Tuesday, March 6, 2012

Today's links

"If income is to grow, the financial markets, where the various plans to save and invest are reconciled, must generate an aggregate demand that, aside from brief intervals, is ever rising. For real aggregate demand to be increasing, it is necessary that current spending plans, summed over all sectors, be greater than current received income and that some market technique exist by which aggregate spending in excess of aggregate anticipated income can be financed. It follows that over a period during which economic growth takes place, at least some sectors finance a part of their spending by emitting debt or selling assets."

(Hyman P. Minsky, 1982, Can “It” Happen Again? : Essays on Instability and Finance. Armonk, N.Y.: M.E. Sharpe

1--Core inflation rising, pragmatic capitalism

Excerpt: Economists have once again underestimated a pickup in inflation. The core (excluding food and energy) PCE Deflator is pushing toward 2%. The chart below show survey vs. the actual numbers.

The Fed pays attention to this number more than the headline PCE Deflator, which was also underestimated today (2.4% vs. 2.3% estimated). And this is by far the preferred inflation gauge to the CPI because it focuses on what the consumer actually buys vs. a set basket tracked by the CPI. With fuel prices elevated and driving season not yet here, we may see further increases in inflation.

Yes, one can argue that inflation is still subdued, but it is certainly not consistentwith the 5-year treasury yielding 0.92% and the 10-year yielding 2%

2--Housing Still Drowning in Underwater Mortgages, WSJ

Excerpt: $715 billion is a lot of money.

That’s the estimated amount of “underwaterness” hobbling the housing sector in the fourth quarter. A mortgage is considered underwater when the amount of the loan is larger than the value of the underlying property, resulting in a negative equity position for the owner.

The more negative equity a homeowner has, the more likely the owner will default. The resulting foreclosures are a negative rippling through the entire recovery.

As Federal Reserve Chairman Ben Bernanke told Congress this week, “problems in U.S. housing and mortgage markets have continued to hold down not only construction and related industries, but also household wealth and confidence.”

According to mortgage-data firm CoreLogic, 11.1 million of homeowners had an underwater mortgage in the fourth quarter, representing a large 22.8% of all residential properties with a mortgage. The share has not come down much since the recovery started in 2009.

Of those underwater borrowers, 6.7 million have only a primary mortgage, with an average negative equity of $51,000. Of the 4.4 million with first and second liens, the average amount is $84,000. According to CoreLogic, an estimated $715.3 billion in negative equity is floating throughout the housing market.

Until that negative equity is sopped up, housing will not recover and home prices will remain under pressure.

Policymakers have taken a shot at solving the problem. There has been little headway in part because of resistance from lenders and investors.

But the sheer magnitude of negative equity also hobbles any government solution. For instance, the latest idea agreed to by state attorneys general would help only about 1 million distressed owners–a drop in the bucket compared with the number of underwater owners.

Washington right now has neither the money nor the political will to provide big-ticket assistance to distressed homeowners.

Instead, the main tonic is better job and income growth. Already, the recovery has helped to lower the mortgage delinquency rate, if only a bit.

This path, however, carries the same risk that overhangs the overall outlook: the euro-zone debt crisis, spiking gasoline prices, and a China slowdown.

“If there is a hiccup in the economic recovery, it could mean a rise in foreclosures,” says Mark Fleming, chief economist with CoreLogic.

3--The effects of QE unwinding, pragmatic capitalsim

Excerpt: The onslaught of positive economic data has been consistent and undeniable to even the most bearish sell-side analysts. Despite this welcome news, many participants point to inflation, which is below the Fed’s target, and stagnant wages as arguments for why a QE3 could still be on the horizon. Many scoffed at such chatter, however real money backed up this thesis. Since late 2011, Agency MBS (the obvious target of future QE) ceased being directional with US Treasury rates and instead grinded tighter hitting record highs in terms of current coupon MBS prices. Noted bond manager Bill Gross increased his exposure to Agency MBS to a staggering 50% of the $250bil PIMCO Total Return Fund. Such a directional bet with risk/reward seemingly unfavorably skewed was peculiar but screamed one thing: a bet on future QE....

I posed a question earlier that asked “What would happen to the economy/markets if the Fed gradually sells down their entire Agency MBS portfolio over the next year?”. This would obviously be the removal of well over $1T in Agency MBS. Would such a directive send such a shock to the system that it would make today’s moves in QE sensitive assets look mild?

One consequence of removing so much liquidity would be the removal of excess reserves. As shown in this Fed paper, “The examples show how the quantity of bank reserves is determined by the size of the Federal Reserve’s policy initiatives and in no way reflects the initiatives’ effects on bank lending.” Overnight money would suddenly be in a lot more demand. Would it go so far as to cause banks to need to pay interest to keep deposits?

More important for most market participants is what would happen to asset prices at large. If QE was a support for asset prices, what would happen if it was fully drained? Many previous buyers of Agency MBS have balked at buying a 30yr MBS at a 2.75% yield. The removal of the Fed as a buyer would surely push mortgage rates up. Extrapolating this thought all the way down the risk chain would apparently push buyers into the nextsafest asset, not the next riskiest. High Yield, Non-Agency MBS, CMBS and the like may not be necessary if said investor can achieve his risk/reward in Agency MBS and/or IG Corporates. With rising mortgage rates would a feeble housing market face damaging headwinds in the form of lower affordability?

Would the US Dollar see a dramatic rise? Would the gold bugs be squashed?

4--Downside risks remain, pragmatic capitalsim

Excerpt: Household debt as a percentage of GDP averaged 55% over the past 60 years, but soared to 99% by 2008. It has now declined to 87% and still has a long way to go before returning to anything near normal. Federal government debt has climbed from 56% of GDP in 2000 to 97% as of September 30th, and is undoubtedly higher now. In our view the overall debt is the single most important factor to take into account in analyzing the future growth of the economy. The reduction in household debt since the 2008 peak has been the key factor in dampening economic growth to date. In fact, household debt has now been down for 13 connsecutive quarters after never being down for even one quarter in the entire post-war period!

The effect of deleveraging is not a vague academic theory, but is clearly reflected in the real numbers. GDP in the fourth quarter was only 0.8% higher than it was at the peak four years earlier. In the last four quarters GDP growth was only 1.6%. While fourth quarter GDP growth was an annualized 3.0%, two-thirds of the amount was accounted for by inventories. These probably have to be pared down in the first quarter. By almost any measure the current recovery has been far weaker than any other post-war expansion.

Although a number of recent indicators have shown improvement, there are major headwinds to economic growth. Consumer spending remains weak as a result of sluggish wage growth, declining wealth, a moribund housing market and restricted access to credit. Savings rates have probably dropped as low as they are going to get, and any further strength in spending will have to come from a lot more jobs and higher wages. Employment today is no higher than it was ten years ago despite large increases in population. Consumer confidence, although improved, is still at recessionary levels. According to January numbers, released today, real personal income was up 0.1%, real disposable income down 0.1% and consumption flat.

Housing remains a weak spot. New home purchases are down 33% from the 2005 peak while home prices continue to fall. Almost a quarter of homes with mortgages are underwater. Although published home inventory figures have improved, they do not include 5 million homes either in delinquency or foreclosure or 3 million more that are vacant, but not on the market.

In sum, we believe that the numerous headwinds to economic growth are creating substantial downside risks to the economy and corporate earnings that are not being discounted by an increasingly euphoric stock market that seems on the verge of running out of gas. At current levels the downside risks are far greater than the potential upside rewards.

5--Are Fannie and Freddie bailing out the big banks?, The Big Picture

Excerpt: economists John Hussman and Dean Baker, fund manager and financial writer Barry Ritholtz and New York Times’ writer Gretchen Morgenson say that the only reason the government keeps giving billions to Fannie and Freddie is that it is really a huge, ongoing, back-door bailout of the big banks.

Many also accuse Obama’s foreclosure relief programs as being backdoor bailouts for the banks. (See this, this, this and this).


And Freddie and Fannie’s recent settlement with Bank of America – a couple of billion – has been criticized by many as being a bailout.

In “BofA Freddie Mac Putbacks Resolved for 1¢ on $”, Barry Ritholtz notes:

Bank of America settled numerous claims with Fannie Mae for an astonishingly cheap rate, according to a Bloomberg report.

A premium of $1.28 billion was paid to Freddie Mac to resolve $1 billion in claims currently outstanding. But the kicker is that the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008. That amounts to 1 cent on the dollar to Freddie Mac....

As the Washington post notes:

“This is a gift” from the government to the bank, said Christopher Whalen of Institutional Risk Analytics. “We’re all paying for this because it will show up in the losses from Fannie and Freddie,” he said.

Congresswoman Waters said:

I’m concerned that the settlement between Fannie Mae, Freddie Mac and Bank of America over misrepresentations in the mortgages BofA originated may amount to a backdoor bailout that props up the bank at the expense of taxpayers. Given the strong repurchase rights built into Fannie Mae and Freddie Mac’s contracts with banks, and the recent court setback for Bank of America in similar litigation with a private insurer, I’m fearful that this settlement may have been both premature and a giveaway. The fact that Bank of America’s stock surged after this deal was announced only serves to fuel my suspicion that this settlement was merely a slap on the wrist that sets a bad example for other negotiations in the future.

6--(From the archives June, 2010) GSEs: $1 Trillion Dumping Ground for Bad Bank Loans, The Big Picture

Excerpt: Post-receivership, the GSEs have become a government sanctioned back door bailout of regular banks. Any mortgage that cannot be refi’d or modified ends up on their books. This includes mortgages on the verge of default and foreclosure.

How much is the worst case scenario for the ongoing bailout of the banking sector, plus Fannie’s and Freddie’s own screw ups?

If everything goes precisely wrong, taxpayers are potentially on the hook for another $1 trillion bailout:

The cost of fixing Fannie Mae and Freddie Mac, the mortgage companies that last year bought or guaranteed three-quarters of all U.S. home loans, will be at least $160 billion and could grow to as much as $1 trillion after the biggest bailout in American history.

Fannie and Freddie, now 80 percent owned by U.S. taxpayers, already have drawn $145 billion from an unlimited line of government credit granted to ensure that home buyers can get loans while the private housing-finance industry is moribund. That surpasses the amount spent on rescues of American International Group Inc., General Motors Co. or Citigroup Inc., which have begun repaying their debts.

Its not a coincidence that many of these banks are finding the capital to pay back their bailout loans. The Obama administration is continuing one of the more horrific policies of the Bush administration: Using the GSEs as a back door bailout for the rest of the banking sector: These banks are selling their garbage to the GSEs — and according to some anecdotal evidence, are getting pretty close to full boat (100 cents on the dollar) for these bad loans.

Hence, Fannie and Freddie have become a dumping ground for all manner of bad bank loans.

The GSEs have had their own problems over the years — accounting fraud, recklessly chasing market share, lowering loan quality, etc. — but they have now become are now the last stop for every crappy mortgage ever written:

Fannie and Freddie may suffer additional losses as a result of the Treasury’s effort to prevent foreclosures. Under the program, banks with mortgages owned or guaranteed by the companies must rewrite loan terms to make them easier for borrowers to pay.

The Treasury program is budgeted to cost Fannie and Freddie $20 billion. The companies have already modified about 600,000 delinquent loans and refinanced almost 300,000 more, in some cases for an amount greater than the houses are worth.

The government is using Fannie and Freddie “for a public- policy purpose that may well increase the ultimate cost of the taxpayer rescue,” said Petrou of Federal Financial Analytics. “Treasury is rolling the dice.”

A recent Federal Reserve report pegged the total exposure of Fannie and Freddie at 53% percent of the nation’s $10.7 trillion in residential mortgages. That’s about $5.5 trillion dollars.

7--BofA Freddie Mac Putbacks Resolved for 1¢ on $, The Big Picture

Excerpt: Bank of America settled numerous claims with Fannie Mae for an astonishingly cheap rate, according to a Bloomberg report.

A premium of $1.28 billion was paid to Freddie Mac to resolve $1 billion in claims currently outstanding. But the kicker is that the deal also covers potential future claims on $127 billion in loans sold by Countrywide through 2008. That amounts to 1 cent on the dollar to Freddie Mac.

Imagine if you had a $500,000 mortgage, and you got to settle it for $5,000 — that is the deal B of A appears to have gottem from Freddie Mac.

B of A also paid $1.52 billion to Fannie Mae to resolve disputes on $3.1 billion in loans (~49 cents on the dollar). They remain liable for $2.1 billion in repurchase requests, as well as any future demands from Fannie Mae.

My biggest complaint about the GSEs post government takeover is that they have been used as a back door bailout of the banks. This latest deal reconfirms that view.

8--Did Obama's stimulus work? One chart tells the whole story, FRED

9--Short sales are on the rise, CNN Money

Excerpt: Homes in some stage of foreclosure accounted for nearly one in four homes sales during the fourth quarter, according to RealtyTrac.

During the three months that ended December 31, homes that were either bank-owned or going through the foreclosure process accounted for 24% of all home sales, up from 20% in the previous quarter and down only slightly from a year earlier when foreclosures accounted for 26% of sales, RealtyTrac said.

In total, 204,080 distressed properties were purchased during the fourth quarter, down 2% from the year-ago quarter. For all of 2011, foreclosure-related sales were down 2% year-over year to 907,138, accounting for 23% of all home sales.

"Sales of foreclosures in the fourth quarter continued to be slowed by questions surrounding proper foreclosure paperwork and procedures," said Brandon Moore, chief executive officer of RealtyTrac, referring to the delays cause by the robo-signing scandal that broke in late 2010. "Even so, foreclosures accounted for nearly one in every four sales during the quarter and for the entire year."

"We expect to see foreclosure-related sales increase in 2012, particularly pre-foreclosure sales, as lenders start to more aggressively dispose of distressed assets held up by the mortgage servicing gridlock over the past 18 months," said Brandon Moore, CEO of RealtyTrac

Short sales are starting to become the preferred method for banks to dispose of properties in default. In short sales, borrowers who owe more on their mortgages than their homes are worth agree with their bank to sell their homes at the lower market value. In return, the bank agrees to absorb the loss.

During the last quarter of 2011, there were more than 88,000 short sales, up 15% compared with a year earlier, according to RealtyTrac. Short sales comprised 10% of all homes sold during the quarter.

Meanwhile, sales of bank-owned homes fell 12% year-over-year to 116,000, comprising 13% of all sales during the quarter.

Steal this house: 7 foreclosure deals

"That trend will likely show up in more local markets in 2012 as lenders recognize short sales as a better option for many of their non-performing loans," said Moore.

Short sales have become a more attractive option since all parties agree on the terms, leading to fewer legal issues, said Daren Blomquist, RealtyTrac's director of marketing.

They also offer better returns. During the quarter, the average short sale sold for $184,221, while the average foreclosure sold for $149,686. And banks typically don't have to spend a mint maintaining a short sale home like they do a foreclosure, where they have to pay more in legal fees,

property taxes, maintenance and insurance, said Blomquist.

10--Highly Unequal Income Gains During the Recovery, economist's view

Excerpt: Miles Corak notes that most of the income gains during the first year of the recovery went to the top of the income distribution:

Over 90% of the income gains in the first year of the recovery went to the top 1%, by Miles Corak: Emmanuel Saez of the University of California at Berkeley has updated his work with Thomas PIketty on the evolution of US Top Incomes to 2010.

He finds that:

“In 2010, average real income per family grew by 2.3% … but the gains were very uneven. Top 1% incomes grew by 11.6%, while bottom 99% incomes grew only by 0.2%. Hence, the top 1% captured 93% of the income gains in the first year of recovery. Such an uneven recovery can help explain the recent public demonstrations against inequality.”

The 10 page update offers a clear picture of how income shares have varied over different business cycles, as well as the long-term trends since 1917. ...

The top 10% in the US take now take home about 47% of all income, but this is driven by the top 1% who account for 20%.

The difference between the business cycle of the 1990s and the 2000s is that the incomes of the bottom 99% grew by 20% between 1993 and 2000, but only by 6.8% between 2002 and 2007.

Saez suggests that this “may … help explain why the dramatic growth in top incomes during the Clinton administration did not generate much public outcry while there has been a great level of attention to top incomes in the press and in the public debate since 2005.”

11--Bipartisan Group Works on Grand Bargain, Firedog Lake

Excerpt: Here we go again.

Intransigence from Republicans basically kept us out of a grand bargain last year. Plenty of Democrats were willing to do it, the White House was more than willing to do it, and even John Boehner was willing to do it, at least on a conceptual level. But House Republicans wouldn’t betray their tax pledge and so it didn’t happen.

There are some different dynamics to the next round of the grand bargain. There are still enough Democrats willing to deal, led by House Minority Whip Steny Hoyer. The White House has de-emphasized a deficit deal, but their budget still shows a blueprint for one, and if they get revenue in exchange, they’ve stated openly that they would make cuts to Medicare and other social programs. So is there a new willingness on the Republican side? According to The Hill, Republicans have joined a bipartisan working group that is preparing a document on deficit reduction.

A small, bipartisan group of lawmakers in both the House and Senate are secretly drafting deficit grand bargain legislation that cuts entitlements and raises new revenue.

Sources said that the task of actually writing the bills is well underway, but core participants in the regular meetings do not yet know when the bills can be unveiled.

The core House group of roughly 10 negotiators is derived from a larger Gang of 100 lawmakers led by Reps. Mike Simpson (R-Idaho) and Health Shuler (D-N.C.), who urged the debt supercommittee to strike a grand bargain last year.

What’s interesting is that this is originating from the House. You would expect something to build on the Gang of Six in the Senate, which included Republicans. But a back-channel process in the House shows a new receptivity. Apparently this is linked to a Gang of Six process over in the Senate as well.

I don’t think we’re going to see any actual movement on this until after the election. But the lame duck presents a number of dangers for those who don’t want to see cuts to social safety net benefits. First of all, you have a mountain of expiring measures, most of which have to do with the deficit. The Bush tax cuts, the payroll tax cut, extended unemployment insurance, the doc fix and the triggered cuts to discretionary and defense spending all expire at the end of the year. So something impacting the deficit will have to get negotiated out at that time. And the lame duck session represents the moment of lowest accountability for the Congress. Many of these lawmakers won’t be coming back, and voters won’t get to weigh in for another two years. So the secret austerity society meetings are designed, in my view, to come up with off-the-shelf legislation that can be pulled during the lame duck to substitute for the expiring measures. The anonymous sources disclosing this to The Hill as much as admit this: “A source close to the effort said the focus is on drafting now, and negotiators will address when to unveil the result later.” Mike Simpson, the House Republican leading the way on this, claims that they aren’t waiting until the lame duck, but the fact that they’re not trying to work through the budget process makes their intent pretty obvious.

The fact that Heath Shuler, who’s retiring this year, is leading the way on this from the Democratic side tells you all you need to know from the Democratic perspective.

This doesn’t mean that a lame duck deficit grand bargain will succeed –

12--Chris Cook: The Ghost of Enron Past Explains Oil Market Manipulation, naked capitalism

Excerpt: So in a nutshell, demand in the West is dropping like a stone. I do not believe for a minute that demand for consumption in the East will make up the slack. In my view much of that demand (if not wishful thinking and hand waving by analysts) is financial, being the building of strategic reserves and refinery stocks as a physical hedge.

It will be seen that the effect of Prepay on the oil market has been to create a parallel financial market in ‘paper oil’ which means that most participants are completely misled as to the true state of the market.

In summary, as I previously outlined, my analysis is that the oil market stands like an Oil-e-Coyote – running hard beyond the edge of a cliff, but not having yet looked down………

Window Dressing Enron

For those with short memories, Enron fraudulently concealed their financial position from investors and the rest of the world through a variety of sophisticated techniques. One of the most egregious was the use of prepay transactions with investment banks via a special purpose vehicle in a tripartite agreement which essentially misrepresented what was in reality a loan as a forward commodity purchase and sale.

In other words, Enron – facilitated by investment banks – was window dressing its balance sheet and fraudulently misleading investors and counter-parties alike.

Window Dressing the Oil Market

It appears to be the case that BP and Goldman Sachs have for many years been directly or indirectly enhancing BP’s balance sheet and cash flow through enabling BP to lend oil to passive inflation hedger investors and in return obtain interest free dollar funding and literally monetising oil.

Possible accounting legerdemain by BP is one thing, but the greater problem by far has been the effect of passive investors entering the market en masse via this route. As I explained, these transactions have eroded the foundations of the oil market, which have become entirely financialised and have lost touch with the reality of physical production, consumption and storage.

The fact that oil market inventory has been prepaid in this way creates a two tier physical market, where the tiny minority who have knowledge of the resulting ‘Dark Inventory’ of oil in temporary investor ownership have a massive advantage over the majority who do not and who enter into derivative contracts upon a completely false assumption as to physical supply and demand.

Whether or not this is illegal, and if so, in what country, is an interesting question. But as a former head of regulation of a global energy exchange I have no hesitation in saying that the result has been a complete perversion of the oil market, which has become, for maybe as long as ten years, in every sense a ‘False Market’.

The sheer scale of this oil market manipulation, and the staggering sums involved, make Yasuo Hamanaka’s ten year $ multi billion copper market manipulation for Sumitomo look like a car boot sale.

If my analysis of the oil market is correct, many if not all prepay transactions have been terminated in recent months as passive investors have pulled out and the market has become free again of Dark Inventory. However the oil price has been kept inflated by a massive wave of speculative buying attracted by rhetoric and noise about Iran.

With the market’s underpinnings eaten away by fulfilment of these pre-paid contracts (which will temporarily depress physical demand), a collapse in the oil price is inevitable once speculators exit. After this, perhaps steps may then be taken by producers and consumers collectively to free the oil market from the pernicious control of middlemen, and to completely reconfigure the market through a new settlement.

I’m not holding my breath, but I do live in hope.

13--EU Bank Units Tap Cheap Cash, WSJ

Excerpt: Some large European banks are using cheap loans from the European Central Bank to insulate themselves from new problems that could flare up in their businesses in financially ailing European countries.

Banks including Barclays PLC, Lloyds Banking Group PLC, Crédit Agricole SA and KBC Group NV have borrowed billions of euros under the ECB's three-year-loan program through their subsidiaries in Spain, Portugal, Greece and Ireland. The goal is to make those units more financially self-sufficient.

Bank officials and outside experts say the strategy is an effort to limit the parent companies' exposure to their far-flung subsidiaries in case the local economies deteriorate further. It also would make it easier to sever ties with the subsidiaries if, in an extreme case, one of the countries were to leave the euro zone, they say.

"It doesn't signal confidence," said Philippe Bodereau, a managing director with bond-fund manager Pimco. "It's also pretty cheap self-insurance [and] helps banks disentangle themselves" from their subsidiaries.

The ECB offered two batches of the loans—first in December and again last week—with low 1% interest rates. Any bank based in the euro zone or with a locally incorporated business there could borrow virtually unlimited sums. In December, 523 banks borrowed €489 billion ($645.5 billion); last week, 800 banks borrowed €530 billion.

A key secondary goal of the ECB was for banks to use the funds to lend money to cash-strapped European governments, businesses and individuals. The question of what banks will do with the funds has emerged as a key uncertainty surrounding the lending program. The banks are allowed to deploy the money however they want. Their ECB borrowing strategy for the peripheral units is one indication of how the goals for the program might be difficult to attain.

A popular move among some banks has been for their subsidiaries in troubled European countries to borrow directly from the ECB. The parent companies could then stop plunking down as much of their own money to bankroll the units' daily operations

14--Vital Signs: Incomes Adjusted for Inflation, WSJ

Excerpt: Americans had a little less money to spend in January. Inflation-adjusted per capita personal disposable income, which is measured after taxes, edged down a bit in January from December, the Commerce Department said. Income growth has been modest in the past year, while consumer prices, including gasoline costs, are running higher recently. That is restraining consumer spending, which rose slightly in January.

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