Rolfe Winkler

Another tidbit from Rosenberg, who offers guidance on what the Fed means when it says it will keep rates low for an “extended period”…

FED CAN’T RAISE RATES UNTIL AFTER 2011

The reason — there is a wave of mortgage refinancings coming in the housing market for one, and not only that, but in the commercial space, there are $2.7 trillion of debt coming due through 2011 and another $1.5 trillion of leveraged loans….In other words, the default rate is going to rise even further and the Fed tightening policy would only aggravate that situation. In other words, the Fed is simply immobile for at least the next two years.

I’ve argued in this space many times that the Fed is trapped. Our monetary system, which is fueled by credit expansion, simply doesn’t work in reverse. To avoid deflation, credit must always be expanding in the aggregate. If the private sector won’t borrow, the public sector must….and vice versa. If they de-lever in tandem, we get deflation.

We’re told to be panicked by the prospect of deflation and yet the solution we’ve been given — unprecedented public credit expansion + inflation of new asset bubble — leaves us worse off than when we started.

Alan Greenspan’s 1% interest rates inflated a disastrous credit bubble. We think 0% rates and quantitative easing will lead to a different result?

From the FOMC statement released a few minutes ago by the Fed:

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions are likely to warrant exceptionally low levels of the federal funds rate for an extended period. As previously announced, to provide support to mortgage lending and housing markets and to improve overall conditions in private credit markets, the Federal Reserve will purchase a total of up to $1.25 trillion of agency mortgage-backed securities and up to $200 billion of agency debt by the end of the year. In addition, the Federal Reserve is in the process of buying $300 billion of Treasury securities. To promote a smooth transition in markets as these purchases of Treasury securities are completed, the Committee has decided to gradually slow the pace of these transactions and anticipates that the full amount will be purchased by the end of October.

The Treasury purchase program had been scheduled to terminate in September.  Instead of letting the program wind down on schedule, buying $47 billion worth of Treasuries over the next six weeks, the Fed will make those purchases over the next 10 weeks.

So far the Fed has purchased $253 billion worth of Treasuries, $109 billion worth of agency debt, and $721 billion of agency mortgage-backed securities.

The other two purchase programs, for agency debt and agency mortgage-backed securities, are unchanged.  As reiterated in the statement, they are scheduled to expire at the end of the year.

IMHO, these programs can’t end soon enough…

On Thursday, the Bank of England said that it would run its printing press a bit faster while the European Central Bank hinted that theirs might slow down sooner than expected.

In the United States, the Federal Reserve’s printing press is running low on ink, and Ben Bernanke has his own choice to make: Buy a new cartridge or shut the thing down. He should shut it down.

In particular, I’m referring to the Fed chairman’s commitment to print $300 billion to buy Treasury bonds by the end of September.

So far the Fed has purchased $243 billion since the program began in March. He’s on schedule to hit the $300 billion mark next month, right on schedule. The question is whether he should buy more.  (Click table to enlarge in new window)

With some signs pointing to a recovery, the conventional wisdom is that the Fed can let the program expire. That’s right, but for the wrong reasons.

The problem with quantitative easing, and with all programs fiscal and monetary intended to artificially support asset prices, is that they badly distort markets, preventing them from grappling with the underlying problem of leverage.

They also send false signals to market participants that it’s safe to take risk.

Leverage is still at record highs. To take just one measure, according to the Fed’s first quarter flow of funds report, total credit market debt to GDP stood at 376 percent. (Click chart to enlarge in new window, ht Comstock Partners)

We’ve run up more debt that we can possibly pay. As any overextended borrower can tell you, the way to deal with excessive debt is to pay it down, or declare bankruptcy.

But quantitative easing encourages people to take on more debt.

Take homes, for instance. Mortgage rates are tied to Treasury rates, which are held artificially low thanks to the Fed. Low mortgage rates lead to higher house prices and higher house prices provide collateral to take on more debt.

But when the Fed’s artificial support is removed, prices will continue their march downward and borrowers will find they can’t pay off their last loan.

Every time we hit a recession, the Fed’s solution is to hit the gas, encouraging folks to go deeper into debt. For a time, credit expansion provides the illusion of economic expansion. Until, that is, inflation fears force the Fed to hit the brakes.

We’re addicted to debt. But instead of trying to kick the habit, we invent ever more creative ways to find our next fix.

Once upon a time, low interest rates were enough. Not anymore. So the Fed devised a dangerous combination of zero interest rates and quantitative easing.

Before we were snorting the junk. Now we’re injecting it. And the high is causing market participants to take more dangerous risks than they should.

People jumping back into the housing market are in for a rude awakening as prices continue to fall and their equity evaporates. If house prices trend back up, it won’t be because people can pay more, it will be because credit markets have loosened up again and they can borrow more.

Then we’re back where we started, but with an even larger pile of unpayable debt.

The economy won’t be on a sound footing until debt levels fall, and that won’t happen as long as the Fed stands in the way. It should let its three quantitative easing programs expire on schedule, and make a firm commitment that they’re not coming back.

Democratic Congresswoman Laura Richardson has even Hillary Clinton beat for selective memory problems. Remember how Hillary kept repeating the Bosnia story? That she dodged sniper fire, etc.? She always knew it was a lie, but she needed a concrete example of her foreign policy experience. It was telling that that was the only story she could come up with. I hope the Clintons (and the Bushes) disappear from American politics permanently.

But I digress. Here’s what Richardson said of her property in Sacramento in a statement this past Wednesday:

the residential property in Sacramento California is not in foreclosure and has NOT been seized by the bank.

Moreover:

I have worked with my lender to complete a loan modification and have renegotiated the terms of the agreement — with no special provisions. I fully intend to fulfill all financial obligations of this property.

These are bald-faced lies. According to the WSJ:

The Sacramento home of Rep. Laura Richardson was sold in a public auction two weeks ago for $388,000….James York, the Sacramento broker who bought the three-bedroom, 1.5-bathroom home, rejected the idea that the home hadn’t been seized. The sale of the home was announced in March. “She’s walked away from the property,” he said. “I would be happy to resell her the home for the $535,000.”

Recall from the original story:

The Southern California Democrat bought the house for $535,000 with no money down in January 2007 and owed nearly $575,000 to Washington Mutual when the mortgage was sold earlier this month at a significant loss to Red Rock Mortgage Inc.

And there is additional irony here:

Richardson didn’t vote on the housing rescue deal that passed the House of Representatives two weeks ago and in a statement attributed her absence to her father’s funeral. But Richardson did vote last fall in favor of the Mortgage Forgiveness Debt Relief Act, which passed and prevents the federal government from charging income tax on debt forgiven as a consequence of foreclosure.

Following up on yesterday’s post regarding credit losses, here is an interview with Carlyle’s David Rubinstein from Bloomberg. The article notes that while credit losses have totaled $329b worldwide, banks have been able to raise $247b to offset those losses. Such capital raises dilute the shit out of common shareholders, though to the extent that those shareholders risk losing everything in bankruptcy if banks DON’T raise capital, a smaller share of ownership in the banks’ continuing earnings is an acceptable price to pay.

Incidentally, I was at the Credit Sights subprime conference two weeks ago (had big plans to live blog it, but there was no WiFi connection!) and heard an interesting tidbit from a hedgie:

You may have noticed that banks forced to raise capital see a temporary boost in their share price. See the uptick in WM from $10 to $12 a couple months back, for instance.

I wondered why that always happens since common stock is clearly worth less after being diluted so substantially. Sure capital raises are positive to the extent they help banks survive, but the guys trading in volume aren’t betting that these banks are threatened with bankruptcy just yet. So why the huge (20%?!) uptick in price?

“Because it’s an elegant way to cover your short.” All the guys short the financials have an opportunity to cover their positions buying newly issued stock at a slight discount to market. Interesting.

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The BBC reports on the latest subprime writedown at a major bank. The conventional wisdom is that most of the subprime related credit losses that have to be taken already have been. Going forward, a larger problem for bank net income will likely be increasing provisions for loan losses, as opposed to straight writedowns on holdings gone South. Here’s a list of writedowns to date for major banks worldwide:

MAIN CREDIT LOSSES SO FAR

• Citigroup: $40.7bn
• UBS: $38bn
• Merrill Lynch: $31.7bn
• HSBC: $15.6bn
• Bank of America: $14.9bn
• Morgan Stanley $12.6bn
• Royal Bank of Scotland: $12bn
• JP Morgan Chase: $9.7bn
• Washington Mutual: $8.3bn
• Deutsche Bank: $7.5bn
• Wachovia: $7.3bn
• Credit Agricole: $6.6bn
• Credit Suisse: $6.3bn
• Mizuho Financial $5.5bn
• Bear Stearns: $3.2bn
• Barclays: $3.2bn

Source: Bloomberg and company reports

The main impact of credit losses is that they reduce bank lending. A handy way to think about it, is that banks typically lend out $10 for every $1 in capital on the books. So credit losses of this magnitude can be incredibly DEflationary.

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Two weeks ago, I said it. Now commentators are saying the same thing on the WSJ op-ed page and on SmartMoney.com (snippets below): house PRICES may still be at historical highs, but house AFFORDABILITY is not, which may mean prices don’t have to fall any farther. The crucial forgotten variable is mortgage rates.

Here’s what I noted two weeks ago:

With a fixed rate 30-year mortgage of 18%, a $2000 monthly payment will buy $132,000 worth of home. Cut the interest rate to 6% and the same $2000 payment will buy $334,000 worth of home.

In terms of affordability, the two homes are totally equivalent. Remember, when you buy a house with a mortgage, your monthly payment has two components: a principal payment to pay down the debt on the total cost of the home AND interest on that debt.

While I agree overall that house prices have to fall, I’ve become skeptical about conclusions drawn from [analyses comparing house PRICES to median income]. The fundamental flaw I see is that it is based on a home’s price, not the total cost of home ownership. Maybe I’m missing something here, but it strikes me as obvious that house prices relative to income were lowest in 1982…interest rates were 18%!

If incomes are stagnating, and they are, then affordability is the key. What percentage of your income is actually being used on a monthly basis to pay for the roof over your head? The two authors I’ve cited use the house affordability argument to claim that the housing market has hit bottom.

But I’m not so sanguine. There are three problems with concluding that home affordability today means house prices have no farther to fall:

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With much thanks to Calculated Risk a compilation of early nominees for word/phrase of the year, 2008. This is NOT shameless plagiarism: I take NONE of the credit for these….I’m just not that witty. The best I’ve saved for last…

• Liquidity Cushion
• Hyperstagflation, or hyperstagdeflation
• “we’re all level 3 now”… with apologies to Tanta who coined “we’re all subprime now.”
• Ben Dover (as in Ben Bernake, I think)
• Bear-Stearned
• Systemic Risk
• Counterparty Risk
• Perfect Storm …. as in the problems facing the American economy
• walkaway
• wheelbarrow….as in the thing you use to carry bus fare after hyperinflation.
• Viagrate: “to artificially pump up.”
• lagflation
• subflation
• “underwater” and “upside down” as in the condition more homeowners find themselves in
• homeower
  
• Banana Republicans … for their subpar economic/fiscal mgmt.
• Hoocoodanode … as in the excuse you hear on earnings conference calls
• subprime food riots
• Mark to Myth
• jinglemail … what you send to you bank when you walkaway from your home.
• Mozilloed
• Bailout
• Paradise Foreclosed
• homedebtor
• short sale
• Alt triple A
• deleverage
• sustainabubble
• Debtrimental
• Housing Pustule … as opposed to housing bubble. Bubbles are cute. The implosion of the housing market isn’t.
• Depression-Lite
• Uncle Ben’s Rice … kind of like Jeopardy’s before/after category: popular foodstuff whose price is soaring after this central banker fans inflation fears with too many rate cuts….
• bank run
• “Japan 2.0″ or “Weimar Republic: American edition”
• meltdown
• residential copper mining
• Granite Countertop Quarries
• Decleverage … when they repo your boob job
• “Don’t Haircut me bro!“
• “I see debt people”

Late entrants (please, offer your own):

• agflation
• ZIRP or ZIRPification … as in “zero interest rate policy.” Closely related to “Japan 2.0″
• Dollar Carry Trade
• equity cushion

And my favorite:

The bad news on housing keeps coming:

WASHINGTON — U.S. new-home sales slid further in March to their lowest level since 1991 while the supply of homes for sale soared to nearly a three-decade high, suggesting little prospect of any near-term turnaround.

Sales of single-family homes slumped 8.5% last month to a seasonally adjusted annual rate of 526,000, the Commerce Department said Thursday. That’s the lowest level since October 1991. Economists had expected a much smaller drop of 1.9%, according to a Dow Jones Newswires survey.

February new-home sales fell 5.3% to an annual rate to 575,000. Originally, the government said February sales dropped by only 1.8% to 590,000. Year over year, new-home sales were down 36.6%.

Other recent data confirm the headwinds the housing sector faces. Earlier this week, the National Association of Realtors said sales of pre-owned homes fell 2% in March. Prospects for a recovery in the broader economy are closely tied to housing, given its effect on construction, employment and consumer spending. With housing still under pressure, Federal Reserve officials are likely to lower official interest rates again when they meet next week.

The median price of a new home decreased by 13.3% to $227,600 in March from the previous year, according to Thursday’s report. The average price tumbled by 11.3% to $292,200 from a year earlier.

Regionally last month, new-home sales decreased 12.5% in the Midwest and 19.4% in the Northeast. Sales fell 4.6% in the South and 12.9% in the West.

The month’s supply of homes for sale rose last month to 11 months, the highest since September 1981.

Inventories of various housing assets (single-family homes, condos, etc.) are the key to determining the path or prices. High inventories mean supply is outstripping demand, putting the onus on sellers to cut prices in order to bring buyers back to the market.

Didn’t think I’d see an op-ed like this in the Journal. The editors themselves hate Fed easing, and for good reason. Inflation hurts everyone in the economy except for those in debt; those who, financially-speaking, have behaved most irresponsibly. But this opinion piece says the Fed shouldn’t feel ashamed about printing money in order to get us through the housing crisis.

The author’s fundamental argument is that if the Fed just prints money, and lots of it, that the ensuing inflation will rescue the housing market and, thus, the economy. He says this would be preferable to nationalizing the housing market, which seems to be the only alternative in his mind.

Nationalizing the housing market may be a fait accompli…..but done correctly it probably doesn’t have to be a huge burden for taxpayers. Lenders who want to be bailed-out should be forced to take massive writedowns on the bad loans they want to pawn off on taxpayers. If the Treasury buys bad home loans at a really good price, taxpayers don’t have to lose that much in the long-run….

If the Fed “prints money”, the ensuing inflation would only serve the interests of those in debt by reducing the value of their debts in real terms.

Inflation happens when the supply of money increases relative to the supply of goods and services in the economy. More paper currency chasing the same amount of goods and services means each individual unit of currency has less purchasing power; it has less value. Savers lose because the dollars they’ve saved buy less after a period of inflation. Debtors win b/c the debts they owe are smaller in real terms after that same period of inflation.

Say I take out a $100,000 loan due next year. To make the math easy, let’s assume my lender isn’t going to charge interest….a rich uncle perhaps. If the value of the dollar declines 6% over the year, then $94,000 of today’s dollars will be sufficient to pay back the $100,000 loan next year.

Of course, most lenders do charge interest and if they EXPECT inflation will decrease the value of the dollars with which they’re paid back, they’ll simply charge HIGHER interest rates to offset the loss in value of those dollars.

Folks who have already taken out loans at fixed interest rates would benefit from higher inflation. New borrowers and those with adjustable rates would be forced to pay higher interest rates.

More inflation could also spark a run on dollar assets.

But perhaps the main reason this is foolish is that if the Fed lets inflation run wild now, it will just take more draconian monetary measures to get it back under control in the future. Take a look at the steps Paul Volcker was forced to resort to in order to tame inflation back in the early 80s. To beat inflation he had to increase the Fed Funds rate to 20%(!) by late 1980. It’s at 2.25% now. How many of my readers who bought a house in the early 80s recall what mortgage rates were back then? Would you believe they got as high as 18% for a 30 year fixed rate mortgage?

According to Wikipedia, raising rates that high to tame inflation “contributed to the significant recession the U.S. economy experienced in the early 1980s, which included the highest unemployment levels since the Great Depression.”

So far Bernanke has laid off the inflation lever. All of us who avoided overpaying for a house should pray that he continues to.

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Arthur Kimball-Stanley published a fascinating op-ed on Credit Default Swaps in the Providence Journal on Monday. I spoke with the author and he gave me permission to republish his piece in its entirety. A 30-page version of this argument was accepted for publication in a law journal to be published this fall. The author gave me a recent draft, though the article below offers the essential elements of the argument. Hopefully it gets traction……

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