s recommendation is the creation of a new line of mortgage-backed securities (MBS). Each security would have two components – a loan level guarantee provided by a privately owned, government-chartered and regulated mortgage credit-guarantor entity (MCGE) and a security-level, federal government-guaranteed wrap.
That is the exact definition of the GSE's. They want to remake what did not work. The MBA proposal is very specific regarding the guaranty role of the taxpayer:
The wrap would be an explicit government guarantee focused on the credit risk of these mortgage securities, similar to that on a Ginnie Mae security.
On the issue of a Regulator the MBA suggested:
"The MCGEs’ regulator should be strong, empowered and adequately funded through the GG insurance premiums".
In other words they want to pay/own their own Regulator. Good touch. They are running straight into the wind with this.
The estimates for the GSE losses of $200 billion are two low. There is little consideration in that number for losses relating to the Agency’s Prime loan book. The number could be double the estimate. The net losses from TARP and AIG will be small compared to Fannie and Freddie. The GSE’s collapsed into a hole of bad credit. They did it to chase profits for shareholders. From the NY Times re: Richard Syron CEO of Freddie:
"More than two dozen current and former high-ranking executives at Freddie Mac, analysts, shareholders and regulators said in interviews that Mr. Syron had ignored recommendations that could have helped avoid the current crisis."
Mr. Syron’s response:
“This company has to answer to shareholders, to our regulator and to Congress, and those groups often demand completely contradictory things.”
The GSE structure is textbook conflict of interest. It puts taxpayers at risk to private shareholders. We can’t recreate that conflict. Next time it will kill us.
I do respect the members of the MBA. I understand that they have an axe to grind. I expected more from them. Their proposal is enlightened self-interest. They should have supported an expanded Ginnie Mae. We are at least five years away from a time when the Foxes can run free again.
In an introductory letter Chairman Courson has this to say about the people who were behind the plan:
“Our Council, featuring some of the best minds in our industry, has spent significant time looking at the secondary market – what worked and what didn’t -- and came up with these recommendations,” said MBA’s President and CEO.
I am certain that Chairman Courson is correct. The people behind this are some of the smartest, most knowledgeable and are the best connected in the industry. They are the Foxes. The list follows. These names want to have the US AAA. Again.
The essence of the MBA proposal is to create new private companies, the securities of which would by guaranteed by Uncle Sam. Their words:
The centerpiece of MBA’s recommendation is the creation of a new line of mortgage-backed securities (MBS). Each security would have two components – a loan level guarantee provided by a privately owned, government-chartered and regulated mortgage credit-guarantor entity (MCGE) and a security-level, federal government-guaranteed wrap.
That is the exact definition of the GSE's. They want to remake what did not work. The MBA proposal is very specific regarding the guaranty role of the taxpayer:
The wrap would be an explicit government guarantee focused on the credit risk of these mortgage securities, similar to that on a Ginnie Mae security.
On the issue of a Regulator the MBA suggested:
"The MCGEs’ regulator should be strong, empowered and adequately funded through the GG insurance premiums".
In other words they want to pay/own their own Regulator. Good touch. They are running straight into the wind with this.
The estimates for the GSE losses of $200 billion are two low. There is little consideration in that number for losses relating to the Agency’s Prime loan book. The number could be double the estimate. The net losses from TARP and AIG will be small compared to Fannie and Freddie. The GSE’s collapsed into a hole of bad credit. They did it to chase profits for shareholders. From the NY Times re: Richard Syron CEO of Freddie:
"More than two dozen current and former high-ranking executives at Freddie Mac, analysts, shareholders and regulators said in interviews that Mr. Syron had ignored recommendations that could have helped avoid the current crisis."
Mr. Syron’s response:
“This company has to answer to shareholders, to our regulator and to Congress, and those groups often demand completely contradictory things.”
The GSE structure is textbook conflict of interest. It puts taxpayers at risk to private shareholders. We can’t recreate that conflict. Next time it will kill us.
I do respect the members of the MBA. I understand that they have an axe to grind. I expected more from them. Their proposal is enlightened self-interest. They should have supported an expanded Ginnie Mae. We are at least five years away from a time when the Foxes can run free again.
Tuesday, September 1, 2009
Wallboard - China Inc.+$25mm, USA $-3.2b
The Wall Street Journal had an interesting piece Tuesday on defective wallboard that had been imported from China .
The LA Times had a more detailed discussion of this problem on July 4th. This article makes a case that the wall material may contain radioactive material. It provides the names of some of the companies involved.
The problematic wallboard was sent to the US in 2006. These imports totaled $25 million. The WSJ estimates that the cost of repairing a home that has this material is $100,000. The LAT piece puts the number of homes involved at 32,000.
Put those two numbers together. There are $3.2billion of losses relating to $25mm of wallboard. The US will eat all of it. China broke no rules:
Consumer Product Safety Commission spokesman Joe Martyak said his agency asks U.S. Customs and Border Protection to inspect items for which there are mandatory testing requirements, such as children's toys. But there are no such conditions for drywall, he said.
Enough said.
The LA Times had a more detailed discussion of this problem on July 4th. This article makes a case that the wall material may contain radioactive material. It provides the names of some of the companies involved.
The problematic wallboard was sent to the US in 2006. These imports totaled $25 million. The WSJ estimates that the cost of repairing a home that has this material is $100,000. The LAT piece puts the number of homes involved at 32,000.
Put those two numbers together. There are $3.2billion of losses relating to $25mm of wallboard. The US will eat all of it. China broke no rules:
Consumer Product Safety Commission spokesman Joe Martyak said his agency asks U.S. Customs and Border Protection to inspect items for which there are mandatory testing requirements, such as children's toys. But there are no such conditions for drywall, he said.
Enough said.
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