Agency FICO Redline? A Question to Ask

The US Treasury Department’s Christmas Eve announcement confirming massive new support for the Agencies had the following as the last sentence:

"Recent announcements on the tightening of underwriting standards by Fannie Mae, Freddie Mac, and the Federal Housing Administration, demonstrate a commitment to prudent housing finance policy that enables a transition to an environment where the private market is able to provide a larger source of mortgage finance."

I believe that this is a very mistaken assumption by Treasury. Take them at their word on this regarding the tightening of standards. I can confirm that all of the Agencies have “independently” (Every thing is coordinated in D.C.) announced that they are tightening standards. It is impossible to quantify that promise at this point. I believe there is some teeth to this.

However there is no connection to the actions by the Agencies and an increase in lending by the “private market”. That is not going to happen. Does Treasury really believe that Citi Bank and Wells Fargo are going to be making cheap mortgage loans to those who have just been ‘red lined’ by the new tighter standards? If private lenders are to be involved it will be on terms more stringent than those new standards being set by the Agencies. The pricing will be much higher as well. Bank of America will not be making sub-standard/mispriced mortgages any time soon.

If you take these two pieces together you would have to assume that as a consequence there will be a significant contraction in the availability of mortgage credit. Its impact should be being felt right about now. We will find out if this is a factor in two to three months when the backward looking housing numbers are released. I would like to know the answer to this question earlier.

I know that there are many out there who are involved with mortgages and real estate. In order to get a reasonable handle on this we need regional input. People who actually have their boots on this ground. So I ask these questions to people who might directly or indirectly know the answers:

Has there been a tightening of standards? Are mortgages more difficult to obtain in the last 30 days?

If the changing standards are in fact constraining mortgage availability the consequences would be significant. It would open a window into those housing numbers that are coming out in February. We all need an edge.

It would also be very interesting to hear that there was no change in availability or in lending standards. That would be an observation for Treasury and the Agencies to ponder. They read too.

This could be one of those “one hand clapping” things. Just an experiment. Blog economics.

What's in Store for 2010

Mohammad said, “One cannot foretell the future”. I think he was on to something. What looks predictable rarely happens. There are always surprises. I have been tripped up so many times. The following are not predictions of things that will happen. Just some thoughts on what might happen in 2010.

-Tim Geithner will resign as Treasury Secretary. Sheila Bair will replace him.

-AIG will be dismantled. What is good will be sold, what is bad will be shuttered. The end result will be a loss to the US of $40 billion.

-The Mid term elections will go to the Republicans. A surprising number of independents will be elected. The Democrats will still have a narrow majority. The end result will be legislative deadlock.

-Gold prices will trade as low as $900 and as high as $1,400. $1,400 will come first.

-Fourth quarter GDP will be at -1%.

-Unemployment will fall from 10% as the 800,000 census workers are hired. Outside of that there will be no growth in employment. Ex the census impact and other government hiring, job creation will be negative.

-Fiat/Chrysler will introduce some sexy new fuel-efficient cars. They will sell well. GM’s Volt will not be in full production. Demand will not be there.

-Boeing will finish a few Dreamliners but they will face many delays and problems.

-Apple will trade at $300 (tablet) and Google at $750. Amazon’s stock will be lower over the full year.

-Overall expect a modest down year for equities. However, the market will be significantly higher and lower than current levels during the year. Expect a high low of +/-15%. Playing the SPY will be tough. This will be a stock pickers market.

-Oil will trade at $100 by midyear, but it will be closer to $75 by year-end as the global slowdown re-emerges.

-The La Nina conditions will revert to El Nino conditions. This will result in a significant increase in Hurricane activity. Four named storms will hit the US coastlines. Total damages will approach $50 billion. There will be no CAT 5 hits on the mainland. But the Yucatan Peninsula is hit with a big one. Storm activity will interrupt Gulf gas production. Nat Gas will trade at $9 at one point in the fall.

-Typhoon activity in Asia will fall from the pace seen in 2009. The result will be a significant increase in Pacific Ocean temperatures.

-2010 will see another significant increase in ice melt. No meaningful steps will be made toward a global response to climate warming.

-Fannie and Freddie will convert their outstanding Preferred stock into common shares at a ratio of 3 to 1.

-After the Preferred conversion the shares of the Agencies will be delisted. Shareholders will be thrown a bone. They will get a beneficial interest in the REO owned by the Federal government. This could be in the form of a trust or individual transactions where old shares are tendered for individual properties. (Hotels/big stuff). The objective of this will be to remove these properties from the market for a meaningful period of time. The result will be that medium priced homes will stabilize in value. Rental costs will fall.

-High-end home prices (+$1mm) will continue to fall in value. In some areas the decline will be 20%. The absence of a viable mortgage market for these homes is the culprit for these declines. Prime defaults will rise to 8%.

-On September 1, 2010 the Federal Funds target will be at ½%. The 10-year bond will be at 4.5%. During the course of the year the ten-year will trade at 3.5% and also 5%. Interest rates will be lower at the end of the year than they will be on September 1st. There will be no meaningful reduction in the Fed's balance sheet.

-At some point in 2010 there will be a test in the bond market for a government auction. At that time the Federal Reserve will, without hesitation or consent, re-establish a form of the QE policy. They will not permit a “failed’ auction.

-The Federal Reserve will become active in the foreign exchange markets. At different times of the year they will both buy and sell dollars. Their objective will be stability. These efforts will be referred to as “smoothing operations”.

-Volatility for all exchanges and commodities will increase from current levels. Intra-day moves greater than 2% will become common.

-The Sovereign Risk Story will continue to be a major theme. Italy and the UK will be lumped into the status of Greece, Spain and Portugal. Eastern Europe will see negative growth.

-There will be no breakup of the Euro. Greece will not pull out. The strong members will provide some relief for the weak. But the problems will not go away and the possibility of some form of two-tiered Euro will be a matter of open discussion. It is in this context that the Fed’s FX intervention takes place.

-There will be no meaningful overhaul of Social Security. This topic will be more controversial than Healthcare. It is too hot a potato for a bi-election year. As a result the SS Trust Fund will be at cash flow breakeven for all of 2010. Down from a surplus of +$200 billion in 2006. This reality will impact bond yields.

-The dollar will trade as high as 1.35 vs. the Euro. The low for the year will be at 1.60. At some point the Yen could weaken to as low as 110 to the dollar. Trade the extremes.

-China will surprise us all and revalue the Yuan by 10%. The currency will still be undervalued. China’s GDP will grow at 10% for the year. But the prospect for 2011 will be in doubt. China will not lose its rank as number 2 in global GDP.

-Mexico will devalue the Peso by 15% and Brazil will revalue the Real by the same amount. The Canadian Dollar will exceed 1 to 1 versus the US dollar.

-The Treasury will not sell the 10 billion of Citicorp shares that it holds. The argument put forth will be to maximize the value of the holdings.

-Some of the folks from Bear Sterns and Lehman will form a Boutique. It will be a success.

-The debate over Glass-Steagall will linger. It will not happen. It is not practical at this point. This creates a dilemma for Goldman Sachs. Can they go private and then just ignore all the noise?

-Fannie and Freddie will be merged. Their troubled assets will be transferred to a workout trust. There will be talk of returning the cleaned up entities to the private sector. The cost of these steps will bring the total losses to $500 billion.

-FHA will receive a $40 billion equity infusion from Congress. This capital increase will be necessary as it will be determined that the FHA model is the best approach for Government involvement in the mortgage market. FHA will use the new capital and substantially increase its lending activities. This step will avoid the necessity of a bailout of FHA. These actions will marginalize Fannie and Freddie.

-In 2010 over 90% of all new mortgages will come from or be supported by the government.

-There will be spot shortages of all manner of things. Soy oil, diesel fuel, specialty steel, industrial chemicals, ball bearings, replacement parts etc. This is an inventory problem. It will result in price jumps for things. This will be a global story.

-There will be several occasions when it will appear that we are about to fall off a cliff (or soar to the moon). Beware of these conditions. It is more than likely that the markets will be oversold and over-worried (or too enthusiastic).Take profits at these points. Do not stretch a bet too far. If you have some winnings in the jar consider counter trading big market moves on the day that the issue at hand gets front page coverage in the NY Times.

-Japan will not get out of recession. They will have to confront the issue of deficit spending and their debt to GDP ratio. Their response will be to sell reserve holdings to fund the deficit. The amounts involved will be small but the change in direction will be perceived to be significant.

-We will pay significantly more for virtually everything that we consume. The CPI and COLA numbers will be modest. We will be poorer as a result.

-American’s distrust of their financial institutions and our financial leadership will deepen. The whole notion of “I Promise to Pay” will come into question. As a result, the availability of consumer credit will continue to dry up.

-There will be no curbs placed on Dark Pools or flash trading. The short sale rule will not be re-introduced. There will be no regulated futures market for CDS. The Securitized Market will not recover.Nothing will change.

-The “Flight to Quality Trade” will be a dominant theme for the markets throughout the year. At some points this topic will drive the big capital flows. A month later they will have been reversed. This instability is driven by the conclusion that there really is no ‘Quality’ that the capital is Fleeing to. It is just the constant movement of the deck chairs. This creates good trading markets. Great opportunities to make and lose money will present themselves. It should be a fun year. Enjoy it.

What are We? - Stupid?

I was disappointed with the Christmas Eve ditties from Treasury and FHFA re: the Agencies. To be honest, I was appalled. The two releases contained significant information. The timing was obviously an attempt to slip in some bad news while everyone is drinking eggnog.

Of course that backfired. The blogs, and yes, the MSM disintegrated those that sent the emails out on Christmas Eve. The smell that these announcements have created is not likely to go away anytime soon.

If you are reading this you know the story. Treasury ponied up for another $200b for Fannie and Freddie and the management of these entities are getting serious paychecks.

The former clearly establishes that Fannie and Freddie have been nationalized. I don’t care what they say any longer. The numbers speak for themselves. The $400 billion the taxpayers have signed up for far exceeds any theoretical value for these two important institutions. Sadly, ‘the people’ own these things at this point.

The notion that the Agencies are private sector companies with influential shareholders is over. These entities are no longer big shot players on Wall Street. There is no earnings prospect for these behemoths. There is no upside. There is no justification for multimillion dollar salary packages.

The Agencies fund themselves with lines of credit from Fed and Treasury. The Fed is buying 1.45 Trillion of their dodgy paper. Why in the world do we need to pay someone $6mm per year to run that mess?

A question for Mr. Geithner; What are the salaries and bonuses being paid to the people who run FHA? These are government salaries. FHA is a part of HUD. Compensation for Fannie and Freddie Exec’s should conform to those guidelines. Not the other way around. We need to end the myth that F/F are private sector entities. They are not.

We are not stupid Mr. Geithner. We watch what you are doing very closely. There are a significant number of us who flat out do not trust you. You have given us good reason in the past and you have proven again that you are not trustworthy. You tried to ‘Sneaky Pete’ some important information past us. In my view you owe us an apology and explanation, or better still, a letter of resignation. This Administration has promised a much higher standard than you have delivered.

US Treasury - Deep Thinking?

I was down in Washington on a business trip. That ended at four and I headed for a bar. I found a spot between Pennsylvania and Kentucky Avenues. Nice place. Two barkeeps, me and another guy who looked like he had been drinking gin for the past few hours. Quiet, just the way I like it.

Sure enough, at five the place fills up. It’s a young crowd. Good looking. Well dressed. This looked like an Ivy League group. I was thinking that they could be DOJ, possibly IRS (they looked too happy, but who knows). They could have been Treasury folks; the headquarters is not far off. Anyway, they had two drinks gossiped for and hour and left. I stayed.

At one point I happened to look under the now empty stool next to me. Some folded up papers. Being the nosey S.O.B. that I am, I picked them up and took a look. Bingo!

I am just guessing, but these initials could stand for Geithner, Volker, Summers, Goolsbee and Romer. Of course they could stand for anything. I will leave it to you to draw any conclusions that might be appropriate after a look at this. Judging from the notes that were taken, this must have been an interesting meeting. I am using the Scribd format so you can enlarge this. Enjoy!

Found Memo


If you haven’t as yet, take a look at the ‘labels for this post’. Life is a comedy. We’re all a part of it. Happy Holiday.
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Fannie's Christmas Present - A Delayed Repo

I was struck by the following announcement from Fannie Mae.

Being the nice guys that they are, Fannie is giving homeowners a few more days before they get tossed on the street. I have not seen that the other D.C mortgage lenders have followed Fannie’s lead, but I am sure they will. Freddie Mac, FHA, FDIC and the Federal Home Loan banks are also “nice” guys who are also in the foreclosure business.

I agree with this decision. What’s the sense of chucking people out in the cold over the holidays? We are supposed to be a compassionate people with a compassionate government. I am not sure that those who get this two-week reprieve will really be enjoying the Christmas spirit. Waiting for the axe to fall does not fit in with the plum pudding and presents thing.

Assume that all of the lenders followed Fannie’s lead and suspended foreclosures from the 19th to the 3rd. That would be a pretty big deal. The number of foreclosure has now reached a level of 11,000 per day. So this break in the action by the lenders would defer as many as 160,000 homes from foreclosure. But that is only for two weeks. It just means the January/February numbers will have a bulge.

The 2009 foreclosure will come in around 4mm. Up from 2.2mm in 2008. In the period 1950-2000 the foreclosure rate averaged less than 1% of all mortgages. In 2010 foreclosures could be 7%. There is nothing normal about our current conditions.

It is certain that there is more bad news in front of us on this issue. Washington has introduced the HAMP and HARP programs in the last year to combat the tide of foreclosures. There has also been pressure by regulators and even the White House on the private sector lenders to avoid foreclosures. These efforts have reduced the numbers, but the real impact is to pass the trash to a future period. We know that 60% of restructured mortgages re-default in less than one year. There is no second chance at this. That 60% is going to hit a wall sometime in 2010.

By any account the US is the wealthiest country in the world. We are also the most indebted. Two years ago I would have thought it impossible that we could come to this. A two-week moratorium on foreclosures is the best we can do. Possibly we are not as wealthy as we think we are.

CITI Secondary - A Busted Deal?

I wrote yesterday about my distrust of the Citibank “Exit TARP” plan. My worst fears have been realized. At the last minute The US Treasury pulled their part of the deal. Treasury was going to sell up to $5 billion of Citi common this afternoon. And now they are not. The taxpayers are going to be stuck with the shares for a long time. The plan to sell these and another $25b next year is simply not going to happen.

It will be interesting to see the headlines from the company and Treasury on this one. What are they going to say? Excuses like, “Market Conditions”, Abu Dhabi did not buy”, are not going to fly. The stock may pop tomorrow morning from the cut back in the amount of shares sold. But there is not much upside given that there is a mountain of shares ($30b) that are on the shelf and have a 4-Sale sign on them.

This just out from Bloomberg. They did not like the price??? Busted.


Dec. 16 (Bloomberg) -- The U.S. Treasury Department is delaying sales of its Citigroup Inc. common stock because of the low price in the bank’s secondary offering, a person familiar with the matter said.

Greece - A Line in the Sand?

On December 10th I raised the possibility of Greece breaking the connection with the Euro. On the likelyhood of this black swan type of event happening I said, “This is not a high probability outcome.” A week later the possibility of a realignment of some sort is still remote. But it is a tad closer.

On December 11th Steve Barrow at the Standard Bank, London wrote a piece that raised the issue of both Greece and Ireland doing something with currencies to assist their domestic economies. Steve clearly has more visibility than I do. His thoughts got to the Finance Ministry in Dublin who responded with, “Uniformed comment”. The Greek FM was very clear on the topic. “No chance Greece would leave”.

This is a risky development. The Central Banks have put a line in the sand on this. That is always a mistake. When a CB says, “Such and such will never happen” you are going to get people (like me) saying, “Oh, really?” The very fact that they are saying, “that is rubbish” just fans speculation.

Greek PM Papendreou proposed a cutback in 2010 expenditures to 8.5% of GDP (down from 12.7%) as a way to instill confidence. For me that is, ‘rubbish’. It will not work. If cuts like that are made there will be social consequences. That instability will just fuel the sovereign ‘flight risk’ issue. This problem will not go away with just that proposal on the table.

The Central Banks have drawn a line in the sand for good reason. They do not have a choice. The countries that are at risk have issued mammoth amounts of debt in Euro’s. If some form of two-tiered Euro were the result the cost of revaluing the debt for both the public and private sector would be devastating.

The flip side is that the countries that are suffering have no policy options available to them. They can’t provide a meaningful stimulus because of the Euro link and limitations on budget deficits that the link mandates. At some point this will become untenable. The argument that a two tiered Euro would stimulate both the tourist and industrial economies of Greece, Spain and Ireland (Italy too) becomes compelling.

I don’t see a soft landing. At an extreme where could this go? It leads to global financial instability, it could be very deflationary. Precisely what the global economy does not need. Greece is a bit like Sub Prime. By itself, it truly was containable. But it exposed other weaknesses. If one was looking for something to upset the applecart, Greece could very well be it.

CITI's Out of TARP!! - Not....

Reading the newspapers and watching TV one gets the impression that Citi is about to exit TARP and all is well in the world. A few headlines to that effect:

Citi itself is pushing the notion that it is about to cross a big threshold:

This overview of the transaction comes from the red herring on Citi’s big secondary:

The dollar value of the “remaining equity stake” is $25 billion. There is no certainty that this amount can be paid back in the “6-12” months indicated in the prospectus.

Citi is not out of TARP. Those headlines were wrong. They will be out of TARP when they have repaid all of what is owed. If Citi receives the benefits of ‘being out of TARP’ before it is actually out of TARP the process will have been subverted.

A question: Were there others (like me) who misunderstood the recent announcements regarding Citi’s changing status?

Rex Tillerson's Carry Trade

You have to hand it to the boys at Exxon. When they go shopping they bring a debit card with no limit. The XTO Energy deal is worth $31 b. That represents nearly 10% of the market cap for XON. They paid a premium of 25% to get it done. That is a measure of how much this deal meant to them.

You can be sure that this deal was looked at every which way before CEO Tillerson said yes. There was a lot of that ‘deep thinking’ going on. At the end of the day I think it was as easy as looking at the futures market.

The closing futures prices for Nat Gas yesterday were as follows:

January 2010 = 5.332

January 2011 = 6.900

The year over year price differential is $1.568. That is a premium over the near month of 29%. That is a very big number. There are a number of contributing factors to this premium. The most significant of which is the lack of storage capacity and a big enough balance sheet to finance it. No doubt but that the good folks at Exxon will be earning a significant portion of that premium in the years to come.

I have never been a big proponent of the thinking that the futures market is a good indicator of where cash prices are headed. However in this case the futures market may be telling us something.

Another way of looking at the forward premium on Nat Gas is as a cost of ownership. When something costs you 29% a year to own you are not likely to own it. A condition like that is one that leads to shortages and sharp spikes in prices. That would be good for Exxon, bad for just about everyone else however.

How to Triple Your Money in One Month!

Three weeks ago, as we were eating turkey, Dubai blew itself up. Quite deliberately. It caused quite a hiccup. Now the problem seems to have been solved thanks to some bailout money from the ‘family’ in Abu Dhabi.

This sounds like the plot of a movie. It’s got all the pieces for a ‘hit’. Intrigue, big money, great location shots (London/Dubai/the desert), the characters are investment bankers, local politicians, Clifford Chance lawyers and Iranian investors. The Iran connection brings in the CIA and therefore the opportunity for high-tech surveillance and gunplay. The necessary sex/romance angles are there.

But this is not the movies. This is the crazy real world. A month ago Nakheel bonds were trading at 110%. They fell below 40 cents two weeks ago. This morning the bonds were trading north of 70. Some of the bonds look to be paid at par.

That is enormous price action in a very short period of time. The opportunity to make money on both the downside and the upside was there. Another way to have played the Nakheel bond story was through the CDS market. Pricing in that market mirrored the action for the bonds. Very big bucks were made and lost as this played out.

To take advantage of this one would have had to have been an insider. No outsider could have sold high and bought low. So the question is how many insiders were there on this deal? My guess: A few thousand.

This deal stinks. It was mishandled from the get go. The critical announcements were made while the US was on holiday. That was not a coincidence. This was orchestrated. If something like this happened with debt securities listed on the NYSE the SEC would be all over it.

This stuff is being played out on a very big stage. Caveat Emptor.

Cocktails and RE in Greenwich

I was invited to a swell cocktail party over in Fairfield County, Connecticut. This is one of the tonier Zip codes in America. It is the home of Greenwich. A very nice town indeed. The hosts (Muffi and Chas) put on a great spread. The invite read, “Seasonal Attire”. I had no clue what that meant in this circle.

It turns out that Seasonal Attire means for the ladies a $3,000 Bergdorf outfit with lots of ice and gold. For the men it means khaki colored pants, a blue blazer and hand made French cuff shirts from China. No tie. I show up in a brown sport coat and black pants. I wore a tie with holly berries on it; I bought it just for the occasion. What do I know?

I ditched the tie in a potted palm and tried to be invisible. In a short period of time I downed six flutes of Moet and most of the shrimp platter. One of the serving girls saw that I was hungry and kept the canapés coming. Her name was Laurina; I learned that she comes from Guatemala. Her story is that her mother hocked the family home for a $12k IOU to the Coyotes. They, in turn got her to El Paso, Texas. That was in 2006. She lives in nearby Bridgeport and works steady. She has already paid back the coyotes (with interest). She thinks America is great. Can you see this picture?

I did my best to mingle. The ladies had a lot on their minds. There was a consensus that the private schools were not as good as they used to be, and as a result there is pressure to find home tutors. The problem seems to be that there is a shortage of the ‘best’ tutors. That struck me odd given the number of layoffs in the public schools of late. Anyway “all” the good tutors have been taken and there is now competition. One lady confided her solution. “Offer to double the fee and they will drop one of their other clients”. Money talks in Greenwich.

They guys seemed to be either bankers, Wall Street types, lawyers or involved with a hedge fund. They only talked money. From the chitchat I concluded that every one of them was long the dollar and short gold last week. At least that was the talk. I think this was like lying about one’s golf score. I attempted to participate in these conversations. At one point I threw out something erudite like, “Ben Bernanke is screwing things up. QE will destroy us!” From the looks I got, you would have thought I had farted.

I did get some insight on the status of Greenwich real estate. Properties with a price tag above $10mm are still in demand and the price drops have been modest. “At most 10%”.
Evidence of this was a home that recently went on the market for a cool $22mm. It sold in a fortnight for $21mm. All cash, of course. Deep pockets are still very much in existence in Greenwich. One guy who might have been drinking a tad too much reminded everyone that there were still another five properties in town with a price tag north of $20mm looking for a buyer. Party pooper.

The problem, it seems, are those properties that are in the $1-5mm range. These have been marked down by 30 –40% and there are still no takers. These are not for the deep pocket set. These homes have traditionally been financed by Uber-Jumbo mortgages. No more. From what I heard, there is no mortgage money around for a $4mm house.

One of the numbers guys provided an update on the market.

-There are currently 496 homes for sale with a price tag greater than $1mm. The listed value of these properties comes to a whopping $1.9 billion.


-The 2009 full year sales for these homes will come in around 175. So there is a two plus year supply on the market. And that is just what is listed.


-Of these high-end homes, 24 are in foreclosure. The listed mortgage balance outstanding against them comes to a tidy $50mm. An average of $2mm. There was some discussion as to who was the lender for the $6.7mm mortgage on the property out on Close Road. No one knew for sure, but the thinking was, “It had to be Wells”.


-Some concern was raised for the “poor bastards” who might be losing their big buck homes to foreclosure in the near future. As I looked around at the unfamiliar faces in the rooms I wondered if any of them were “poor bastards”.

The average mortgage in the US is about $200k. The average loss in foreclosure is $75k. In Greenwich the average mortgage is $2mm. So when one of these babies goes under it causes a big splash. The loss is closer to $1mm. About 10 times more destructive than your every-day foreclosure loss.

After listening to all this I concluded that America’s problems with Sub Prime and Alt-A are in fact finally contained. That is not to say the problem is resolved. But we at least know what the scope of the problem is. The problems with Prime Jumbo mortgages are however still in fourth gear. It is not just a Greenwich issue. It is in every high-end community in the country. The loss of wealth by the owners of these palaces is staggering. The impact to the lenders will be so as well. The stink of Sub Prime has finally bubbled to the top.

I have never been a big proponent of the “trickle down theory”. But a lot of others are. We may be seeing its affects. The impact of the illiquidity and the drop in value of high end RE will influence consumption and demand for a very long time to come.

At one point someone asked me what I did. I responded that I wrote about financial issues. When asked where these might be seen I said “Zero Hedge”. Talk about cutting a fart. I went home early.

The Wall Street crowd is very much aware of Zero Hedge and the other new sources of financial information/ideas. I did not get the sense that it was welcome. That’s a good thing.

Greece, China, USA and the Euro - All Connected?

I spoke with some friends who are Greek and also in the shipping business. They hate the problems that Greece is facing. The 12.7% budget deficit is the highest in the EU and is not sustainable. Efforts to cut government expenses have caused a political backlash against PM Papandreou. The only available solution is to raise taxes and crack down on tax evaders.

The Shippers are largely untaxed on their global operations. Their status is ‘protected’ under the constitution. Taxing the shippers would go a long way toward closing the budget gap. The changes in tax laws will not come easy. There is no certainty of the outcome. The sense that I got from these discussions was that there is a short window open for Greece to come up with a plan to cut its deficit to approximately 9%. I asked for both a ”good” and a “bad” news scenario. Although the responses to the question I asked are speculation, they have interesting implications.

GOOD NEWS:

"If Greece is able to restructure its tax code and install a plan to reduce its deficits to 8% of GDP, then China will invest Euro 25 billion in Greek bonds."

The issue of the Chinese investing in Greece was first raised on November 29 by the WSJ. I think it was one of those well placed rumors. If this were to happen, it would be of significance. It would establish that China is assuming a role as some form of 'lender of last resort'. The bilateral trade conditions that would be attached to a deal of this magnitude would re-raise the issue of China’s trade hegemony and economic muscle. For me, the most significant aspect of this is that it would represent yet another significant diversion of China’s investable funds away from the US.

If this were to happen, the $40 billion under discussion would not impact the supply demand equation for US debt. But the direction of this would be significant. The US desperately needs China to significantly increase their holdings of US IOU’s in the coming years. They are under no obligation to do so. What if they were to take a stance with the US similar to Greece? We would get a headline that looked like:

China to Purchase $200 Billion of US Debt

Terms include: Higher interest rate, a commitment to buy Chinese goods and a promise to reduce the deficit.

Of course we are not going to see a headline like that anytime soon, but the developments in Greece are a possible first step in that direction. If China bails out Greece in 2010 it is a game changer from a number of perspectives.

BAD NEWS:

"If Greece is unable to address its budget deficit the Chinese will not invest and financial conditions for the country will deteriorate quickly. One consequence would be that Greece would be forced to separate from the Euro."

This is not a high probability outcome. However, talk of  it would have a very significant impact on the FX markets. The people who I spoke with made an interesting observation, "Switzerland is very much integrated with the EU and the Euro, but they have maintained their own currency. If Greece had its own currency it could adjust it to achieve a trade advantage that would address the fundamental imbalances." (Same argument as "the weak dollar is good for the USA"). These same people point to the fact that the Swiss National Bank has been intervening in the currency market to weaken the Swiss Franc in order to achieve a trade advantage. The thinking is, “If it works for the Swiss, then Greece should do it too!”

Consider where this could go. If there is talk of this happening, it would raise the same issue for Spain and Italy who are suffering from their association with they Euro. This could lead in the direction of a two-tiered Euro. One would be strong. The other weak. The implications for the dollar would be significant in both the short and long term. It could be the source of instability as the process unfolds.

The Greece story has already gotten the money moving. It is a story that could take us in some surprising directions. I got the sense that there was a short fuse on this. The next three months may put some powerful forces into play.

Is there anything behind the Chinese/Greece connection? I think so. I always assume there is something to it when you get statements like the following. Asked whether Greece is negotiating with China to sell bonds, a government spokesman said:

"It may be true, and if it is true, we do not want to comment. But even if it isn't true we wouldn't want to comment.”

Bernanke's $50 Billion Hidden Stimulus

Chairman Bernanke has remarked on the Fed’s program to purchase Agency bonds on a number occasions. He has been very clear on the Fed’s intentions. The Federal Reserve itself has been exact in the language used in the official communiqués on this topic. It boils down to this:


The Fed will purchase $1.25 Trillion of Agency MBS. They will complete these purchases by March of 2010.

That sounds pretty straight forward, but of course nothing is straightforward when you are dealing with such large amounts of complex securities.

A review of the reports on the Fed’s POMO - Agency buys shows that a significant amount of the purchases are of high coupon 30-year paper. The coupons on these bonds were in the 5.5 – 6.5% range. They also have purchased new issues with lower coupons. A conservative assumption on the average premium paid on the bonds acquired is 4%. I arrive at that by discounting 1/2% for ten years. *

If you pay 1.04 for 1.25 T you have shelled out a total premium of $50 billion!! Bernanke could have described the program in an alternate, but equally accurate way:

By the end of March 2010 the Fed will have acquired $1.25 Trillion of Agency mortgages. The total cost of these purchases will be approximately $1.30 Trillion.

The difference between the cost and par value is just a way for Bernanke to understate the scope of what he is doing. The extra $50 billion is just more monetary stimulus. It is exactly what he wants. I am surprised that Mr. Bernanke does not tout the bigger number as a broader measure of his success…..

*I know that a number of you will have more accurate estimates of the total premium that will be paid. I would love to see them.

Bernanke: "Long Live the Carry Trade!"

The jobs report turned the market hard on Friday. A 2 big figure gain on the Euro and $50 on the gold price tells it all. Based on the employment data it is very hard to believe that US interest rates can remain at zero for much longer. But that is exactly what is going to happen. The carry trade is alive and well and will resurface as a dominant market factor. It is just going to take a bit for the power of zero cost debt to start driving the money flows.

My totally non blue chip economic forecast for GDP goes as follows:

4th Q 2009 = 4%
1st Q 2010 = 4.5%!!
2nd Q 2010 = 2.5%
3rd Q 2010 = 1%
4th Q 2010 = 0%

These numbers are not too far from the thinking at Goldman. They see things chugging along and then slowing. My numbers are more extreme then theirs for end of 2010. My guess is that we are going to hit a wall sometime around mid-year. By then most of the monetary and fiscal stimulus will be gone. Without the oxygen we are are going to stall.

Bernanke has stuck to his guns and set out a timetable for the end of the Agency purchases as “March”.  This certainly means that there will be no increase in the Funds target until at least then. After that it gets a bit murky. The Fed Funds Futures closed Friday at levels that I think are a pretty reasonable assessment of what might happen. My read on what those numbers say:

-It is a pretty decent bet (70-30) that the Funds rate will be increased 25BP by June.

-It is almost certain that the Funds target will go up 25BP by August of 2009.

Let’s say that that is wrong. Take a scenario with a more extreme outcome than suggested by the futures market. Assume Ben shows his muscle and tightens the Funds rate by a whopping 50BP by September 1st. Who cares? That is nothing.

So now it is September 2010, the economy is again clearly decelerating. Unemployment will be at best 9%. Does anyone think that Bernanke will increase rates by more than 50BP given the economic backdrop that he will be looking at? Not a chance.

When people get to understand that this low rate environment is going to be with us for a long time, the seduction of the carry trade will again be the dominant theme.

The price action on Friday killed the leveraged players. I talked with a lady on Friday night. She runs big money in liquid macro trades. She got beat up. She said,  

“ The carry trade is like an orchid. It looks beautiful, but when you get too close it smells like rotting meat”.

The rest of the conversation was about timing and entry points to put the trade back on. Nothing has changed.

Jobs - A Solution at Hand?

Big job confab at the White House today. Some very smart folks are in attendance. No doubt but that there will be some good recommendations made. The question is can we afford to implement any of them?

I am as certain as I can be that one of the suggestions that will be put forward would work. The National Federation of Independent Business’s (NFIB) has recommended that payroll taxes be eliminated for at least one-year.

Take a closer look at the implications of this. It is my estimate that 2010 calendar year payroll taxes will be $680 billion. This is a massive amount of money. If the tax were suspended for a year a portion of this pile of money would go directly into the pockets of America’s 90 million+ workers. It would equally go into their employer’s coffers. The primary beneficiaries would be small businesses. In other words, this would go right to where it is most needed.

At roughly $700 mmm this would be a size equal to the entire two-year stimulus program of February 2009. But its impact would be multiples of that in terms of increased demand in the economy.

I do not have a big computer, but a program like this would result in a jump in GDP of 3-4% just by itself. A guess on job creation would be around 3mm. If you want a big jolt in the arm this is it.

Eliminating payroll taxes for one year would be a very progressive step. Therefore there would be political support for this approach. Doing so for 2010 would put hundreds of billions back in people's pockets just before next year’s elections. Who could find fault with that?

There is one significant flaw to this approach. It would devastate the Social Security Trust Fund. That is something that Congress will not allow to happen. Even with the benefits that may go with it, that would be a 'no sale'.

There is a way to do this Revenue Neutral to the Trust Fund. It is relatively easy. You just have to cut current and future benefits that the Fund pays out. That would be extremely unpopular. Nothing like that could pass either.The Grey Panthers would rise up against the Democrats.

There is one approach that could work. A “means” tax on benefits for a stated period of time. A simple rule: If one has taxable income over $150,000 they do not get benefits for the following year. If this were in place for approximately five years the Fund would have offset the shortfall incurred in the first year where no taxes are collected.

The number of individuals who are both 65 and earn $150,000 is not large. They may yell and scream at this, but they are small in number. Those same individuals have significant irons in the fire. They would benefit from the robust economy that would follow.  To make it fair, the amount that had been withheld could be deducted from future death taxes that will come due. My point is, this deal is sellable. The bulk of the "Panthers" would love it.

These are the pieces for the largest stimulus effort in history. And it is budget neutral. Keynes would be proud. The results would be dramatic. The impacts would be lasting. This by itself would not right our economy. But it would give us three to four years in order to dig ourselves out of a hole.

It will be interesting to see if the approach by the NFIB gets the attention that it deserves.

Note: The Trust Fund owns $2.5 Trillion of Government IOU’s.  For them (through Treasury) to repo $650b into the 1-3 year credit market over the course of a year would not represent a significant issue for the bond market. One consequence would be that this would drain available liquidity; precisely what the Fed has told us it intends to do. This would be achieved with less impact on supply and demand than other options available to the Fed. A drain of about $700b is approximately the right size.

Threshold of Pain

In late September the weak dollar and strong gold story were becoming obvious on the charts. I made a comment on someone’s blog:

“IF gold gets to 1200 and the Euro reaches 1.5 and the Yen is at 85, then Bernanke will be forced to give up the QE policy and reverse the emergency zero interest rates.”

I could not have been more wrong on that call. We have achieved the levels that I thought would be a, “Threshold of Pain” for the Fed. As of today the likelihood of the Fed amending its monetary stance anytime soon is nil.

For me this means that the pressure on the $ and gold has to continue. We are already at some galactic levels for gold and the dollar. I would have thought we would be in a “panic mode” if the screen read 1.51 and 1200. But there is no sense of panic at all.

I am revising my forecast for the threshold of pain: IF the Euro gets to 1.55 and gold goes to 1400 Bernanke will be forced to accelerate the timetable for reversing the emergency monetary measures. (I think the Yen is now a side show, it may add to $/Euro weakness)


Note: It is not possible to forecast short-term currency/gold movements. I have learned that a number of times. Therefore do not read this as a prediction of the next currency blow up. Rather it is a prediction that the Fed bows to the market to avoid a currency blow up. If we do see 1.55 and 1400 there will be a sense of panic.