My Vote

If you give money to candidates the amount and beneficiary are made public. If you look me up you would see that I have contributed to Democratic candidates on a regular basis for a long time. Not this year. As a long time Dem, it is hard for me to describe my disappointment. There is very little that I can look to over the past two years and say, “They got this one right”. So this year I am going to vote with my feet. I think people like me are key to this election.

I live in Westchester county NY. This is the 19th Congressional District. There is a lot on the ballot this year including a local plan to raise taxes and create a “reserve fund.” I will most certainly be voting against the latter. I have come to learn that “rainy day funds” get spent at the first sign of clouds.

The NY story is not so important. This is a Blue state and even with the lousy governance the Empire State will remain blue. But I think the Wednesday morning look will show that NY has gone decidedly in the direction of purple.

For Governor we have Andrew Cuomo versus Carl Paladino. Cuomo will win handily. Paladino is an upstate Pol who has no credentials to be Governor. He has threatened news reporters with violence and made a number of blunders. He said NY’s junior Senator Kirsten Gillibrand, “is Schumer’s “little girl”. That went over big. Carl’s only contributions so far has been is his slogan, “I’m mad too”. Well I am mad and I am voting for Carl. Andrew Cuomo will be NY’s next governor, but the mandate he thinks he will get will fall much shorter than is expected.

Chuck Schumer and Gillibrand will be returned to the Senate. Chuck is an ass but he is so connected that he can’t be beat. Gillibrand is running against a no-name and will coat tail herself to another term in the Senate. I'm voting for the opposition. The hell with the "ins".

My vote will likely decide the Congressional race where I live. The incumbent, John Hall, was voted in (thanks in small part to me) in 2006 when the anti Bush sentiment was racing. He was re-elected in 2008. He is a former rock star that is somewhat famous for his song, “Still the One”. John has done an okay job as a junior congressman. He voted 98% of the time with whatever Nancy Pelosi told him to. He also did a good job helping veterans get the benefits that they deserve from the government. He is running against Nan Hayworth. She is an eye doctor and has no political experience. I will be a crossover voter for Ms. Hayworth. I believe she is going to win. The polls disagree.

As you can see this is a tight race with a slight bias to Hall as a result of his 52/43 advantage in Westchester County. Well I can tell you that many of my neighbors are Mad too and I don’t think that Hall will carry Westchester with the majority suggested. As a result Mr. Hall will lose his seat. This district was considered “safe” for the Democrats not so long ago. I think the loss by the Dems in NY’s19th is a bell weather for how many congressional races will go. There will be a surprising number of safe seats in the House that are going away to other candidates.

At this point it is not surprise that Congress is going to go to the Republicans. The NY congressional races are not going to swing the outcome. It will just add to the majority that the Republicans will hold after this election. I do think that folks like me who are predictable Democrats that will vote against the party is going to be a very big national phenomenon. Much bigger than is now being contemplated. While the Senate may not fall to the Republicans, it is going to be much closer than is now assumed.

So I am forecasting a blowout. There will be such a significant, I’m mad too outcome that I believe it could shake the tree and cause some leaves to fall.

This election is in large part about the economy. The will of the people will be overwhelming evident that big changes are required. Some probable outcomes:

-Obama care is dead. The entire legislation will be ripped apart.

-There will be no new significant stimulus measures voted on in the next twelve months.

-Tim Geithner will be replaced as Treasury Secretary. (A woman will be appointed as the replacement)

-The recommendations of the Fiscal Commission (due out 12/3) will have a greater chance of implementation.

-Social Security (the biggest expense) will be changed. Taxes will be increased, benefits cut and the age for benefits will be raised. This will happen in 2011. The cutbacks will be greater as a result of this election. The social consequences could be very significant.

-The fate of the Bush tax cuts will be altered. This issue must be addressed prior to 12/31 or taxes just go up. The “Voted Out” legislators will still be the ones casting ballots on this critical issue, but the public mindset will not be ignored. There are three significant tax issues on the table. Tax breaks on those earning under $250k and separately breaks for the over $250k set. This has been decided long ago. The above will get hit, the below will get the tax break extended. Nothing new.

But the wild card that will come on the table is AMT. If the exemption is allowed to expire it will hit nearly every American family making $100k. An estimated 20mm households will pay more as a result. If the Dems were to hold congress AMT would be patched and rolled over for a few more years. If the Dems lose the House but hold the Senate there will be enough sentiment to patch over the problem a bit longer. But if the Senate falls or the House is a biblical rout for the Dems (my thinking) then AMT could become law for 2011.

-Fiscal conservatism will become a respected concept. Right or wrong this will be the result if the pendulum of sentiment turns as violently as anticipated. The likes of Paul Krugman (who having been calling for a few trillion in additional deficit spending) will have been quieted.

-The election will mean an end to bailouts. Treasury recently sneaked by a $35b bailout of the National Credit Union Association. That will not happen again. The concept of TBTF will be tested. The safety net will have been taken away by the election. The area of most concern to me is a few of the Mortgage Insurers. Some have been beaten to the ground. Foreclosure gate is another problem for these players. The MI companies owe a boatload to the banks but they owe bazillions to Fannie Freddie and FHA. A collapse of any MI company could start a chain reaction.

-The stock market likes a split government. The idea that, “Nothing will happen in D.C.” has been market friendly in the past. To a significant extent this has been priced in with the big run up in the past six weeks. At some point the market will look at the future and say, “Where’s the growth?” Without deficit spending/stimulus coupled with the higher taxes soon to come the outlook for the economy has to be taken down a notch or two. The prospect of long-term growth at sub 2% is not built into the market.

-The dollar might benefit for a bit should the headline read: America Goes Conservative. The exact opposite mentality exists in the FX market today, so the election could be seen as a welcome change in direction. But a frozen government that is faced with critical issues does not support the dollar. At the end of the day this is about “Store of Wealth”. A broken government does little for sentiment.

-Bonds will be interesting. The slower GDP outlook that will follow the election is supportive of the bond outlook. But bonds are not trading on fundamentals any longer. They are trading on QE. Bernanke wants to buy a few trillion, so prices are all geared around this.

Bernanke does not give a rat’s ass about the election. The Fed is independent and pays no heed to what the people are saying they want for the direction of our country. A dozen or so folks make these choices with absolutely no consideration for popular sentiment. This election might change that.

If the vote goes the way that I think it will the unlimited power of Ben Bernanke will be checked. It will be done in the pages of our newspapers from Wednesday on. But the real changes will take place on January 11 when the new “ins” start to stretch their muscles. There is something fundamentally wrong with a country that will send a very clear message of conservatism and a Federal Reserve that is out of control and printing $100b of phony money every month. Bernanke is going to be called on the carpet to defend what he is doing with QE. It will happen in Q1. Bernanke and his risky plans are in for a slap in the face. It will tie his hands. The results of this are potentially very unfriendly to the bond market.

Fed Eats Treasury

Historically the US Treasury Department has been responsible for the Dollar policy and liability management (debt issuance). Both of those responsibilities have been co-opted by Ben Bernanke.  That Treasury has let this happen speaks volumes for the lack of leadership. In my opinion Treasury is allowing the Fed to run wild while the systemic risks are rising.

The issue of exchange rate policy is, I think, clear-cut. There is a direct correlation between QE and dollar weakness. A weak dollar is a primary goal of QE. A cheap dollar policy will bring us the inflation that Bernanke keeps telling us we need.  It will also make us a pariah. This comment from the German Finance Minister at the Korean G 20 says it all.

“I tried to make clear that I regard that (QE-2) as the wrong way to go. An excessive, permanent increase in money is, in my view, an indirect manipulation of the exchange rate.”

The issue of liability management is not as clear as is the case for FX policy. Let me try. Consider this chart of existing treasury debt outstanding.

As Zero Hedge has been pointing out for weeks, there simply is not enough long-term bonds outstanding for the Fed to purchase.  

QE-Lite commits the Fed to buy Treasuries in an amount equal to the roll off of the MBS book from QE-1. Between the low rate/refi’s, repurchases of mortgages in default (20+%) and the normal turnover in homes a substantial portion of the Fed’s MBS book will run out over the next 24 months. We could push $1 trillion just from that. Then there is good old QE-2 that is staring us in the face. That number starts with $500b and goes easily to a Trillion. A reasonable estimate for the amount of total Fed POMO buys between now and 12/31/11 is $1.5 Trillion.

With that estimate go back to the graph and tell me what are they going to buy? There are few choices:

(A) The Fed could buy 100% of all existing issues from 2018 on. They could also buy up all of the scheduled new issues for the next 14 months with a maturity greater than eight years. That would come to the $1.5 trillion.  This approach would be insane.

The existence of a viable and liquid long-term bond market is a cornerstone of America’s capital market. Eliminating a substantial portion of the float for maturities ten years and longer would have negative implications for liquidity for all long-term debt issued globally. The US Treasury market has always been a benchmark from which thousands of other credit instruments are spread priced. Liquidity in Treasury issues is an essential ingredient for swap and hedging pricing. A busted Treasury market is like putting sand in all of the capital markets. Things will grind down. Liquidity will be impacted.

(B) The Fed could buy all maturities such that their purchases approximated the average life of existing US debt. This would be supremely insane.

The problem is that the average maturity is just a bit over four years.  Looking again at the chart you will see that in order to achieve a balanced purchase program the Fed would have to acquire hundreds of billions of 2, 3 and 4-year paper. Two problems:

(I)           Interest rates for these short maturities are already at historical low levels. Further reductions would starve more savers and fatten bank income statements. But they would do nothing for the housing market and the unemployment rate.

(II)         What happens in two years when $300b of bonds owned by the Fed come due? Is Treasury forced to issue more debt to the public to pay off the Fed? That would be an opportunity for the bond market to rape the taxpayers. They would have the Fed and Treasury in their crosshairs. Keep in mind that this conflict is not some time far off into the future. On the day that QE-2 is completed it will be less than twelve months more until the first maturities hit. What will inevitably happen is that Bernanke will rush to the rescue and announce that he is rolling over his holdings and will do what he has done with QE Lite. He will have permanently expanded the Feds balance sheet. He will have no other option but to do so. IMHO there is no greater systemic risk that the nation faces. We will have been forced into a policy of perpetual QE. PRECISELY WHAT BERNANKE HAS PROMISED AGAIN AND AGAIN THAT HE WOULD NOT ALLOW.

We are getting dangerously close to a trade war with our closest allies. The US weak dollar policy engineered by Bernanke has global considerations beyond short-term economics. This is a matter for the Executive Branch of government. Elected officials are responsible for this critical policy matter.  So far they have just looked the other way.

Treasury is responsible to the people for maintaining viable capital markets.  They are mandated to minimize the risks associated with bunching of maturities. Yet the Fed’s QE will clearly undermine their efforts. And they have been silent these past few months. If they were looking out for the best interest of all Americans they would have been yelling and screaming that the long-term strategic interests of the US are not aligned with a short-term bet by the Fed.

Bernanke has his foot so deep in his mouth with QE that he can’t back off and he can’t win. If he comes with some minimalist approach it will accomplish nothing, except disappointing all those who think they own a free put. He could go the other way and give us shock and awe. Thirty-six months later America will fall into a hole that will take a very long time to dig out of. Either way, QE and the Bernanke Fed will go down in history as one of the worst mistakes the country has ever made. History will not be so kind to Geithner either. As Treasury Secretary he ignored two critical obligations of his office. We will all pay a big price.

Ackman Loses – Fannie/Freddie Win! Not…

Bill Ackman of Pershing Square Capital looks like he lost a small battle. He was in a fight to take over NY’s Stuy Town. The property was foreclosed on today, so Bill lost out. But, as is usual, he came out a winner. Fannie Mae and Freddie Mac were on the other side of this. So you might say they won. I think they just made a mistake they will regret.

Stuy Town was bought in 06 for $5.4b. The cash flow never covered interest. So when the reserve ran out the deal cratered. The transaction was financed with a $3b first mortgage. The balance of debt was subordinated junk and worthless equity. Fannie and Freddie bought a total of $1.5b of the mortgage. The other half was picked up by Wachovia. The Wachovia interest was put in a mega ($7b) CDO .

The Wachovia piece has been scattered to the wind. That puts Fannie and Freddie in complete control. CW Capital is the servicer, but one can assume that nothing happens without F/F signing off on it.

Ackman got into the story by buying a piece of the sub debt. He paid $45mm for a $200mm chunk and tried hard to use his position to muscle his way into controlling the property for little money down. He has been fighting this in the courts and delaying the foreclosure for months. I have no connection to this deal but it might have sounded like this:

Ackman to F/F/CW:

"My lawyers have bigger balls than yours do. We will paper you to death. You want me to take a walk?  Pay me the $45mm I’ve got in the deal."

This from Reuters:

Under the settlement, an entity created by CWCapital will buy back the loans for the $45 million the joint venture between Ackman's Pershing Square Capital and Winthrop Realty Trust paid for them, Winthrop said in a statement.

Okay, Bill is out, money good. And Fannie and Freddie are sitting on a loser. This discussion of the Stuy Town value comes from the FHFA. Fitch had valued Stuy Town at only $1.8b I asked FHFA about it:

FHFA:This is Fitch’s estimate. Other firms estimates place the values between $1.6 and $2.2 billion depending on the cap rate.

The first mortgage is at $3.6b and there is accrued and unpaid interest piling up. The assets don’t cover the principal. But the worst news is that our pals at Fannie and Freddie are about to become one of the biggest landlords in all of NYC. This is a 60 year old property on 80 acres with 11,250 apartments. It is hard to even conceive of the cost of maintenance and infrastructure improvements. Keep in mind that this in Manhattan.

If you follow the ownership responsibility for Stuy Town it goes straight to the Treasury Department as they are the administrators of the zombies called Fannie and Freddie. A letter to the T.Sec might read:

Dear Mr. Geithner,

I am writing to you as you are responsible for Stuy Town now that you own it. So here are some of my problems:

-The water tastes bad and the pipes are leaking. The electric is faulty and dangerous.
-The washing machines are always broken. The coin changer keeps getting robbed.
-My windows all leak air. The heat never works. The lights are out in the hall.
-The sidewalks are all broken. There is graffiti everywhere. Our playgrounds are in disrepair.
-I think I saw a rat near the garbage bins.

Please help me with these problems. Thanks in advance!

New York City Councilman Dan Garodnick
(represents Stuyvesant Town and Peter Cooper Village and lives at Stuy Town)

I am sort of joking about the citizens of Stuy Town directing their complaints to poor Tim Geithner. But in another way I am not. Fannie Freddie and Treasury will rue the day they took control. The New Yorkers will just eat them alive.

Bernanke: Tap Lightly

Jon Hilsenrath at the WSJ has been THE mouthpiece for Bernanke for the past few months. Bernanke has been telling him what is on his mind and Jon prints it. That the debate on monetary policy is being conducted like this has been one of the big mistakes at the Fed this fall. Today Hilsenrath has leaked more of the maestro’s thinking. This time it is a big shocker to me. Bernanke has apparently heard all of the opposition to his mega QE-2 plan, and he has changed the scope of QE-2 as a result. From the Journal today:

The central bank is likely to unveil a program of U.S. Treasury bond purchases worth a few hundred billion dollars over several months.

A few hundred billion? What happened to the $2 trillion that Goldman thinks might be the result? To prove that Bernanke is having second thoughts on a major expansion of QE he gave this quote to the WSJ:

Mr. Bernanke has used the analogy of a golfer with a new putter: Unsure how it will work, he finds best strategy is to tap lightly at first and keep tapping until the golfer figures out how best to use the putter.

A putter? Does Mr. Bernanke think this is a game he is playing? He is saying that he has never putted before, has no clue how to do it, so it it is best to tap lightly? What kind of monetary policy is that? "Learn as you go", does not make me feel that there is much hope.

I warned of a possible QE-2 Mini recently. The opposition to a broader program from other Fed members and the huge public outcry against currency manipulation (QE is currency manipulation) has forced Ben to back off.

The market will be very disappointed should we get a QE Mini. A program that says, “We’re going to buy 200b in two months and then see”, will do nothing favorable to the markets. I would argue that the markets could be sadly disappointed by this.

The Fed has tried to manipulate both markets and public sentiment with its leaks of strategy. They got the world to believe that something massive was coming and now we will learn that it’s a “No big deal”. They Fed should shut up. They should not leak more disinformation. They set us up for a monetary program that would have tipped the scales. Now they have to back up because they realize the scales would not be tipped, but broken. The consequence is going to be for a bursting of expectations. Risk Off.

War On?

The G20 was a predictable dud. Our boy Tim G went to Korea trying to sell a plan to limit external deficits to 4%. This was Ayn Rand utopian economics that does not work in real life so all the other ministers said “No thanks”.

There was talk in the final communiqué that currencies should not be manipulated. That was just talk. I love it when they use words like “refrain”. What does that exactly mean?

“Countries should refrain from competitive devaluation of currencies”

The real comment on currencies came from Yoshida Noda, Japan’s finance minister:

"A prolonged appreciation in the yen is not good for Japan’s economy. Our stance, that we will take appropriate, bold action if needed, is unchanged.”

That sounds like fighting words to me. So much for peace and love from the G20. But what does "If needed" really mean?

Since nothing happened this weekend the question is how is the FX market going to read it? The logical reaction to a status quo G20 is for status quo FX action. Generally speaking that means a weak dollar play. I would not be surprised to see USDJPY trade below 81.00. The Euro will try to catch a bid over 1.40.

So we have an interesting test of the market in front of us. Do we take another big leg down in the dollar? Or does the market just try to do that and back away?

I weak dollar move would be a “risk on” market. One thing fighting against the weak dollar story is that I see little evidence that the rest of the market actually wants to take more risk on. The tail is wagging, but the dog is not.

One thing I thought was interesting from the statement:

The United States and Britain, both with large deficits, agreed to be “vigilant against excess volatility and disorderly movements in exchange rates.”

That is new. It does not mean much as the adjustments taking place have largely been orderly. It does open the door for coordinated intervention should things actually become disorderly. This statement is most certainly a measure of what the G 20 ministers are worried about. Their worst fear? A run on the dollar. The catalyst for a run would come from Bernanke. The German finance minister made that clear:

“I tried to make clear that I regard that (QE-2) as the wrong way to go. An excessive, permanent increase in money is, in my view, an indirect manipulation of the exchange rate.”

I wonder if Bernanke even listens to this. He probably spent his Sunday looking over a textbook on the depression. Why is this man smirking smiling?

New CBO Forecast – Age Warfare

I wrote a piece on a federal retirement program that elicited some interesting comments. It was clear to me that there is already a negative bias toward the baby boomers. There is an understanding out there that the boomers are going to be sucking up a great deal of resources in the next decade or so. Some comments:

We have witnessed the unprecedented lack of fiscal responsibility from the majority "Baby Boomer" voter base.

We've met the enemy, and it is the emerging 'ruling class' pensioners of the Baby Boomer generation.

...get ready for AGE WARFARE

As if on cue, the Congressional Budget Office has thrown out some numbers to fire up this emotive issue. The CBO report confirmed (to me) that age warfare is in our future.

CBO looked at all of the scenarios regarding Social Security. They ran a total of 500 simulations that reflect the different variables of the puzzle. The analysis assumed that there would be no changes in current law on SS. The objective of the exercise was to quantify the probabilities of which generation would most likely not get the benefits they were (A) paying for, (B) entitled to and (C) expecting.

The results of the CBO analysis is that there is societal/economic trouble in front of us on this issue. It should come as no surprise to readers that if you are young, you have a problem. The CBO report defines which generation(s) will be hurt and by how much. I found their conclusions to be very troubling.

If you were born in the 1940’s the probability that you will receive 100% of your scheduled benefits is nearly 100%. The people in this age group will die before SS is forced to make cuts in scheduled benefits.

If you were born in the Sixties things still do not look so bad. Depending on how long you will live the odds (76+%) are pretty good that you will get all of your scheduled benefits. However, if you were born in the Eighties you have a problem. The numbers fall off a cliff if you are between 30 and 40 years old today. In only 13% of the possible scenarios you will get what you are currently expecting from SS. If you were born after 1990 you simply have no statistical chance of getting what you are paying for. The full CBO report can be found here. This (hard to read) chart is from that report.

Sometime next year the issue of SS will have to come up. It will be central to the recommendations from the toothless and worthless Fiscal Commission. The results of that review and the recommendations that will be made are already know. Payroll taxes will have to rise for both employers and employees, the age for eligibility will raised for those under 55 and benefits for that same group will have to reduced. If those steps are taken the promised benefits to the baby boomers (60+) can be met.

That can’t possibly work. How can we convince a 30-40 year old that they should pay much more than any other generation and at the same time get less back than their predecessors did? The boomers have a big vote, but not that big. At some point it is inevitable that there will be a backlash. Laws and tax policy that favor one (minority) age group over all others have no chance of acceptance. The only question is when and how badly it will end.

France has been ripping itself apart over a subset of this issue for the past few weeks. America’s problems are much larger than France. We just have not confronted ours as yet. In France they are burning cars to vent their anger. I don’t think it will play out like that in America. We will not burn cars. We will just grow to hate old people. Cars can be replaced. The social consequences of age warfare will last a very long time.

A Whiff of a “Mini” QE-2?

The 100% certain sure thing in the market today is that QE-2 will come on November 3rd and that it will be decisive in its scope. Well I am not so sure any more.

-The Fed’s Beige Book from yesterday did not make a case for an economy that needed emergency measures. Yes there was some discussion about the weak housing market and soft loan demand. But we know that QE-2 is not going to fix those problems.

-It is of significance to me (and should be to all) that Zero Hedge was featured in a Time/CNN article titled, Will the Federal Reserve Start a Civil War?

I am certain that the Fed reads Zero Hedge. But how much influence they have is a question. When it gets up to Time magazine however, it is another matter altogether. It is not possible for the Fed to avoid the collective roar that is coming from across the country at this point. If the Fed blunders with an unpopular QE-2 the results will be disastrous. Not only will the economy tank but the Fed will have lost a good chunk of its remaining credibility. The downside risks to Bernanke are enormous. I don’t think he believes he is in a popularity contest, but he does know he can’t run monetary policy with protesters outside his door. How much is he prepared to gamble given that he clearly does not have a consensus amongst his own board? He is an academic, not a gambler.

-Today St. Louis Fed Bullard made remarks to reporters that were a warning sign to me (and the market). He talked a much different game than what has been dished out of late. He made reference to a smaller program. Maybe less than $500billion (about half what is now in the street). He also threw out something that blew me away. He suggested that the 11/3 decision was in someway dependant on the Q3 GDP numbers that come out before the Fed meets. Bullard even “spun” the numbers on the hot side:

"it may come in a little stronger than the second quarter." So we have to keep our eye on that."

Bond traders shit in their pants and hit bids on long coupons. I like that read. Bullard gave us a hint that maybe this QE-2 is not such a slam-dunk. (See ZH story on Bullard)

-The WSJ had a market story about Bullard’s comments but their big gun on QE, Jon Hilsenrath, has been quiet. Should the press follow with the new question mark on the timing and scope of QE2 we may have an October surprise that is bigger than a SF-Texas series.

I started this with; “The 100% certain sure thing in the market today is that QE-2 will come on November 3rd and that it will be decisive in its scope.” If that certainty factor falls to 50% the S&P is going to take a big dump. That possibility is simply not in the print at the close.

An "In Your Face" Entitlement - FERS

I don’t think there is anyone who looks at the issue of entitlements in the US who is not gravely concerned about the direction we are on. Economists of all stripes, damn near everyone in D.C. and a long list of academics have all highlighted the problems. But the same groups that are raising red flags are misleading us on when and how this problem will affect us.They say/think it is a tomorrow problem. Actually it is hitting us today.

I want to focus on the Federal Employees Retirement System (“FERS”). This is a retirement program for federal workers. The program is similar to Social Security in a number of ways.

-FERS collects money from government workers and their employer.

-The program pays benefits to eligible workers and their families.

-FERS has a trust fund. Currently there is $775b of Special Issue Treasury securities in the fund. This is equivalent to 6% of our total debt and is therefore a very big deal. FERS holds as much of our paper as do the Chinese and the Federal Reserve.

-FERS is running a cash flow deficit. This is a new phenomenon. FERS is converting itself into a defined contribution plan that will address some of the problems. However the cash drain experienced in 2010 will not be reversed in the foreseeable future. It will increase. Some numbers from OMB:

The benefits paid in 2010 will come to $70b. Therefore total revenue exceeds expenses by a tidy $28b. This is the conclusion presented to the public. Clearly there is no problem with FERS. They are running a surplus! I look at it exactly the other way around.

Note: In fiscal 2010 our deficit was $1.3 trillion. Total expenses were $3.4t. Therefore ~40% of all federal expenses were funded by debt. I will use this percentage when adjusting for the FERS impact on our debt profile.

Cash out at FERS was $70b. Cash in was only $4.0b. The difference of ~$66b is the real measure of what is happening at FERS. They are sucking down cash. A substantial portion of the deficit is funded with debt creation.

(A) The $17b of payments by Agencies is a paper transfer from the government agency that is the employer. Treasury turns this script into cash. Treasury has no money as we are running a deficit. The pro rata share that becomes debt is $7b (17*.40). The entire payment is recognized as a current budget expense.

(B) The $42b of interest is a non-cash item. It is just script. Think of it as borrowing from a HELOC. If you don’t pay cash each month they just add it on to the principal. In D.C. they call it the Intergovernmental Account (IG). Interest paid whether in script or cash is a current expense.

(C) The $32b of General Fund transfer is paid by Treasury. Again, Treasury will have to borrow $13b of that (32*.40) from the public to make the cash available to FERS so it can cash the retirement checks. The whole thing hits the budget.

(D) The money from Treasury (17 + 32 = 49b) is still short 17b from the 66b cash deficiency . Where does that come from? Treasury of course. FERS sells $17b of those Special Issue securities it holds back to Treasury. Once again, Treasury has to go to the public market to come up with this entire shortfall. This results in an increase in Debt Held by the Public (“DHBP”) and a decrease in the IG account. But this $17b does not find its way onto the current budget.

By my count:

-FERS had a 2010 on budget cost of $89b.
(A+B+C) =17+42+32=89

-FERS increased 2010 total debt by $62b.
(A*.4) +(100% of B)+(C*.4) = 7+42+13=62.

FERS caused an increase in the all-important DHBP of $37b.
(A*.4)+(C*.4) +(100% of D) = 7+13+17=37.

I pick on FERS as it is a little known entitlement program. They paid out only $70b last year. Their big sister, Social security will lay out $700b. But in 2010 FERS had a larger impact on DHBP and total debt than SSA. In my book if you’re adding to the debt load you're adding to the problem.

In our big economy FERS won’t sink us. But it is just one piece of the puzzle on entitlements. When you put all of the pieces on the table and study them you would see that all of programs have their lines crossing, FERS is just the first to “cross over” in a big way. Cash is going to be King in the future. All entitlements will be eating cash. The problem is that there is absolutely no way to make them paygo without busting the economy. We are in the first year of a losing battle with entitlements. It will go on for another fifteen years or so. Blame the baby boomers. I expect that is exactly what we will do.

FDIC Folds to Banks, Again

The FDIC announced this morning that they will not be going through with the scheduled increase for deposit insurance for America’s banks. The reason for the roll back in premiums comes as a result of a downward revision of the losses the FDIC faces:

The FDIC has updated its income, loss and reserve ratio estimates and has concluded that expected losses for the period 2010 through 2014 are lower than were projected in June 2010. The FDIC now projects that losses during this period will be $52 billion, rather than $60 billion as projected in June.

What has changed since the June analysis that showed a $60b loss versus the mid October guess of only $52b? How about the foreclosure fraud issue? As of today we have no clue what the impacts will be of this mess. It could be very significant. The stock market has been beating up the stocks of the banks since this story has been on the front page. While the actual impact may be unknown, what is now a certainty is that the banks will have to take additional losses due to the foreclosure disaster. Some of those losses will take some banks into the hands of the FDIC.

There is no way that loss expectations at the FDIC could be reduced in this environment. So what could be the motive for the FDIC to reduce fees at this time? Simple, they wanted to help out their pals, the banks, with some additional earnings:

The FDIC has concluded that given the continuing stresses on the earnings of insured depository institutions and the additional time afforded to reach the reserve ratio required by Dodd-Frank, that it will forego the uniform 3 basis point increase in initial assessment rates scheduled to take effect on January 1, 2011.

Is this a big deal? Not really. The FDIC insures $7.6 Trillion of deposits. Three basis points comes to just $2.3b a year. But these savings will be concentrated on the big banks. So it means a few hundred million to BAC, C, JPM, WFC and the other bad boys. These big slugs are doing just fine. They are earning billion thanks to ZIRP. They do not need the extra $300mm the FDIC just gave them.

We are not even close to a point where our financial institutions are truly sound. We have massive losses in front of us from the RE problem. Should we hit an economic wall again (an increasingly likely prospect) the FDIC will be faced with big losses. The taxpayers will foot any shortfall. This has happened in the past with both the FDIC and their sister the National Credit Union Administration. ($30b bailout two months ago!)

We have not learned the lessons from 2008, that or we have forgotten them. I am disappointed in Sheila Bair. She folded to the big banks on this one.

Social Security, Illegal Immigration and Ben

It would be correct to say:

“What is good for Social Security is good for America”.

Some of the variables include:

-Rising GDP
-Modest inflation
-Expanding employment (low unemployment)
-Worker productivity
-Innovation
-Rising population

SSA evaluates the prospects for the variables and produces a forecast. They create three alternative cases. They call them the Intermediate and the High/Low cost assumptions. That’s a bit murky. A better description might be:

Intermediate = What we are hoping/assuming will happen.
High Cost = Bad News!
Low Cost = Break out the Champagne!

Now consider how SSA looks at the highly emotive issue of illegal immigration/undocumented workers. SSA refers to this group in the PC way as “others”. This from the SSA 2010 report to Congress, page 84.

Note that the “What We’re Expecting” case has illegal immigration at 400,000 per year for the next decade. The “Let’s Party!” case has the average over 500k. Heaven forbid that illegal workers fall to only 200k per year. That would be the “Worst Case” outcome. Looking at this one has to wonder what would happen if illegal immigration fell to zero. Clearly if 550k is the good news then zero must be very bad news.

So it is not always correct that what is good for SSA is good for the USA. It makes me wonder about those other categories where the interests appear to line up but actually to do not.

As a mature economy we can only achieve high rates of growth with significant expansion of debt at every level. Consumers, corporations, cities, towns, states and of course the Feds all have to borrow and spend more if we are going to have the growth that SSA (and all other public and private entitlements) so desperately needs.

Debt = Growth
Growth = Good, therefore,
Debt = Good

Our dependence on illegal immigration to sustain growth is not unlike our need for debt to fire the engines. But like illegal immigration, debt/growth has a dark side to it. If you want evidence of that fact just consider what Bernanke is going to unleash on us. Yes he might achieve some growth with his QE-2. But what is the real cost for that growth?

On FX

A big miss by me this past week. I thought for sure we would see the BoJ at around 81.80. But they were a no show and we closed NY much lower at 81.40. In hindsight I missed a big factor in the equation. The talk of currency wars has elevated in every capital. The IMF is urging restraint. With that as a backdrop, if the BoJ were to have supported the flagging dollar, it would have meant more global bad press for Japan. So they sucked it up and did nothing.

Japan is getting hit from both sides. The weak dollar scares them to death but China's dollar peg will kill them. It amazes me to see how the economic fate of nations is being played out in the currency market. It is even more amazing that all of the key players are attempting to rig the game.

There are so many cross currents that I am not sure what comes next. Taken by itself the absence of the BoJ this week says USDJPY has to go lower. If I had to guess what’s in store I would say volatility is going up. The mark to market loss from the 9/15 $25b of intervention is now over $800mm. Of course that is chump change. The number to look at is the whole dollar book of 800b. They are down $66b on that just since August. They gave up 8.4%, or about four years worth of interest in less than three months. I wonder if anyone even notices?

The rest of the action was not of significance to me. It does not surprise me that the Euro traded over 1.40 and Sterling north of 1.60 for a good part of the week. After all, that’s what Uncle Ben wants. It also does not surprise me that they closed below those levels in NY. They both look a bit peaked.

The winner of the week was Aussie. The market conclusion, “The dollar stinks, the Euro is a trap over 1.40 and then Yen is setting up as a colossal short in a few big figures, so I want to own the AUD.” Completely logical in an illogical world.

The EURCHF is hiding in the woods. At 1.3400 it looks like a better short than a long. The problem is the number of the big positions and how they move. When the Euro is strong against the dollar the EURCHF will also have a steady bid. The Swiss don’t really care where the dollar rate is. But looking at the NY close of USDCHF .9590 you have to wonder how many folks from the US are going to St. Moritz this winter.

The China story will drive FX markets for a bit longer. There are only three possible outcomes:

#1- China continues what it has been doing. Fractionally increasing the CNY against the dollar and telling the world to, "drop dead".

#2 - China signals that it is willing to accelerate the process of CNY revaluation. The new “assumed rate of appreciation” is satisfactory to the US, Japan and the EU.

#3 - China does a one shot revaluation of the CNY by 7%. After doing so it tells the rest of the world, “Okay, we did our part, now drop dead”.

#1 means that the “currency war” talk stays in the headline. By itself I see that as a weak dollar environment. Pure economics says that an overvalued CNY puts pressure on the US current A/C. So that is a logical reason to be $ bearish. I don’t think economics has much to do with it in the short run. Market sentiment is more important. To me the China story is just uncertainty that weighs on the dollar. The US is beating on its largest foreign creditor with a very big stick. And they don’t like it. It’s not hard to think of scenarios where this could end badly.

#2 is a possible outcome. It is a middle of the road approach. It would ease the tensions for awhile. But they will resurface.

#3 would seem a long shot. It is the opposite of what China Inc. has been saying. Yet it has some appeal. It would shut down the opposition from Japan, US and EU for at least 18 months. The IMF would hail China. For its part China will have locked in a very favorable exchange rate for the next few years. In addition, everyone in China becomes a little “richer” overnight, and that would not be so bad either.

I would see #2 as being dollar neutral to slightly positive. I see #3 as being dollar bullish. I don’t think #3 is the long shot that it is perceived to be. It might be the preferred option given that one result would be China’s ability to say once and for all, “Now drop dead”.

An interesting story during the week that maybe China might be buying up some gold with their bountiful reserves. The story made sense and was good for $20+ on the gold price. China is getting next to no interest on its reserves and the policy makers behind all those reserves are doing their level best to reduce the purchasing power of what China is holding. One can’t blame China for wanting to own something that was not so hostile.

The numbers don’t add up for me however. China is sitting on $2.65T (worth) of financial assets. They can’t buy gold for any reasonable percentage of that big number. The biggest holder of gold is still the USA with 8,000+ tones. That comes to $400b. That is still only 1/8th of the Chinese cash hoard. I make this comparison to show that China can’t diversify any meaningful amount of its reserves into gold. They would overwhelm supply with even a modest effort to diversify. The price action in gold would undermine the dollar and that would not be in China’s interest. But, on the other hand, if your really wanted to say, “Drop dead” this would be a good way to say it.

Question to Readers On Mods

I’ve been hearing a story this past week that intrigues me. I can’t prove it, but I would love to know if it were true. I will throw this out to the blog world and see what comes back. Who knows, we may get some clarity on a key issue.

I have heard this story directly from a few folks in Nevada. I know someone in NY who has a similar story. But when I heard from yet another person in Florida this morning I said, “There must be something to this”. My sample of information is too small. I want to know if this is a coincidence or is there something bigger and nefarious afoot.

There has been (from my narrow perspective) a flood of approved loan mods in just the last few weeks. People who were on the edge and not paying a mortgage get a letter in the mail that says their application has been approved. After weeks and months of hanging on a phone and waiting for an axe to drop some relief arrives.

Nothing particularly unusual about that. Mods are granted all the time. But I was struck by the timing. The foreclosure story is exploding around the banks. It is not possible to see where this will end but it is a certainty that it will cost the banks big time.

What might a banker do if he was sitting on a pile of defaulted mortgages and now the traditional route of foreclosure was blocked? Adding to the problems of the bankers is that there is no assurance that they even have a valid claim to foreclose given that so much of the paperwork is tainted.

One possible response would be to get all troubled borrowers to reaffirm their debt, the second is to get the trouble borrowers back to paying something on the mortgage, even if it were a fraction of what was formerly owed on a monthly basis. A loan modification would achieve both results. When a borrower signs up for a loan mod they sign new papers. A portion of this process will re-establish any loan balance that is due. The language in the mod could have new foreclosure terms that eliminate the banker’s problem with past tainted documentation. Once a borrower makes a few months of new lowered payments they are, in effect, confirming their acceptance of the new terms.

Most Mods go bust in six months. So little is accomplished from the lenders perspective. But what if the lenders motivation for doing a Mod was not to get a borrower to a loan balance and monthly nut that they could pay, but rather the motivation was to circumvent the foreclosure trap the lenders are in? A Mod could legally resolve the problems.

The story I have been hearing is that tens of thousands of Mod letters have been sent by servicers in the past few weeks. Anyone who had an application pending is all of sudden getting the happy news in the mail.

Question to the audience: Has anyone else heard or seen evidence of this?

If this were to be true is would be a very big slap in the face of the banks. For years they have been fighting off Mods. But when the tables turn on them due the unforeseen explosion and chaos in foreclosure the banks turn on a dime and go into mass Mod mode. Should that be the case it would prove (once again) that the banks will do anything to screw their customers. The mod is just a vehicle to perfect the mortgage lien.

Bruce Krasting
bkrasting@gmail.com

Ben Lied

Over the years a good number of speeches by our leaders have been marked by history. Abe said, “Four score…”, Jack said, Ask not…”, George said, “Mission accomplished…” I think we got more of those memorable worlds today from Bernanke. His comments will be remembered like George’s. They will stick in our minds and thoughts for decades. And like George’s words, history will prove them to be a lie. Ben’s lies will cost us trillions, and quite possibly our way of life. His lie:

I am confident that the FOMC will be able to tighten monetary conditions when warranted, even if the balance sheet remains considerably larger than normal at that time.

How could he possibly be “confident” that this can be done? It has never been done before. No sane man can make such a promise when there is no history to guide us. Bernanke is sane, therefore I conclude that he is lying to us on this critical fact.

What economic environment would exist when “conditions warrant tightening”? That’s simple to forecast. If inflation goes above 4% in any 12 month period or averages above 3% in 24 months they would have to tighten. Bernanke thinks he can sell a few trillion in Bonds in that environment? Not a chance in hell. If the Fed said, “From now on we will be selling 100b a month” the bond market would fold. Long-term interest rates would pass 5% in months. 6% mortgages and competition for credit from the private sector would collapse the economy.

Bernanke is an academic who studied the Great Depression. He has never sat on a bond desk. He has no idea what it is like when the holders of your paper say, “No mas”. He thinks that because there is an insatiable demand for fixed income today the same conditions will exist when tightening is required. He says he is confident of that. Not possible.

For me the Grand Experiment of QE rests on the issue, “Can we get out this?” If that is in doubt (as I strongly believe) then the policy can only be viewed as a reckless gamble. Before Bernanke pulls the trigger he needs to convince me and many others that his confidence is justified. I want to hear some thoughts from others on this issue. I want to hear from Brian Sack at the NY Fed. It is he who will have to execute what Bernanke is so confident about. He would never soft sell that risk. He knows full well that it can’t be done without the possibility of a spectacular blowup. He would never use the word “confident”.

I want to hear from the primary dealers and the likes of PIMCO. Put them on a stand in D.C. and ask if they are confident that this can be accomplished. Not one would. Get some former Treasury Secretaries to opine. I would like to hear from Greenspan. NO ONE would say they are confident on the outcome. I want to see just one credible source chime in with Bernanke on this. Just one.

Bernanke put his reputation on the line with his “confident” remark. How can anyone be so certain about an uncertain future?

We’ll Never See Dow 10,000 Again – And Other “Good” Things

A guy I know for a long time calls up to bitch about my rants on Bernanke and the QE. He is a 2&20 Walls Street “buy side” type. He’s been at it for a long time. He says to me:

You don’t get it. Bernanke is giving you a once in a lifetime opportunity. He’s writing a put under the market. You’ll never see Dow 10,000 again. What the Fed is doing is a “good” thing.

This guy is coining money on the prospect of QE, he will probably rake in more when it is a reality. We shall see if this all works out, but one can’t argue the fact that from his perspective QE=Good. There are so many things that we contemplate as being “good” when in fact they are really not good. To me, saying,” QE is good” is like saying. “War is good for the Economy”.

-It is Good when the US pursues a beggar my neighbor policy of trashing the dollar. It is Bad when China manipulates its currency however.

-Laisse-Faire economics is Bad, Keynesian economics is Good.

-Price discovery is Bad, mark to model is Good.

-Balanced budgets and paygo are Bad, deficits are Good.

-ZIRP is Good for the economy, saving is Bad.

-A no downside risk equity market is Good. Bubbles however are very Bad.

-The Fed forcing inflation is Good. It would be Bad if prices were stable or went down.

-That QE and ZIRP undermine the dollar is good. When oil goes to $100 that would be Bad.

At the end of the day QE is going to raise the cost of living for every American. We face the double hit of homegrown and imported inflation due to the collapse of the dollar. The vast majority of Americans will be poorer as a result. But some fat cats earning 2&20 will make a bundle in a rigged market. QE will put the mother of all hurts on us at some point in the future. But for now it is a Good thing. And therefore we need more of it. And we’re certain to get it.

We need some leadership that cuts through the crap. It makes no sense to follow a reckless and dangerous policy that has the objective of enriching such a small portion of the population. The downside risks are large. We are in completely uncharted waters with monetary policy. The Fed is making a “Grand Experiment” with absolutely no consent from the people.

We can only hope that the next election brings a sea change of thinking. That would appear to be unlikely. While it is now certain that the “Ins” will be “Out” I don’t see a single voice in those who will step into leadership that is apposed to QE. Until that happens Bernanke will continue to brush off the warnings (from other Fed board members) and plod down a road that he is espousing as Good, even though he knows full well that it is Bad.

Bernanke’s Conflict of Interest

Thank heavens for the Federal Reserve. Were it not for them our deficit would have been 6% higher in the just ended fiscal 2010. The hard working folks at the Fed have contributed a net of $76 billion to the general revenue. They are now earning at a rate equal to 1/3 of all corporate tax revenues. Think of that, just a handful of people are making one third of what our largest corporations contribute. Talk about doing some heavy lifting!

I, and a few thousand others, have been bashing the Fed on a nearly daily basis. But actually we should be dishing out some praise for a job well done. $76b still goes a pretty long way these days. The even better news is that in 2011 the Fed will make us even more money than last. Way to Go Ben B! Here’s how they made the long green:

A graph of the Fed balance sheet as of 9/30. The total balance sheet comes to a modest $2.2 trillion. The net income generated from all these holdings is the $76b estimated by the CBO:

The net income number comes to an interest spread on the portfolio of 3.45%. There are some folks in the portfolio management business who would die for that result. The Fed did it the easy way. They borrowed money at no cost thanks to ZIRP.

We know the Fed is going to be buying in more paper during 2011. Jon Hilsenrath at the WSJ tells us that just about every day. If you don’t believe him just read the Fed minutes. QE-2 is baked in the cake. The leaks and guesses suggest that we are looking at another Trillion of POMO buys over the next year. The thinking is that the Fed will acquire a portfolio with an average maturity of around seven years. The yield on that maturity today is about 1.8%. Based on that a pro-forma look at the Fed BS a year out:

Assets: 3.2 Trillion

Income: 94 billion

Average yield: ~2.93%

This quick calculation overstates income and average yield. The reason is that a significant amount of high coupon MBS will be prepaid over the course of the year. Given that a primary objective of QE-2 is to reduce mortgage costs and therefore encourage refinancing at lower rates I am going to assume a high prepay rate that will result in $300b of reduction in the MBS portfolio. The adjusted estimates for the portfolio as of 10/1/2011:

Assets: 3.2 Trillion

Income: 88 billion

Average yield: ~2.75%

When I look at this I conclude that the Fed will Not raise the Funds target to 3% for many years to come. To do so would imply that they would incur an annual loss. No one wants losses. When you have losses you are a squeaky wheel. In D.C. they don’t oil squeaks. They investigate them and put collars on the problem. No one at the Fed would want that.

Here is a chart of Funds rate up to 2008. It does not include the madness of ZIRP. I would call this “normal”. We had extreme highs to fight inflation and we have had several periods where rates where well below average. But look at this chart and tell me where a 2.75% break even rate comes into play. For the past 70 years we have been above that level 90+% of the time.

Mr. Bernanke’s sole objective with monetary policy at this point is to create inflation. Given that he is hell bent for leather on this I think we will get want he is engineering. And like every other historical Fed effort they will overshoot on stimulus and inflation will come back at some point. But Bernanke will not have the balls to pull the trigger on Fed policy and tighten as he may have to. To do so would straddle him with big losses.

The Fed is creating a conflict of interest between its own institutional best interests and the proper choices for monetary policy. That is the definition of a systemic risk. Bernanke needs to address this conflict. I want him on the record acknowledging the risks of what he has done and is about to double up on:

The Fed commits to all interested parties that it will act in all future periods consistent with its mandate for stable prices. Should circumstances arise that require a rapid tightening of monetary policy the Fed would act accordingly and ignore the consequences to its own financial position. Should this occur substantial and sustained losses would be incurred. The Fed accepts in advance the full consequences of its actions.

Of course we will never hear these words or anything close to it. That is why most people do not trust QE and believe it will end badly. For the record, the annual cost to the Fed assuming a Federal Funds rate rise at some point (keep in mind that we were at 5.5% just three years ago):

Annual loss at:

3.5% = $24b

4.5% = $56b

5.5% = $88b

FX on Edge

David Rosenberg had this to say in his piece today:

Right now, the foreign exchange market is in a state of disarray and, as I said above, problems here inevitably work their way through the arteries to the equity market.

As is often the case, I am in agreement with David. The FX market is in a state of disarray.

Zero Hedge clarified the picture with a heat map of the action. My observation is that both the dollar and the Euro are weak. The net money flows went to the Swiss Franc and the Yen. The volume for the USD was heavy again and the two way trading in the key crosses was very big.

The bad news story for the EU is heating up. France has gone on strike. Ireland is increasingly looking like an IMF deal is close. After a decent few months the numbers are turning south again. And if you wanted to throw a wild card into the picture consider what is going on in Brussels. I don’t know where this goes. I am certain that it runs against “Pan EU Solidarity”. Watch for this type of thinking to evolve in Germany.

The USD side is dominated by QE2. After the Fed minutes the dollar dropped a bit. Right on cue as it were. What a joke.

Consider the day chart for the EURCHF cross. The drop at time 11 is pure old-fashioned supply and demand. Someone dumped a ton of Euros against the Swissie. The backup in the EURCHF cross in the last 24 hours is a red flag. I see this is evidence that the fast money is again leaving the Euro. Note the pop in the cross at hour 18. That is the Fed minutes. The market reads this as a sell signal for the dollar. This creates demand for the Euro. That demand spills over to the crosses. This can be explained, but as Rosenberg pointed out, there is disarray.

The USDCHF chart completes the story. The people who actually make prices change in the FX market are of the mind that the dollar is a piece of crap and at the same time they are scared to death of the Euro. More disarray.

 

The USDJPY story will be headlines in the next 28 hours. Yes, that is a long-shot call by me. Note that I gave myself tonight and the first few hours of trading on Thursday. I have said previously that I thought the BoJ would be out until one big figure below the last intervention of 82.80. We are there and I am sticking to my view. Should that happen it would have a short-term effect of lifting the USDJPY. It would also hit the EUR on the cross, that means the EURUSD will catch a bid and move back toward 1.40. This would be a “risk on” development. Stocks might catch a bid in Asia on the news. But this is a “shit in your hat” story too. If by noon in NY (on the day of intervention) the USDJPY is trading below the invention, the risk on trade turns to a “risk off” one and a fast reversal will follow. Beyond disarray into chaos.

If the BoJ is a no show we will have another busy day tomorrow. That scenario means money flow to JPY from all directions. My guess this would translate into demand for dollars versus Euro. That would imply a weak EURCHF cross. It took nearly a month for USDJPY to fall 1 big figure. If we have no intervention the next big figure will happen in days. Disarray (squared).

Okay, I’m half kidding you with this gibberish. I was actually thinking it through and ended up writing it down to make a point. The range of outcomes and the various risks associated with what may come are substantial. Use whatever adjective you like. Unstable, disarray, unpredictable, or chaotic. I recently warned that the money flows would heat up. They have. Where this goes is by definition uncertain. For me the status in FX land is at a point where the only conclusion can be that it is a “risk off” market. I’ll repeat Rosenberg’s wise words:

problems here (fx) inevitably work their way through the arteries to the equity market.

No COLA - Bernanke gets Trumped?

Social Security announced that there will be no increase in benefit levels for another year. The reason? Deflation. Based on the Cost of Living index no increase in checks is justified. You might get an argument on that from the 60+% of the beneficiaries whose primary source of income is SS. This will impact the macro economic picture.

In the period 2000-2008 the average COLA increase was 3%. Because of the big eco dump it has been zero for 2010 and now again for 2011.

SSA will pay ~$700b in benefits this year. 3% of that comes to $21b. That is a pretty important number. Most of the SS checks are spent. Little of it is saved, so this will impact consumption on a nearly 1 to 1 basis. $21b is 1/4% of our GDP (includes multiplier). Poof!

Does this matter? Sure it does. Economists who forecast growth will have to knock down their numbers by at least ¼% as a result. There would have been some multiplier affect from the extra spending, now there won’t be any. Between the cumulative impact of two years of no increases and the multiplier this could be a drag on GDP by 1/2% for 2011 versus what has been assumed.

We don’t know what Ben B will do in a few weeks, but we can sort of guess about what is coming. It will be a longer-term commitment to acquire Treasury bonds. The high-end estimates are about $100b per month for a year. Something over a trillion in all. Using those kinds of numbers, I have seen estimates that the impact will be a positive to GDP to the tune of a lousy ½%.

So for those that have been believing that Bernanke has written the economy a put, look again. You just got trumped, by of all things, Social Security. Big Ben can’t row quick enough on this river. The water against him is moving too fast.

A Different Direction for the Foreclosure Mess?

I keep thinking of the mortgage foreclosure story and wondering, “Where will this go?” The problem is that this question is very hard to answer. One possible direction.

According to Realtytrac the number of actual repossessed properties in August was 95,000. They also have reported that in the second quarter the number of repos was 248,000. Call it a million over the last 12 months. "How many of these are now tainted" is a central question. But for me the more significant issue is, "Why were they were tainted".

From what I have read it would appear that this has been administratively blown up due to the volume of foreclosures. No one in the housing/mortgage story really wants to do a foreclosure. It is the most costly outcome. Not only does the lender lose principal and interest there is a big cost to close on a homeowner. So the lenders, lawyers, servicers and document houses all tried to push the process through a hole that is too small. Along the way they hired bozos to do the work and the cut every corner they could to close a file.

That sounds bad, but it does not worry me too much. A probable outcome would be that most of the closed deals are either properly documented or they deal with an original borrower who was so far underwater that the last thing he/she would want to do is restart the process with the old IOU’s. To be sure there is going to be a percent of deals that will result in some form of restitution to the original obligor. That will be a loss to all of the players. But it is not going to bring down the house.

There is a great deal of difference between a lender who is facing a loss and cuts corners to minimize the loss and fraud that occurs when the same tactics are used to make money. And that is what I fear has happened. Should that be the case we are looking at a very big hole developing in the mortgage space.

Assume there is a home that has a $250,000 mortgage and the loan is in default. Now assume that the owner of that mortgage wants to sell it. Assume further that the mortgage is bundled up with a bunch of other busted mortgages and sold at a deep discount from par. Say the price of the loan package is 40 cents on the dollar. Now finally assume that the property can be sold at an auction level price of $175,000.

If you add up all my assumptions you get a situation where the mortgage is purchased for $100k (250*.4) and the actual value of the assets securing the mortgage is worth $175k. That 75k for a “flip” is big money if there is a lot of them to be done. And as Realtytrac says it is a million or so a year.

If you’re reeling from all those “assume this” crap I was selling don’t be. What I describe is happening in very big numbers. Busted whole mortgage loans are being packaged and sold to investors to the tune of at least $10b a month. Some of the biggest players on Wall Street are in the game of arbing the sellers. Packages are regularly being put together and sold. Who are these sellers? A lot of the banks. The big ones have sold large amounts, the smaller banks have sold regional portfolios at distressed prices. But by far and away the biggest sellers that have created the “profit window” all reside in D.C. A big seller has been the FDIC. Fannie, Freddie and FHA have also been steady sellers.

I have no idea how much abuse there has been when secondary market purchasers of mortgages push through foreclosures and auction off homes to make a big profit. But the answer is it is not zero. What if only 10% of foreclosures were the result of some outfit or the other pushing to make some fast cash? What if they were doing it on the cheap. Say $10k a pop. Well that comes to a billion a year. And for that much money people will pull all matter of strings. They will buy lawyers and document processors who will gladly take the dough. When you have nine-figure money and a short time window of opportunity you press it as hard and fast as you can. That is how it works.

Two possible headlines we may see:

In an effort minimize losses Federal Agencies relied on improperly documented foreclosure procedures. 

Thousands may be affected. FHFA to issue apology.

Or it could look like this:

Federal Agencies Sold Loans to Scheisters

Improper payments made to foreclosure agents. Billions of profits at stake. Hundreds of thousands lining up for class action suit.

Congress suspends all foreclosures and new lending at Agencies. Mortgage market seizes up.

I have been amazed to see that more than 25% of all home sales of late have been the result of foreclosures. There are some folks who are burning the midnight oil to get all this done. And for a portion of them the profit motive, not a paycheck, is what is keeping them awake. I have seen bank REO sit on the market for years. And I have watched other parcels get priced deep in the hole and go very fast. In some of those cases the motivated seller is not taking a bigger loss. They are taking a fast profit.

If an investigation shows that even a small amount of foreclosures were done with a profit motive objective and those beneficiaries had “sweetheart” (AKA “Side deals”) with the servicers and closers to achieve their objectives there will be hell to pay. Something like this is likely to come. There is too much money involved. That brings abuse. Greed is in our nature. So is bending the rules.

Ben’s Cohiba

Last Sunday night I wrote about the coming week:

If next Friday the Buck is lower across the board and the BoJ is a bit bloodied Ben Bernanke will light a cigar.

Okay, so our boy Ben is smoking a big fat cigar tonight. He could not be happier. Everything is going his way.


-On the week the dollar got crushed against the majors.

-The Japanese central bank did get its nose bloodied. As of the close in NY they are down about $700mm on the 9/15 intervention of $25b. It’s not just the money (actually it is the money). They lost a battle. The USD/JPY has to go lower. The BOJ has tipped their hand. They are playing defense. And that is losing strategy. Their internal effort at QE just got trumped by Ben’s weak dollar policy. They must be pissed.

-Euro group chairman Junker (ZH article) said the weak dollar will hurt EU growth. Sure it will. That is what Ben wants. He wants to export our deflation to our “friends”. They also must be pissed that Ben is dishing this out to them.

-The gold moves were impressive. If I were at the Fed and watching this near daily slap in the face I would be unsettled. I wonder if they even care. At one time they did, but not in the last few years. Ben is probably pleased with the ratchet up in gold. He not only wants to boost inflation he wants to increase expectations on inflation. High marks on that score for the week.

-Stocks keep going up. Why shouldn’t they? A weak dollar makes top line numbers of a big chunk of the S&P look better. Also, you have to look at what money is competing with. The five-year closed at 1.1%. After-tax that comes to 0.7%. Against a very low rate of inflation the tax adjusted yield guarantees the investor a negative 8% return. Not hard to beat, one would think. So stock multiples have to widen. Right? If so, can we do this forever? If not, how long can we continue?

-The commodity numbers are blowouts. Sugar, wheat, corn, copper, every off the run thing you can think of and of course oil are all on the rise. This is coming home to shoppers soon. Ben is just delighted at this. He has been preaching the need for inflation.

-Possibly the most significant achievement by Bernanke this week was in shaping public opinion. Through the press and direct comments from Board members the word went out, “The Feds gotta do something about the unemployment thing”. And sure enough the NFP numbers confirm that the private sector is not doing enough to cover the job losses by the states. So now the thinking is, “That guy BB had it right. We have a real problem again. I am glad that our pal Ben is going to do the heavy lifting.” Look for the press to confirm this over the weekend. It's part of the propaganda.

So Ben has every reason to celebrate this evening. Everything on his list has a + next to it. I’m looking at the same list and I want to puke. Raise the cost of things that we consume by trashing the dollar is what we need? Destroying savers so they are forced to cut consumption is a cure? For whom? Piss off our “friends” and “investors" is good policy? We shall see. It’s hard to blunt the argument that a good stock market is synonymous with better times. But this market is bought with POMO. And everyone knows it.

There is another thing that Ben can celebrate this evening. He is clearly running the entire show. Treasury has had not one word to say on the monetization of our financial system. I always look into things and ask why? Tim Geithner is out, is why. We just have to wait for the election. Between then and now Tim will be used as cannon fodder in a face saving effort at avoiding a trade war with China. Summers is gone. So Ben is holding all of the cards. Exactly how he wants it.

Red Alert?

My success ratio of calling short-term tops/bottoms in markets is about 1 in 4. Lousy. With that caveat I tell you I cut all my trading positions this morning. I cut the long gold short dollar stuff. I took off a bunch of equity high alpha stuff. I cut the syndicate stuff to as small as possible. Why? Because all this ‘stuff” is getting to scary prices, and it is happening too fast.

My concern is regarding the NFP numbers tomorrow. Things could change almost regardless of the results. There are only three possible outcomes. The number could be hot, cold or “just right” (consensus).

If there is no surprise I think I have a decent chance of getting back into things over a few days without much opportunity cost.

If this number is hotter than expected watch out. It will turn the QE debate in a different direction. How can Big Ben and his mates push a dangerous monetary policy when there is evidence it is not needed.

If the data is cold and unemployment pushes up a notch or two and the employment numbers are much worse than anticipated and it is clear we headed into a 4Q break even GDP then I will be wrong. But not poorer. And even in this scenario I could still be right.

If the number is cold tomorrow QE-2 becomes a certainty. But really that has been the case for weeks now. Bernanke has made up his mind some time ago on this. A soft payroll number would give him the cover he wants/needs to get acceptance for the "pedal to the metal" monetary approach. The stupidest most dangerous monetary policy decision in the past 70 years is good for stocks? When does the reality set in that we just set the ship of our own demise?

All the markets are correlated around strong equities and the "risk on" trade. We have had that for the past six weeks. I am afraid that no matter the result of the NFP we are going to into a risk off mode.

If that is the case I will be able to get back into my favorite trades at better levels.