MonkeyBusinessBlog

Curb Your Enthusiasm

I was out yesterday and missed this great piece in The Financial Times by Crispin Odey It May Be a Bubble But It's Completely Rational

I have been doing a lot of thinking and questioning with regard to the surge in equities and other risk assets, namely high yield corporate bonds.  The answers that I have been getting from people that I  respect for their insights as well as their position to see capital flows have all centered around a similar theme.  The government and the Fed, through it's traditional monetary policies, quantitative easing programs, debt guarantees and and super cheap lending facilities has essentially worked to drive cash out of the low end of the risk spectrum to the high.  While it may very well be true that back in the early Spring, a package of high yield loans or bonds with spreads greater than 13% was very attractive, they are a lot less attractive at +6.5% to +7.5%.  However, the money keeps coming.  Here is a piece from Mr. Odey's article (I strongly suggest that you read the whole piece.)

With money set to stay artificially cheap, with many governments facing commitments they cannot meet, and with taxes rising, it is rational that investors want assets whose value is as far as possible independent of governments.

Equities buy a slice of a company's future earnings and current assets. Commodities buy something tangible and possibly scarce. Gold is portable wealth. It is rational to seek returns not correlated with governments' ability to pay. This is a rational bull market in real assets, with room to run.

However, we are not in a sustainable recovery. Too much debt brought about the crash, not just bankers and their pay packets. And debt levels have not fallen. Much of the debt has merely been transferred to or has been underwritten by governments. We are no more secure than before. A world economy in which rational consumers take to paying down their debts, as they are doing, will not allow a return to the inflated demand we knew. There is more money around, but it is not being spent.

The rational investor drives up real assets; the rational consumer pays down debt. And governments? They do not bestride the world; they are, like Atlas, holding it up. They are angered by the spectacle of the croupier-bankers raking a cut from the rising asset prices. But Atlas knows that if he shrugs, the world drops to the floor. That is why ChinaU-turned on plans that would have prevented smaller banks from increasing loans without raising equity. It is why President Obama is in trouble over healthcare because US voters will not accept what they see cannot be paid for. It is why central bankers in euroland and the UK talk of ending stimulus measures but know that if they do, the recovery ends.

How far are governments able to meet their social promises, and how and when will they settle or partially default on their IOUs?  

The investor, whether he is fully conscious of it or not, is trying to run as far away from the government time bomb as fast as possible.  Unfortunately, I do not think that he can get far enough away in enough time.  "Rational" behavior is driving flows into sectors on a massive scale, pushing them way beyond their fundamental values (in my opinion) and setting more and more precious investor capital up for another gigantic wipe out.

Meanwhile, in related news we have the Fed looking at tapping the $3.5 trillion money market to help the Fed drain at least $500 billion of excess liquidity as part of their eventual plan to unwind it's unprecedented creation of excess reserves and liquidity.  One of my favorite shows, and hence my title, is Larry David's "Curb Your Enthusiasm".  The story line for every show centers around the neurotic Larry, spinning some sort of ridiculous lie or scheme that he thinks he can get away with.  However, by the end of the show, in hilarious fashion, Larry's lie always comes back to nail him in ways he never thought possible!  This is how I feel about the Fed's plan, introduced here in the Financial Times Fed Eyes Money Market Fund Link For Exit Strategy.

The Federal Reserve is looking to team up with the money-market mutual fund industry as part of its strategy to ensure that its unconventional policies to stimulate the economy do not produce a bout of post-crisis inflation.

The central bank envisages eventually draining liquidity from the financial system by engaging in trades called “reverse repos” with the deep-pocketed money-market funds. In these, the Fed would pledge mortgage-backed securities and Treasuries acquired during the crisis as collateral for short-term loans from the funds.

First of all, I have to applaud the Fed for trying.  However, what I see happening here is the Fed becoming a victim of it's own strategy, as noted earlier.  They will have spent more than two years feverishly working to drive money OUT of the money market and now they realize that they must lure it back to exit their extraordinary liquidity programs.  The Fed wants to hit up the money markets for at least $500 billion in borrowings through treasury repo transactions.  I am sure they will also be using something similar for their near $trillion mortgage backed securities portfolio (dollar-rolls, a funding transaction to be discussed at a later date for those non-MBS geeks!).  Either two things can happen.

1.  A good chunk of the funds driven out of the money markets may get consumed in the great capital wipeout I noted earlier, therefore leaving less funds for the Fed to borrow (although, I guess if the great explosion occurs, the Fed won't be unwinding anything!)
2. As the Fed raises rates in the money markets, due to their borrowing, as well as the increasing rates they will have to pay on the $800 billion of excess reserves it has created and now has sitting at the Fed in order to stop member banks from lending those reserves out, won't this produce a sharp spike in short term interest rates?  Won't the Fed's borrowing binge in the money markets crowd out other borrowers like the $1 trillion commercial paper market?  Maybe the answer to the crowding out effect will result in driving funds out of the riskier part of the credit spectrum and into the "risk free rates" (no credit risk and no duration) provided by the Fed manipulated money markets?  Won't that have the effect of shutting off credit to the rest of the economy and thus wiping out any real economic recovery.

At least when Larry David's nonsense comes back to bite him in the ass it's funny!  Here's the theme song and as a special bonus, one of my favorite scenes.

Federal Reserve's Permanent Open Market Operations: At the Track, At the Wall...See Yah!"

The 73 Tyler Durdens at Zero Hedge continue to do a fine job tracking the Fed's monetization of our debt through Permanent Open Market Operations ("POMO").  Click on the Zero Hedge link to see the latest details.  Looks like the Fed took in a cool $5.1 billion of the latest 3-year issue.  Nice!  

Chinese central banker: "Hey, you guys are trying to inflate your way out of your debt!"

Fed: "No we're not!'

CCB: "Yes you are!"

Fed: "No we're...Hey look, it's Yao Ming!"....{whisper} "Hey Tommy, we'll lift that $5 billion, throw a 1/32 in for yourselves and mums the word!"

CCB: "Hey you just did it again!"

Fed: "Did what?"

Now the problem, as Tyler Durden #8 rightly points out is the Fed is running out of available POMO dough.  The Fed now has only $25 billion left.  Last I checked the Treasury isn't going to be stopping its monster funding operations anytime soon.  I hope there's another patriotic entity out there that want's to take down a big chunk of every auction with money made out of thin air!

The Fed Just Knocked on Our Front Door and Peed on Our Shoes!

This story is just too easy!  From the Financial Times Fed Turns a $14 Billion Profit on Crisis Loans

The Federal Reserve has made a $14bn profit on loan programmes that have provided hundreds of billions of dollars in liquidity to the financial system since the start of the crisis two years ago, according to Fed officials.

The internal estimate is based on the difference between the fees and interest on the lending facilities and the interest the Fed would have earned had it invested the funds in three-month Treasury bills.The central bank earned about $19bn in income from charging interest and fees to financial institutions and investors that tapped the new facilities to obtain much-needed funds during the turmoil. The interest the Fed would have earned by investing the same amount in T-bills was an estimated $5bn, leaving a $14bn gain since August 2007.

The Fed assessment underlines the possibility that other central banks could make a profit on their crisis-fighting measures – at least before adjusting for the risk they assumed.

The calculation by Fed staff, which has neither been audited, published or risk-adjusted, only deals with its liquidity facilities.

These moe-moes (technical term) have the balls to put out this number, one that is unaudited and not even officially published, at the same time as they legally cling to their right NOT to disclose;

Who they have lent to.    

How much they have lent. 

What type of collateral they have taken in. 

The marks on said collateral.

What they (we) own from the Bear Stearns, AIG freak show also known as Maiden Lane I, II and III,      or where they have marked the assets.

What the market value is on their (ours) $1+ trillion Treasury notes and Mortgage Backed Securities      portfolio.

Here's the capper, and with all due respect to the Fed, this part comes from the Financial Times.  If it came from the Fed I would be on my way to Washington right now to put a burning bag of doggie-do on the Fed's front steps!

Critics have warned the central bank might lose money on its vast efforts to avoid financial collapse and ease financing conditions for the economy as a whole.

But the internal estimates suggest that the Fed might well make a cash profit on the crisis. They show that the fees earned on the loans were high enough to more than cover defaults to date – leaving a sizable cushion against future losses on these loans and other parts of the Fed portfolio.

How about a Fresca?!

The White House Oval Office: October 2009.

The scene: The White House Oval Office

The Players: President Obama, David Axelrod, Rahm Emanuel, Tim Geithner, Larry Summers, Sheila Bair, Peter Orzag.

All to the President: "Congratulations sir!  The "2009 Health Insurance Reform Act" is a smashing success! 

Emanuel:  "Sir, thanks for finally letting me take the gloves off and crack some skulls.  I know you don't like or approve of the bare knuckle stuff, but it had to be done."

Axelrod: "Simply incredible sir.  The Clintons must be fuming with jealousy.  I bet you anything that Bubba's face is a dark shade of purple right now!  

Orzag: " Sir, you strong armed the big pharma guys into promising to not be greedy anymore AND to sponsor a nationwide run of "The Best of Rogers and Hammerstein" for the seniors in exchange for our promise that Medicare won't use its size as leverage to negotiate lower prices!"

Emanuel:  "Let's not forget the deal we rammed up the insurers asses!  In exchange for us dropping the public option the insurers promised to make their process more transparent and hold weekly lotteries for the poor.  The lucky winner gets a yearly $5,000 deductible, $10,000 max out of pocket health plan!  

Summers:  "I hope you realize the lottery was MY idea.  My research shows the poor LOVE lotteries."

President Obama: "Now now, take it easy fellas.  I had a lot of help from all you.  No way I get this landmark piece of legislation without you guys.  Ok, lets not revel in our successes.  There's still a lot of work to do.  Tim, you had something on General Motors you wanted to discuss?"

Geithner: "Yes Mr. President.  It seems General Motors Acceptance Corporation, GMAC needs about a $2 billion capital infusion."

Emanuel: "Jesus Tim, $2 billion?  Why don't you just come up here and ask the President of the United States to validate your parking?  

Orzag: "Seriously Tim.  Welcome to 2009.  If isn't at least $50 billion, handle that weak sh*t at your shop! Don't bring it up in here."

Summers:  "Listen you two neanderthals, the only one around here who gets to bitch-slap Tim is me!"

President Obama: "Alright fellas, take it easy.  Go ahead Tim. What is the story with GMAC?"

Geithner: "Well sir, remember Cash for Clunkers"?

Summers: "You mean the best stimulus idea since the Chinese built the Great Wall?  Duh, I think so!"

Geithner:  "Anyway sir, it seems that the 100,000 or so customers that participated in the program with GM essentially traded in a paid off vehicle for a new car."

Emanuel: "And.....?

Geithner:  "Well, essentially almost all these folks used the $4,500 Clunker Credit as a down-payment for the new vehicle and then borrowed the balance from GMAC at 0% for 72 months.  It appears that nearly 50% of those loans are already delinquent!"

President Obama: "Well that's bit odd isn't it?  It almost sounds like the subprime problem doesn't it David?"

Axelrod:  "It certainly does.  

Geithner: "You both are correct there.  It turns out that many of the borrowers are the same people.  Now the loans GMAC made to the Clunker borrowers are coming up delinquent.  And once these these folks go delinquent, they usually don't get things straightened out.

President Obama:  "Wow, who knew right?  Now, many of other car companies have been selling lots of vehicles.  Are they experiencing the same thing?"

Geithner:  "Yes Mr. President.  In fact, this is where it gets tricky.  See, remember all those neat lending facilities we set up with the Fed.......the Term Asset Backed Lending Facility or TALF?"  That is where we tried to help jump-start consumer financing by lending money at very generous terms to investors to buy the securities collateralized by things such as auto loans."

President Obama: "Okay..?

Geithner:  "Well the defaults on these Clunker loans are really starting to clobber those new securities that the Fed lent money on and the FDIC backstopped losses.  It looks like the FDIC may be taking some sizable losses as a result."  Additionally, a lot of this paper is ending up in money market mutual funds.  Last year we threw a government wrap on this market too.  So the FDIC may be on the hook for that as well.

President Obama: "Hmm, major bummer.  Sheila, what do you think?

Bair: "Umm, I suppose this isn't a good time to bring up that our FDIC reserve fund is out of money?"

President Obama: "I wonder if President Bush would let me clear some brush out at Crawford?"

 

"Lend Freely At High Rates Against Good Collateral."

My title is a quote from former Federal Reserve Chairman Paul Volcker, made in April 2008 after the Federal Reserve orchestrated the JPM Chase takeover of Bear Stearns.  Here is the entire quote;

"The Federal Reserve has judged it necessary to take actions that extend to the very edge of its lawful and implied powers, transcending in the process certain long-embedded central banking principles and practices. What appears to be in substance a direct transfer of mortgage and mortgage-backed securities of questionable pedigree from an investment bank to the Federal Reserve seems to test the time-honored central bank mantra in time of crisis: lend freely at high rates against good collateral; test it to the point of no return.''

If there was ever a guardian of Federal Reserve secrecy it was Paul Volcker.  Watching the Chairman go up to Capitol Hill back in the 1980's, smoke his cigar and "testify" in front of Congress was pure comedy. The Chairman treated his House and Senate inquisitors like you would treat a piece of gum on your shoe.  While certainly bordering on obnoxiousness, what Volcker believed was that the Fed was permitted its independence based, in large part, on the fact that the integrity of its balance sheet was beyond reproach.

How about now?  Like Volcker said, more than a year ago when the Fed had taken on a "mere" $30 billion in toxic Bear Assets, the Fed actions, tested that integrity, "to the point of no return."

I am reminded of what Chairman Volcker said in April 2008 as I follow the Fed's legal ballet with Bloomberg concerning the disclosure of specific information on their various lending facilities.  The public wants to know who is using the programs, how much and what type of collateral are they posting.  Bloomberg has a nice little summary of the proceedings to date here Federal Reserve Says Disclosing Loans Will Hurt Banks. 

How many times, especially during scandals involving the Executive Branch of our Government, have we seen Presidents hide behind the old, "to release such information would greatly endanger national security."?  What usually followed was a severe reduction in the integrity and credibility of those hiding behind "national security".  Isn't that what is happening now with the Fed and our banking system?  How can we know just how "healthy" our major banks are if we don't know how reliant they are on Fed programs, forged in the near meltdown state of 2008, that normally would have never even be suggested to or by the Federal Reserve?  

More importantly (relatively speaking because the whole damn thing is real important), what exactly does the Fed have on their $2+ trillion balance sheet?  Is it, "good collateral"?  And by "good collateral" we are talking about credit risk free. That is what Volcker was talking about.  Is the collateral at least haircut properly?  It's bad enough the Fed is essentially monetizing our exploding debt through its Treasury and MBS purchases (I include MBS purchases in that sentence because the Fed is using its MBS purchase program to, at least in part, soak up the duration that hits the market every time Treasury pushes out its monthly $200 billion of supply) by creating money out of thin air.  How much is the Fed's balance sheet underwater?

I think it is important to remember that in addition to the Fed's unknown toxic asset collateral that it has taken in from unknown banks at a unknown size and at a unknown rate, the Fed has at least $1 trillion of unhedged (interest rate risk) MBS and Treasury bonds.  For every basis point rate rise, what is the Fed's exposure?  If the economy improves and rates rise, is it possible that the Fed will be sitting on a $200 billion loss on this $1 trillion?  Hell yes!

I believe that once the Fed went down this path of lending against toxic assets and quantitative easing MBS and Treasury purchases, the terms "integrity" and "independent" became mutually exclusive.  In the long run the Fed does more harm to both itself and the banking system by stonewalling. 

Quantitative Easing - Part VII

If only the Fed were as cool as Jimmy McNulty.  At least we could have a few laughs on the way to ruin!

Quantitative Easing - Part VI

 

I think Larry Summers bears a strong resemblance to Peter no?

This FOMC Announcement Should Be Fun.

All eyes will be on the Fed's FOMC announcement today, specifically to see if they will announce an end to their Treasury Purchase Program.  The $300 billion program is down to its last $50 billion and is set to expire next month.  From the Financial Times Fed Under Spotlight On Interest Rates 

Some in the bond market believe the US central bank should adopt a flexible stance and keep the Treasury buyback programme open to the end of the year, when the Fed completes buying $1,250bn (€880bn, £760bn) of mortgages. That way, should yields rise in the coming months, the Fed could switch from buying mortgages to purchasing Treasuries.

Nonetheless, a transatlantic copycat manoeuvre from the Fed is on the outer reaches of options open to the bank and the planned $300bn Treasury purchase scheme - now down to the last $50bn - is expected to be allowed to expire next month.

Where an extension is more likely - probably not appearing in the statement but announced as soon as today - is the Term Asset-Backed Securities Loan Facility (Talf), where the New York Fed provides low-cost loans to investors buying asset-backed securities. Investors want certainty that the programme will continue into next year.

Meanwhile, not explicitly calling time on the Treasury purchase scheme would be a mistake, argue both Mr Meyer and Mr Greenlaw, who say the Fed is under pressure to behave more transparently. "Our view is that [not stating the expiration] is not transparent, it's not explicit . . . They'd look wimpy," says Mr Meyer.

Ah, the fun things that come up when you mess with free markets.  Maybe there is a future Fed Chairman sitting at a university right now who will write his doctoral thesis on "How The Ben Bernanke Federal Reserve Managed to Make Itself a Laughing Stock While Destroying The Country!"

The Fed is indeed in a pickle.  Like former Fed governor Meyers said, the Fed will look wimpy if they don't stick to the Treasury Purchase deadline and limit.  However, with the Treasury printing new bills, notes and bonds by the billions every month, how can the Fed monetize the debt and keep rates low?  They are going to have to buy a butt-load more of mortgage backed securities!  That program can be extended and expanded in the name of keeping mortgage rates low, even as underlying Treasury yields rise with supply.

Mortgage backed security spreads to Treasuries will scream tighter until they are tighter than a buzzard's ass in a nose dive (technical phrase).  That will make the Fed the proud owner of a trillion or so of the most expensive MBS ever to be bought.  So to Wall Street MBS dealers, "On your mark...Get set....FRONT RUN!!!!!!

The Horror......The Horror.

Starting today, Treasury will begin it's monthly sale of $75 billion notes and bonds.  Today they will auction off $37 billion 3-year notes, followed by $23 billion 10-year notes tomorrow and finally $15 billion 30-year bonds on Thursday. The Financial Times, Record $75 Billion Treasury Sale to Test Bond Investors. reports;

While the central bank is expected to reiterate that rates will remain low for an extended period, investors are focused on the outlook for the Fed's policy of purchasing Treasuries and mortgages.

The Fed has nearly completed meeting its target of buying $300bn in Treasuries, with about $250bn already purchased. But last week, the Bank of England decided to boost its quantitative easing limit. That has some people thinking the Fed could seek to buy more Treasuries in order to keep market rates low.

At its current pace of buying, the Fed's Treasury programme should finish in six weeks, while the purchase of $1,250bn in mortgages should be completed by the end of the year.

Some analysts think the Fed should adopt a flexible approach and extend the terms of the Treasury buying programme until the end of the year.

That way, the Fed could buy fewer mortgages and more Treasuries, should yields rise sharply in the coming months.

Have things been screwed up for so long that the we just don't see the insanity and the futility of this exercise?  Every month, due to our sky-rocketing deficits and the official government policy on capping mortgage rates, the Fed has to run around like the Keystone Cops trying to offset the effect of new treasury supply.  They do this  by buying some concoction of Treasury notes and Mortgage Backed Securities, taking losses all the way, as the natural effect of supply and demand, as well as increasing market duration, takes yields higher and higher.  The Federal Reserve has become a comedy act, running around on a gigantic "Fools Errand" at least once a month.

How long will it take before the institution of the Federal Reserve loses all its credibility?  Their willing involvement to participate in a political program to artificially cap key interest rates and pump up, or at least artificially support the value of gigantic asset classes like residential and commercial mortgages is both futile and embarrassing. Is anybody keeping score as to whether any "gains" we might be getting by keeping primary residential mortgage rates low has offset the losses the Fed has taken on their MBS and Treasury portfolios?  I don't think so.

Yesterday, Maguire Properties, the largest office landlord in Los Angeles, handed the keys to seven properties over to their creditors (special purpose CMBS vehicles).  This is starting to go on all over the country.  The commercial real estate sector in this country is now suffering from the same things that residential mortgages have already suffered;

• The loans were horribly underwritten. 
• The borrowers were a combination of bad and over-leveraged. 
• The borrowers had little real skin in the game. 
• The value of the underlying collateral was driven up by extremely cheap credit, provided in large part by the Wall Street securitization machine. 

The game is over now.  The government's answer is to expand the Fed's TALF program to commercial mortgage backed securities (CMBS)?  This isn't a liquidity problem!  The bonds and loans are bad! They have learned NOTHING from the residential mortgage crisis!  How is the Treasury's Public Private Investment Partnership (PPIP) going for residential mortgages?  It's NOT EVEN GOING!  The only way TALF can work even a little bit for CMBS is if somehow the rating morons can keep the "AAA" CMBS AAA.  How are they going to do that when commercial real estate is down at least 30% from when most of the loans were made and borrowers are failing by the dozens? Unless they commit fraud (which isn't beyond the realm of possibility for them) they can't.

The question now is, will the Fed help Treasury engage in another Japanese style exercise wherebye putrefying assets are kept on bank books at cost, clogging up balance sheets and creating a legion of zombie banks?  Everything that I have seen in the last twelve months tells me that they will and that scares the crap out of me. 

Timmy Blows a Gasket!

Wow.  It has been written in the Wall Street Journal today Geithner Vents at Regulators as Overhaul Stumbles.  that Treasury Secretary Tim Geithner blew up at his chief regulators last week in a;

expletive-laced critique last Friday as frustration grows over the Obama administration's faltering plan to overhaul U.S. financial regulation, according to people familiar with the meeting. 

About time he blew up at something.  This whole regulatory overhaul issue really pisses me off.  First of all, I love how it seems every answer to improving financial regulation is to give more authority to the Fed.  Just what exactly did the Fed do this decade, officially or unofficially, to safeguard the system?  Zilch. Nada. Nichts.  Absolutely nothing.  

Geithner, the former President of the New York Fed from 2003, sat there and watched about $1 trillion of asset backed commercial paper , paper backed by AAA rated MBS and CDOs, get created and never asked where $1 trillion of this crap came from.  

Greenspan, and Bernanke?  They sat in the catbird seat and never seemed to question just how the hell savings rates could go negative, incomes could stay relatively flat and somehow the American consumer could keep buying piles of crap every year.

These ass clowns can say all they want but the bottom line is that all the rest of the regulatory agencies take their cue from the Fed and the cue was to not rock the boat.

Anyway, I continue to believe that we do not need a year long power, ass-grabbing, turf battle to give us better financial regulation.  What we need is regulation, free from Congressional and White House meddling, by folks who actually "know stuff".  We need to stop recycling the same 100 or so people that have seemed to get all the top posts for the past two decades.  They, for the most part, have proven that they either lack the knowledge or courage to intelligently regulate their jurisdictions.  And sprinkling in some "new blood" in the form of a few "financial professionals" that managed to run their institutions into the ground the last few years isn't the answer either.  

You want my regulatory framework?  Here's something I wrote in March.  We need about ten to fifteen guys and gals to float about, ask questions to whoever they please and then direct the various regulatory bodies to deal with any "issues".  I call them "Common Sense Czars";

One of the many things going on in Washington is financial system regulatory reform.  I have a suggestion that I have brought up before on this blog.  How about a guy like Paul Volcker or Henry Kaufman gets nominated as the "Common Sense Czar"?  I used to read about how Henry Kaufman used to walk the floors of Salomon Brothers, poking his head in to different trading desks and saying things like, "Hi,I see you guys are up a lot so far this year.  Are those gains realized, or are we still holding risk?  Who's buying the bonds you're selling?  Who are we buying our hedges from?"  Mr. Kaufman was like the "Czar of Common Sense."  He would collect a bunch of this information and figure out if the firm was over-exposed to anything.

Think about how a Common Sense Czar would have approached our current crisis BEFORE it fully developed.  Let's use the year 2006.  If we snuffed out the growing disaster then, we still would have had a disaster, but not life threatening.  Anyway, lets fantasize!

1. First the Czar visits the folks making tons of money "guaranteeing things".  Guys like AIG and Ambac and MBIA and asks the question, "Hi, how are you making your money?"  They would say, "We have this great business where we get paid to use our AAA rating to guarantee bonds that ARE ALREADY RATED AAA!  In fact sometimes we guarantee bonds by writing credit default swaps against bonds that ALREADY have another AAA rated company guaranteeing them!  It's like taking candy from babies!"  The Czar of Common sense does some quick math versus those firm's capital positions and says, "Wow, I guess as long as you don't take a 10-15% loss against this portfolio you don't die.  Still, if the losses ever become significant won't you get downgraded?  If you lose your AAA don't you lose your franchise?"  The guarantors say, "?". 
2. The Common Sense Czar then goes to Freddie and Fannie and asks them, "Hi, how are you making your money?" Freddie and Fannie say that they are a combined mortgage insurance shop and leveraged mortgage investment portfolio.  For the insurance they have private mortgage insurers to mitigate risk (especially the sub prime credit they have guaranteed) and with regard to investments they are in a AAA position on the dodgy credits so they are more than fine too.  The Common Sense Czar does some quick math on Freddie and Fannie's combined $3.5 trillion guarantor book and $1.5 trillion retained portfolio  and says, "Wow, if you take a 2% loss on your mortgage insurance portfolio you lose $70 billion?  You have that kind of capital?"  Freddie and Fannie pick up the phone and call Barney Frank and Chris Dodd!
3. Now the Common Sense Czar has similar calls with the private mortgage insurers and they essentially say the same thing that Freddie, Fannie, AIG, MBIA, Ambac, etc have said.  The Czar of Common Sense does the same quick calculations and arrives at similar conclusions, a small percentage loss on a BIG number wipes these guys out too.
4. The Czar of Common Sense pauses and says, "Man, all these guys with pretty thin levels of capital are relying that these mortgage bonds can't lose money because the ratings companies rated them AAA or AA- at worst.  I need to go visit those guys but before I do that I am going to drop in on Bear Stearns and Lehman Brothers since they are the two biggest underwriters of these bonds.
5. The Czar goes to Bear and Lehman and says, "Hi, how are you making your money?"  The two investment banks tell the Czar that they make their real money from originating their OWN dodgy loans, structuring them and selling them to a variety of investors for a much higher price.  The Czar asks, "How is this possible?"  Bear and Lehman say that through the magic of diversification, they are able to create a very large percentage of AAA bonds that sell for a much higher price than the subprime loans backing them would.  The Czar says, "Hmm, that is interesting.  It all seems to come back to these rating companies.  Oh, by the way, do you guys ever get stuck holding some of these bonds?"  Bear and Lehman say, "Well, we certainly wouldn't call it 'getting stuck'!  But yes, we each have about $50 billion laying around earning us GREAT carry."  The Czar says, "Wow!  How do you guys finance that?  After all, you aren't banks so you don't have retail deposits."  Bear and Lehman tell the Czar, "Oh contraire, we have hedge fund prime brokerage cash.  That money is stickier than the best mom & pop retail deposits.  Besides that, our commercial paper programs are over-subscribed every month!  The last thing we are worried about is funding! The Czar says, "Commerical Paper?  You guys issue CP backed by this stuff?"  "Oh sure, but we don't do THAT much.  You should go talk to Citigroup.  They are doing hundreds of billions, UBS too!"  The Czar makes a note to ask New York Fed President Tim Geithner about this.  Surely he is on top of it.
6. Now the Czar takes a trip out to California to see the subprime giants Ameriquest and New Century.  The Czar says, "Hi, how are you making your money?"  The subprime guys say, "We have thousands and thousands of loan brokers prowling the countryside making the loans that give folks a chance to have things they never had AND make loans that the boys at the Wall Street shops say they need.  We get paid a premium for the loans and we make a lot of fees." The Czar says, "The subprime sector used to be pretty small.  Now suddenly it is very big.  How did that happen?"  The subprime originators say "?".  The Czar asks for a sample of the loans and sees they look pretty horrible.  He then asks the subprime originators, "By the way, what happens if these loans go bad early on.  Don't you guys have to buy them back?  How much capital do you have?"  The subprime guys say, "Oh we have some capital, but not to worry because if guys default we just sell the property and no one takes a loss.  After all, real estate only goes up!"  The Czar says, "Well yeah, but lets just pretend real estate goes down and a lot of these borrowers, especially the ones who are speculators shrug their shoulders and default.  Wouldn't you have to buy all these bad loans back at par?  Do you have enough capital to do that?  Oh, and who regulates you guys?"  The subprime originators answer those two questions by saying, "?" and "?".
7. Now the Czar is a little worried.  It seems like the entire financial system is betting that somehow these loans were magically transfigured from garbage to riskless assets.  It's time to visit S&P and Moody's.  The Czar says, "Hi, how do you make your money?"  The ratings companies say, "Oh, we make lots of money rating all these structured securities.  We are having record earnings every year!"  The Czar says, "Who pays you?"  The ratings companies say, "Why, the issuers of course!"  The Czar is now pale.  He gulps a drink of water and says, "How is it possible to take $1 billion of subprime loans and create $800 million AAA rated bonds?"  The ratings companies say, "Well, diversification of course.  All real estate is local and all economies are local. Real estate prices can never go down NATIONALLY at the same time as we are having a recession and folks are losing their jobs.  Anyway, even if we do have a recession, economies are local and diversified too.  And even if they are not, if we have a recession and the dollar falls, the Arabs, Europeans and Asians will just come in and support real estate prices.  It's all covered see?"
8. The Czar call the President and says, "Houston....we have a problem!"

Federal Reserve Gets Slammed by "Low Latency Trading"!!

There has been tremendous focus on program or "high latency trading" as of late.  This type of trading takes place in the equity markets.  The definition of latency is the amount of time a package of data takes to move across a network from one computer to another.  Major Wall Street firms and hedge funds who deploy high latency trading programs are accused by many of using their super fast computers and algorithms to figure out what large trade orders are coming and get in front of those trades milliseconds before they are made and scalp a penny or two.  Done a few trillion times and you are talking about some real money!

The focus this morning however, is something one of our favorite readers describes as "Low Latency Trading."  Since we are making this term up, here is our definition;

"Low Latency Trading occurs when a gigantic counterparty announces to the known capitalist world that it will be a size buyer of a certain mortgage backed security or Treasury note.  The low latency trader will normally announce his intentions days in advance, allowing time for dealers, hedge funds and money managers to "set up" for the low latency traders order, thus allowing for large profits at the low latency trader's expense."

Check this out from the Financial Times Wall Street Profits From Fed Role

Wall Street banks are reaping outsized profits by trading with the Federal Reserve, raising questions about whether the central bank is driving hard enough bargains in its dealings with private sector counterparties, officials and industry executives say.

The Fed has emerged as one of Wall Street’s biggest customers during the financial crisis, buying massive amounts of securities to help stabilise the markets. In some cases, such as the market for mortgage-backed securities, the Fed buys more bonds than any other party.

However, the Fed is not a typical market player. In the interests of transparency, it often announces its intention to buy particular securities in advance. A former Fed official said this strategy enables banks to sell these securities to the Fed at an inflated price.

The resulting profits represent a relatively hidden form of support for banks, and Wall Street has geared up to take advantage.Barclays, for example, e-mails clients with news on the Fed’s balance sheet, detailing the share of the market in particular securities held by the Fed.

“You can make big money trading with the government,” said an executive at one leading investment management firm. “The government is a huge buyer and seller and Wall Street has all the pricing power.”

A former official of the US Treasury and the Fed said the situation had reached the point that “everyone games them. Their transparency hurts them. Everyone picks their pocket.”

Imagine that!  I spent a lot of my time on Wall Street in the agency mortgage backed securities market.  One of the most important things that I, along with my clients, traders and research departments would do would be to gage the supply and demand technicals of each particular Fannie Mae and Freddie Mac coupon.  For example, we would try to figure out how many 5% Fannie Mae MBS (FN 5%) would being made by originators, how many were currently in the hands of accounts who do not lend them out (Asian central banks as an example), what big accounts, who normally lend out huge amounts of FN5%, might suddenly not re-lend all or a portion of the bonds, etc.  This covered the supply part of the technicals. Essentially, you were trying to find MBS that might get "squeezed". Then on the demand side, we would try to figure out who wanted or needed these FN5%'s.  If you got your technicals right there were all kinds of ways to trade and make money. However, it is important to note that all of this was educated guesswork. You could guess wrong and lose.

Now however, we have the Fed as the largest buyer of mortgage backed securities.  Not only do we know that the Fed is a buyer (long only), but they are telling the dealer community what they want to buy in advance.  Because the Fed does not lend those securities back out and because they are not selling the securities anytime soon, even if dealers weren't front running, the price of what the Fed wants to buy will spike ahead of their purchase.  However, because the Fed's program is designed around keeping keeping primary mortgage rates below 5%, it's pretty easy to figure out when the Fed is going to be a buyer and what coupons they can buy.  It's like shooting fish in a barrel.  Check out this quote from Barney Frank (also from the FT);

Barney Frank, chairman of the House financial services committee, said the potential profiteering may be part of the price for stabilising the financial system. “You can’t rescue the credit system without benefiting some of the people in it.” Still, Mr Frank said Congress would be watching. “We don’t want the Fed to drive the hardest possible bargain, but we don’t want them to get ripped off.”

Crystal clear Barney!  We told you back in December Will Anybody at Treasury of The Fed EVER Learn How the Secondary Mortgage Market Works? last year that the Fed might easily lose more money on these programs than the country makes through artificially low mortgage rates. Between the MBS and Treasury notes and bonds they have bought, un hedged, the Fed probably has duration exposure of about $500,000,000 per basis point (one-hundredth of one percent)! That's a lot of risk no?  Add to that irresistible front running/guessing on the part of dealers and it seems like another moronic program that puts our central bank at huge risk (which isn't a good thing when the credibility of a central bank is supposed to be unquestioned) and transfers more money from taxpayer pockets to major Wall Street banks.

The Fed's Exit Strategy: "There Will Be No Inflation. However, Real Interest Rates Will Go to Fifteen Percent!"

From the Financial Times Credit to Remain Tight Says Dudley 

I love how the Fed keeps shaping the conversation around its quantitative easing exit strategy.  They keep describing the tools they have to drain the $1 trillion or so excess reserves, without explaining what effect these "tools" will have on the economy.  Here's a great example from New York Fed President William Dudley;

However, the majority of Mr Dudley's remarks were meant to address inflationary concerns, which could themselves hinder economic recovery as the Fed's balance sheet swells from about $870bn (£528bn) two years ago to $2,000bn today - possibly as much as $2,500bn before it starts shrinking.

Mr Dudley argued that this sharp expansion was not inflationary because the Fed now pays interest on excess bank reserves. That means banks no longer have an incentive to create excessive credit, which in the past led to an overheated economy and ex-cessive inflationary pressures.

"This is not the world in which we now live," said Mr Dudley. "Because the Federal Reserve now has the ability to pay interest on excess reserves it has the ability to prevent excess reserves from leading to excessive credit creation."

Mr Dudley added that the Fed could drain excess reserves from the banks "to provide reassurance that we will not - under any circumstance - lose control of monetary policy"

What President Dudley and the rest of the Fed never seem to get around to telling us is, what rate will they have to pay on those excess reserves to keep them out of the money supply once things start turning around?  How many mortgage backed securities and treasury notes and bonds must it sell to reduce its balance sheet?  The Fed, through what I consider to be a disastrous policy of quantitative easing and artificial mortgage rate capping, has put itself and the country into a intractable situation.  The only way the Fed can drain these reserves and and stave off an explosion of the money supply it to jack real interest rates into double digits.  As a commander in Vietnam once said after a battle with the Viet Cong, "We had to destroy the village in order to save it."

Am I wrong?  Please tell me I am and why. 

"You Shut Up!" "No, YOU Shut Up!!"

Heidi Moore put a piece out yesterday titled Will Everyone Please Shut Up About Goldman Sachs? Since the title is in the form of a question then I will answer, "No, I will not shut up as long as people like Heidi Moore write things like this."   

The image of Goldman Sachs (GS) as a Borg-like hive mind that breeds a bald master-race of capitalists has picked up speed during the last month. Rabble-rouser Matt Taibbi in Rolling Stone memorably called Goldman "a vampire squid wrapped around the face of humanity, relentlessly jamming its blood funnel into anything that smells like money." Joe Hagan in New York magazine devoted several pages to "Goldman's current public tarring." The controversy has even attracted the genius of Michael Lewis, who wrote a searingly funny column in the wounded voice of the firm, arguing that Goldman owns only one of the three branches of government outright and that the firm habitually rounds down any number under $50 billion directly to zero.

Needless to say, there is much to make Goldman's rivals suspicious. Super-powered trading programs? Politically prominent alums? Orcs and vampire squid? No wonder rivals can't imitate returns like the firm's $3.4 billion second-quarter profit. These guys are clearly running on a supernatural level, right?

Mission accomplished: The House of Representatives now wants to call Goldman—a firm that no longer owes anything to the government—on the carpet in what are sure to be disastrously populist hearings.

First of all, fabulous suck up to Michael Lewis.  

Secondly, calling Taibbi a rabble-rouser makes Ms. Moore sound like someone sitting on Senator Joe McCarthy's Committee on Un-American Activities.  

Thirdly, Ms. Moore's line, "Mission accomplished: The House of Representatives now wants to call Goldman—a firm that no longer owes anything to the government—on the carpet in what are sure to be disastrously populist hearings." sounds eerily like Jack Nicholson (Colonel Jessup) line to Tom Cruise (Lt. Kaffee) in "A Few Good Men" after Kaffee exposes Jessup as a liar, unfit for command. "Congratulations son, you've weakened the nation."  

Additionally, Moore asserts that Goldman has paid its debt to society with a quick and dismissive line, without addressing the legitimate question, "Would Goldman Sachs be alive today without government intervention?"  What kind of journalism is that?  You can't tell everyone to shut up and get back in line without answering that question, supported by facts.  This is exactly what Goldman has been doing since last year.  They have stated repeatedly, without any factual information, that the firm was never in any trouble and that the firm's exposure to AIG was "immaterial".  If Taibbi is a rabble-rouser then Moore is a shill.  

Anyway, the premise of Moore's article is that Goldman's superior culture is the reason for their consistent, out sized success.  Additionally, Moore illustrates what happens to a lot of Goldman people when they leave the mothership.  They become shockingly mediocre.  Having witnessed average people going to Goldman and becoming stars, and Goldman stars leaving Goldman and becoming average, I agree.  I also agree with Moore's take on the management of most top Wall Street firms.  It's horrible. Goldman on the other hand has a deserved reputation for being an outlier in this regard.  No doubt it is a very well run ship.  However, Goldman management, as brilliant and communal as they are, still managed to run the ship aground like everyone else in this decade.  I have gone through what I believe happened to Goldman many times on this blog so I am not going to do it again.  There's a nice big category "Goldman Sachs" if you want to have a read.

Goldman Sachs is a very well run firm with incestuous political connections that would have made J. Pierpont Morgan blush.  These connections not only saved them in 2008, but set them up to completely dominate the playing field going forward.  Between the firm's global political connections, its dominance in debt and equity raising, its ability to see massive amounts of non-public information as well as the trade flows of the world's largest institutional investors, Goldman has a distinct advantage over its weakened rivals.  When you know the answers to the test you tend to do very well.  This may go a long way in explaining the phenomenon of what happens to superstars leaving Goldman.  They no longer have the answers to the test.    

Fed's Yellen Sees "First Solid Signs of End to Slump"......With One Little Caveat: Reality.

From Bloomberg News,

Yellen’s remarks echo the view of Fed Chairman Ben S. Bernanke, who told Congress last week the economy is showing “tentative signs of stabilization.” Those indications include a rising stock market, slowing declines in housing prices and a waning pace of job losses, the regional bank president said.

“The interaction between the economy and the credit crunch, often described as an adverse feedback loop, led to what could become the most severe recession since the Great Depression,” the 62-year-old bank chief, who votes on monetary policythis year, said in the speech to a convention of the Oregon Bankers Association and Idaho Bankers Association.

“We glimpse the first solid signs since the recession started more than a year and a half ago that economic growth may be poised to resume,” Yellen said. “Indeed, I expect that to happen sometime this year,” she said, while adding that risks to the outlook remain, with the commercial property slump the biggest threat.

Hmm, rising stock market?  That's always a good indicator.....like Dow 14,000 in October 2007. 

Slowdown in the decline of housing prices?  Maybe, Yellen....maybe.  Personally, I think there's plenty more pain to come, especially at higher price points.  Additionally, like we said in an earlier post, there's a massive shadow inventory just looking for a bid to pop its head up.

Waning pace of job losses?  Ummm, no.  Even if job losses slow, we still have major "underemployment" and a level of long-term joblessness that we have never seen before in our modern economy.  We are just starting to see the effect of long-term joblessness as family savings run out along with health benefits.

The main risk to the outlook is the "commercial property slump".  "Slump"??  If there is one thing that almost everyone agrees with it is that commercial real estate is going to be a lot more than just a "slump".  Commercial real estate has been the crazy uncle everyone has been trying to hide away in the closet for more than a year.  He's coming out of the closet now and is ready to pee in the punchbowl, take time to personally insult everyone in the room and then light the drapes on fire with his Tiparillo.

Why did Yellen even bother making this speech?  Speaking of Tiparillo

Good Thing We Got Rid of "Regulator Arbitrage"!

Remember all those stories about how firms like Countrywide and AIG essentially shopped for the easiest regulator the same way a prescription drug addict shops for doctors who will write him a script for Percs? 

Remember how all the "former" investment banks like Goldman and Morgan Stanley used their regulator, the SEC, like a poor junior high-school substitute teacher to get away with all kinds of mischief?

Well, it appears when it comes to risk taking in 2009, Goldman Sachs has managed to do both!  The boys and girls at Zero Hedge (Richie and I are starting to wonder if they are Goldman arch-enemy Deutsche Bank!) have done another fantastic job bringing to light Goldman's approved request to their NEW regulator as a bank holding company, The Fed, to use their OLD regulator, the SEC when it comes to Value at Risk models and limits! Why Does Goldman Need a Fed Exemption For VaR Calculations?

The clue may come from a February 5 letter by the Federal Reserve to Goldman CAO Sarah Smith. The letter had come in response to GS requests for "temporary exemptions from the application of certain aspects of the Board's Market Risk Rules for state member banks and bank holding companies and the Board's general risk-based capital rules for bank holding companies." Basically through the end of 2009 Goldman is basically using non-traditional. SEC approved VaR models as can be seen here:

GSGI has requested that (1) through December 31, 2009, GSGI and Bank be permitted to use certain Value-at-Risk ("VaR") models approved by the SEC... to determine their capital requirements for specific risk under the Market Risk Rules; (2) through December 31, 2009, GSGI and Bank be permitted to use methods approved by the SEC to determine their capital requirements under the Market Risk Rules for those trading assets, including distressed debt and restricted stock investments that the SEC did not require to be included in the VaR-based models of GSGI and Bank; and (3) GSGI be allowed to use methods approved by the SEC to calculate risk-based capital requirements for its nonfinancial equity investments that are subject to the Board's Credit Risk Capital Rules.

Lets translate this because it's real simple.  Goldman wants to be a bank holding company so they will never have to worry about pesky things like liquidity and funding rates ever again.  However, they would still like to be regulated by Mrs. Doubtfire....the SEC.  Splendid.  Like Zero Hedge says, "Mr. Van Praag, the floor is yours....again."

Ahhhh, It's Time For The G-8.

I love the G-8 conference, I really do.  I like it especially when things are going horribly wrong..like now. When times are good, we get a bunch of pompous asses standing around in photo session circle jerks talking about fabulous new world orders and listening to Bono's plan to end global poverty.  

That's pretty funny, but not like now where no one trusts each other, everyone is blaming each other and all of our great celebrities are in Los Angeles deifying Michael Jackson.  Now you get something like this, from Bloomberg News;

“Once a recovery is assured, we have agreed on the need to prepare appropriate strategies to reduce the extraordinary measures taken in response to the crisis,” said the draft, which was read to reporters by a G-8 official as the leaders gathered in L’Aquila, Italy. The exit strategies “will vary from country to country, depending on domestic economic conditions and public finances and to assure a sustainable recovery in the long term.”

That was a nice way of saying, "I don't care if we are the G-8 or the Jackson - 5 (had to throw that in there), we are going to do what's good for ourselves.  If it meshes with what you are doing, God bless, if not....well, we'll see you at the World Cup."

What I find interesting is this line, "Once a recovery is assured."  Hah!  Who makes that decision?  In the United States we have a supposedly independent Federal Reserve.  The art of central banking is to get ahead of the game. What the central banker sees as the beginnings of a solid recovery usually do not mesh with what the politicians see.  Right now the Fed is sitting on a keg of dynamite in the form of hundreds of billions of excess reserves.  As soon as the Fed sees a return to normalcy, which might be sometime around 2010, they will be playing a frantic game of 52-card pick up to keep that keg of dynamite from exploding. That time will be right around the mid-term elections.  You think politics won't come into play here as the Fed tries to slow the recovery down and control inflation?

Anyway, when things start turning it's going to be every man for himself.  The G-8 summit in 2010 will look something like this;

I Think Bernanke Threatened Ken Lewis.

I really wonder about Ben Bernanke.  I wonder;

• Is he the gentle, humble, academically-minded central banker that he appears to be when seen in public or;
• Is he a quiet "Original Gangsta"?

To this day, we still really do not know what Chairman Bernanke knew about Bear Stearns and when he knew it in those dark days of March 2008.  We highlighted these concerns in a piece we wrote last May "Hi Fellas, What Are You All Talking About?  Meetings were held with all the major heads of Wall Street, EXCEPT Bear Stearns, and Ben Bernanke and Tim Geithner on Tuesday, March 11, 2008.  The Fed has never explained what was discussed at those meetings but the next day, Bear Stearns had their funding lines clipped by every firm at that meeting that did business with Bear.  While that, in and of itself is troubling, what is even more troubling is Ben Bernanke testified to Congress after Bear went down that he did not know the gravity of Bear's liquidity crisis until Thursday afternoon.  By that time the Bear was morte.  Chairman Bernanke has never explained what was said at that Tuesday meeting, but as we have said since last May, it's highly improbable that a meeting taking place that week with every major Wall Street player, except Bear Stearns, wasn't about Bear's liquidity squeeze.  It is my opinion that Bear was shot at that meeting and Chairman Bernanke had something to do with it.

Now we come to Ken Lewis, BofA and Merrill Lynch.  Yesterday, Chairman Bernanke was grilled on Capital Hill as to whether he threatened Ken Lewis with his job if he invoked the Material Adverse Change ("MAC") clause and canceled the planned purchase of Merrill Lynch last December.  From the Financial Times;

Mr Bernanke said there had been no threat but if BofA had pulled out and then needed a bail-out there should have been repercussions. "I think if somebody makes a decision that results in their company failing and being rescued by the government, I think there should be consequences for them," he said. Darrell Issa, senior Republican member on the committee, accused Mr Bernanke of a "cover up" and of shutting out other regulators such as the Securities and Exchange Commission.

I don't know about you but that sounds a lot like the threat a smart and slick extortion artist would make to a small business owner.  "Hey listen, things are okay now but you never know.  A fire could start, some kids may break your windows, maybe the trucks that bring you your deliveries may not show up.....stuff happens."

There was only one way Ken Lewis could read what Bernanke said.  If he didn't go through with the Merrill deal and Merrill was left to die, the whole shebang (big technical term) could very well go down.  At that point, the Fed is going to have to save everybody, including BofA.....and they would insist on Ken Lewis and the board of BofA being gone before they got their lifeline.  When BofA realized that Merrill Lynch was going to drop another $15 billion in Q4 2008, Ken Lewis would have had no problem invoking the MAC.  Merrill CEO John Thain had a very recent history of lying about Merrill's financial position (see Q2 2008 when he said they were adequately capitalized.....and then less than two weeks later shocked the world with nearly a $6 billion loss on the sale of CDOs).  It would have been EASY to prove that Thain was disingenuous with BofA about their financial position at the time of the purchase in September 2008.  No honest judge would have stood in BofA's way.  I am certain of this.

Chairman Bernanke wasn't making the idle threat like, "Hey, if you invoke the MAC and then later on your bank, without Merrill, runs into trouble, you personally have used up all your brownie points."  Chairman Bernanke was saying that WHEN the world goes up in flames as Merrill fails YOU will be the roadblock to your bank being saved and YOU will pay the price.

That's what I think anyway.

Quantitative Easing - Part V

Oh dear;

In these circumstances, the Federal Reserve will employ all available tools to promote economic recovery and to preserve price stability. 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 will buy up to $300 billion of Treasury securities by autumn. The Committee will continue to evaluate the timing and overall amounts of its purchases of securities in light of the evolving economic outlook and conditions in financial markets. The Federal Reserve is monitoring the size and composition of its balance sheet and will make adjustments to its credit and liquidity programs as warranted.

Quantitative Easing - Part IV

Ten-year Treasury approaching 4% and the average mortgage backed security down a couple of points....again.  Just another day in hell for the Fed's "Quantitative Easing" Department.  On a $500 billion portfolio, two points is $10 billion for those keeping score.  As we predicted when we warned the Fed in January, not to try to bring mortgage rates down by creating a long-only mortgage fund that buys whether they're rich or cheap, low dollar or high dollar, skinny or fat.  They buy to try to artificially hold a multi-trillion dollar market from going where it wants to go, which right now is DOWN.

Like Richie said in an earlier post, maybe if the Fed or Treasury actually had a few decision makers that actually knew how markets trade and work, maybe things would be different.  However, they don't....so they're not.  Us cretins that worked the bond markets would describe the Fed's situation something like this;

"Wow Bob, that trade went right up their asses didn't it?"

"Why yes Al, I believe it did.  In fact it looks like a few bonds are tickling their tonsils."

Here's a visual from the great Chevy Chase;

Quantitative Easing - Part III

From Bloomberg News Bernanke's Conundrum Threatens Housing On Mortgage Rate 

“The Fed is stuck in a very difficult place,” said Mark MacQueen, a partner at Austin, Texas-based Sage Advisory Services Ltd., which oversees $7.5 billion. “You can’t have it both ways. You can’t say I’m going to stimulate my way out of this problem with trillions of dollars in borrowing and keep rates low by buying through the other. I don’t think that is perceived by anyone as sound policy.”

Here at Monkey Business we've been pretty clear on how "over their skis" we think the Fed is with regard to their quantitative easing program.  We've come up with some fun illustrative examples;

Fed's Quantitative Easing Program - Part II

  A Preview To the Fed's Quantitative Easing Program

Now today, keeping in mind the Fed's impossible wish of capping mortgage rates when Obama's Treasury is cranking out Treasury supply at breakneck speed, I give you the great Burgess Meredith;

This Has Gotten Out of Hand.

ENRON

What exactly do you think of when you see the above?  Whatever it is, I'm sure it's not something pleasant. Before the banking sector really showed us what wanton financial deception and destruction was all about, Enron was our poster child for everything that a modern company could do harm its country. Not only did they wipe out countless investors, take down one of the nation's largest public accounting firms (Arthur Anderson), bruise the credibility of countless financial institutions (unfortunately, that was a nice peek into the future that we should have taken advantage of), Enron actually created severe energy shortages in the nation in order to make windfall profits!  If these guys were named Mohammad or Akbar as opposed to Kenny and Jeff we would have thrown them into Gitmo with the other terrorists!  

Therefore, one would imagine that anyone that was a senior player with Enron would be persona-non-grata in the halls of government.  Well, as we talked about last Friday afternoon, the Fed doesn't feel that someone who was ENRON'S CHIEF LOBBYIST IN WASHINGTON D.C. should be excluded from positions of influence and power.  From Bloomberg News;

The Federal Reserve intends to hire a veteran lobbyist as it seeks to counter skepticism in Congress about the central bank’s growing power over the U.S. financial system, people familiar with the matter said.

Linda Robertson currently handles government, community and public affairs at Johns Hopkins University in Baltimore, and headed the Washington lobbying office of Enron Corp., the energy trading company that collapsed in 2002 after an accounting scandal. She was also an adviser to all three of the Clinton administration’s Treasury secretaries.

First of all, the Fed needing their own internal lobbyist is pretty funny.  However, I can see the need. The Fed is supposed to be independent of all government influence.  The oversight of the Fed is non-existent.  Central banker independence is something that has scared many smart people for centuries. In times like these where the Fed is launching multi-$trilllion financing facilities and engaging in the purchase of $trillions of Treasury and mortgage backed securities, the Fed's independence even scares the Fed!  So it makes sense that they would want to hire a liaison to explain to Congress what they are doing and why.  However, perhaps they would hire someone who actually understands things like how markets trade, how our system of asset-financing works..silly stuff like that.  Nope!  Instead they hire a crackerjack lobbyist!  And not just anyone mind you, but ENRON'S crackerjack lobbyist.  The fact that Ms. Robertson bounced from her Treasury post to Enron when the Democrats lost the White House is just another example of what President Obama is supposed to be against.

Some of you may say, "Eric, the Fed is independent.  They made this personnel choice so don't go blaming it on the Obama Administration."  To that I would say, "Don't you find it troubling that Ms. Robertson worked closely for Larry Summers and Bob Rubin?  Do you think Ben Bernanke had Ms. Robertson at the tip of his tongue when it came time to hire his internal lobbyist? I doubt it."  

Somehow, I think Mr. Summers had a big hand in recommending Ms. Robertson to the Fed.  You would think these boys would want to stay away from someone as potentially toxic as Enron's chief lobbyist. After all, it was Bob Rubin who, back in late 2001, as head of Citigroup's Executive Committee,  made what was universally deemed a highly inappropriate phone call to Senior Treasury official Peter Fisher, asking Treasury to intervene with the major bond rating agencies.  The rating agencies, under the backdrop of a growing ENRON collapse, were ready to sharply downgrade Enron.  Rubin asked Treasury to advise the rating agencies against an immediate downgrade of Enron debt on the grounds of.......?  There were no legal grounds.  Enron was a giant scam and they were insolvent.  Citi had huge exposure and Rubin tried to use his influence to keep the Enron charade going.

Did you forget about that one?  We didn't. They want to dig all that back up to show another example of "influence abuse"?  Be our guest!  These guys, Rubin&Summers Inc., are so smug, so arrogant and so out of touch, that it probably never occurred to them that this move might be viewed by the public as getting another golden shower from this gang that was supposed to offer hope and change.  How many times have we heard President Obama, both on the campaign trail and now as President say;

 "We want to change the way things are done in Washington." 

This isn't change Mr. President.  It's just more of the same and maybe even worse.  Your financial team is making you look like you're either full of it or clueless.    

You Really Really Can't Make This Sh*t Up!

They really must want to see how much they can push the envelope before we have riots in the streets!  From Bloomberg News Fed Intends to Hire Lobbyist In Campaign to Buttress Its Image.

The Federal Reserve intends to hire a veteran lobbyist as it seeks to counter skepticism in Congress about the central bank’s growing power over the U.S. financial system, people familiar with the matter said.

Linda Robertson currently handles government, community and public affairs at Johns Hopkins University in Baltimore, and headed the Washington lobbying office of Enron Corp., the energy trading company that collapsed in 2002 after an accounting scandal. She was also an adviser to all three of the Clinton administration’s Treasury secretaries.

Robertson would help the Fed manage relations with lawmakers seeking greater oversight of a central bank that has used emergency powers to prevent Wall Street’s demise. While she wasn’t tied to Enron’s fraud, her association with the firm may raise questions, analysts said.

“Some members of Congress think there are votes in attacking the Fed” after it “unnecessarily and unwisely entangled monetary policy with fiscal policy,” said former St. Louis Fed President William Poole. “The Fed is going to have a tricky time of unwinding what has been done” and will need to “keep in touch with members of Congress more thoroughly,” said Poole, now senior fellow with the Cato Institute in Washington.

Robertson served under Treasury Secretaries Lawrence Summers, Robert Rubin and Lloyd Bentsen. She didn’t return calls seeking comment.

Enron!!  Well at least she didn't work for Goldman Sachs.  However she worked for Summers and Rubin so...yeah, she kind of worked there too!  Oh, and if you aren't mad enough....they were considering her for a senior Treasury post but the Adminstration stopped it because she's a lobbyist.

I feel like I'm living in a banana republic.....with no bananas!!

So Long PPIP

Well, it looks like Timmy Geithner's first semester project, the "Public Private Investment Program" is getting marked INCOMPLETE and getting tossed in the bin.  From Bloomberg News;

The Federal Reserve may not start lending against residential mortgage-backed securities under its Term Asset-Backed Securities Loan Facility, Federal Reserve Bank of New York President William Dudley indicated.

“We’re still in the process of assessing whether a legacy RMBS program is feasible, and if it were feasible, whether it would be significant enough to make a major impact,” Dudley said at a conference in New York hosted by the Securities and Financial Markets Association and Pension Real Estate Association.

His comments today add to signs that Treasury Secretary Timothy Geithner’s Public-Private Investment Program to boost debt prices and rid banks of devalued assets to expand lending is stalling, after helping to spark a rally in stocks and bonds. The Federal Deposit Insurance Corp. yesterday delayed a test sale of bad loans held by U.S. banks that had been billed as a tryout for its role.

If you remember, this was the big plan that helped ignite a huge rally in financials, which in turn aided the quick raising of bank capital.  As we said yesterday in The "Bigger Idiot Theory" Is Alive and Well. folks who have thrown other peoples hard earned money at the freak-show that is our banking sector are going to be standing with the same dumb-ass look they had on their mugs last year when they got scammed and did the same thing.  You think that Timmy's plan of clearing the banks of their "legacy" loans and securities wasn't already factored in by the investors who just recapitalized the banks?  It's a distinct possibility.

The other main factor that got investors to belly up to the bank bar was the "Stress Tests" administered by the Fed.  The "Stress Tests" were the mechanism we used to determine how much capital the 19 major financial institutions needed.  I wonder what the starting price was for the "impossible" to value legacy assets and what prices were assigned in the "Stress Position"?  Ah, details, details. As they said in jolly old Rome, "Purgamentum init, exit purgamentum"

Anyway, PPIP was a bad plan that, coupled with the suspension of mark-to-market accounting, and the warranted mistrust of dealing with the government on the part of investors, assured that NO PARTY WANTED ANY PART OF THIS PLAN.  The plan put the FDIC, and hence us, at huge risk without commensurate reward.  So what are we going to do with all these putrefying assets clogging up the financial system?  Here's FDIC head Shelia Bair;

“Banks have been able to raise capital without having to sell bad assets through the LLP**, which reflects renewed investor confidence in our banking system.”

**LLP = Legacy Loan Program

Remember last year, around September when you felt the world was ending and you wished you had more canned goods, bottled water and ammo?  Well, my advise is stock up now because we are gonna blow again.

Clarification and Correction to "Paul Krugman Says We Are Not Printing Money."

On Friday I wrote a piece Paul Krugman Says We Are Not Printing Money.  I was responding to this statement from Mr. Krugman;

"Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all."

I proceeded to lay out an accounting example of what happens when the Fed engages in quantitative easing by purchasing assets like mortgage backed securities from a dealer like JPM Chase with "money" that the Fed essentially "makes" and then directs into the reserve account JPM Chase has at the Fed. Many of our readers have been kind enough to either comment or email to clarify Krugman's point.  Essentially, what Krugman is saying is even though the Fed is making money through quantitative easing, the banks are not putting the new reserves into the financial system as they would normally do by lending, thus triggering the classic money multiplier effect.  If you take the classic MV=PY  (M=Money Stock, V=Velocity of Money, P=Price Level and Y= Real Income) and assume that the increase in M is being offset by a decline in V (because the banking system is damaged AND the amount of good credits to lend to have also declined sharply), then what the Fed is doing through Quantitative Easing is not inflationary.....yet.

My point with Mr. Krugman (Dr. Krugman?) was that it was incorrect, at least in my tiny mind, to say that the Fed was not "printing money".  They are "printing money".  However, the banks are not putting it to work.  I have two questions or comments about managing this gigantic increase in M though quantitative easing.

1. Even though the massive increase in money stock ("M") has not found its way through the financial system to be inflationary, isn't perception 99% of the battle with markets?  We are a huge debtor nation.  If you are trading U.S. dollar assets and you see the Fed and Treasury making more and more of them at an alarming rate aren't you going to either sell dollars or at a minimum, either reduce future purchases or not buy any more?  Therefore, won't this lead to dollar weakness, higher dollar denominated rates and commodity inflation for the U.S.?  Isn't this part of the reason oil is sky-rocketing again.?
2. What happens when, Lord willing, "V" or bank lending picks up?  How is the Fed going to take back all the "M"?  This quantitative easing reminds me of the "Trinity Test" in New Mexico back in July 1945.  Trinity was the first test of the atomic bomb.  As we got closer to the date, a very alarming possibility popped up into some of the scientists heads.  Could the explosion of an atomic devise ignite the Earth's atmosphere and......destroy life on the planet?  They were so scared they had super-brain, Enrico Fermi, do some math to disprove the notion.  Do we have some "Enrico Fermi" equivalent to disprove that as soon as the economy turns, this massive amount of "M" won't ignite the mother of all bond selloffs and interest rate spikes as the Fed fights to get all that "M" back?

Dr. Fermi?

Paul Krugman Says We are Not Printing Money.

Let me start by saying I like Paul Krugman.  I know that is heresy in many circles but not in mine.  That being said, I either don't understand or I disagree with what he says today in the New York Times The Big Inflation Scare. Specifically this statement;

"Now, it’s true that the Fed has taken unprecedented actions lately. More specifically, it has been buying lots of debt both from the government and from the private sector, and paying for these purchases by crediting banks with extra reserves. And in ordinary times, this would be highly inflationary: banks, flush with reserves, would increase loans, which would drive up demand, which would push up prices.

But these aren’t ordinary times. Banks aren’t lending out their extra reserves. They’re just sitting on them — in effect, they’re sending the money right back to the Fed. So the Fed isn’t really printing money after all."

Here is how I understand things as a dumb fixed income guy.  JPM Chase has $10 billion FNMA mortgage-backed-securities.  These MBS are real securities and they are assets on JPM's balance sheet. The Federal Reserve asks JPM to offer these securities.  JPM offers the securities at 100-00.  The Fed says, "Thank you, your done."  JPM says, "Great, $10 billion MBS sold to you at 100-00."  Upon settlement, those MBS leave JPM and settle with the Fed.  The Fed pays for the securities by crediting JPM's Federal Reserve account by $10 billion.  Isn't that credit an asset for JPM?  If not then JPM just gave away $10 billion right?

Now the question is, "Where did the Fed get the $10 billion to credit JPM with?"  It certainly seems like they got it by expanding the money supply no?  Maybe they didn't "print" the money but they certainly "made" it. Those excess reserves at the Fed that Mr. Krugman is talking about are assets on JPM's balance sheet.  I bet they would be a little upset if the Fed treated these assets as fictional and just made them disappear.   As far as I know, the only way the Fed can get back the reserves they credited JPM's account with is to sell them an asset of equal value.  At least that is what they taught us in Accounting 101.

If I am wrong please in all seriousness tell me why.

Funny Things Happen When You Create Money Out of Thin Air.

Did anyone with a brain in their head think that we could issue enough debt to eventually match our GDP, or even surpass it and very bad sh*t wasn't going to happen?  Did anyone think that we could issue $100 billion of debt in one week, with the promise of coming back to the market next week for another big slug......and then repeat the process next month, and the month after that and the month after that....and the Fed would solve the supply problem by "buying" billions of it back by wiring cyber-money into dealers accounts at the Fed....and the bond and currency markets weren't going to puke?

Unfortunately for us, we have people running things who have never actually been in "the markets"  and have seen the simple yet brutal arithmetical answer to what happens when you hear over and over again,

"Please bid $1 billion.  Thanks, you are done, please bid another $1 billion on the follow.  Thanks you are done.  Please bid another $5 billion on the follow.  Thanks you are done...."

Prices tend to go down and yields (rates) tend to go up....by a lot.  That is what is happening now and it's just the beginning.  The President and his Treasury Secretary and his Budget Czar can say all they want about how they are going to eventually balance the budget down the road and make all these new Treasury notes and bonds disappear.  To the market that means nothing.  President Clinton understood that when he apparently said upon taking office, "You mean the course of my Presidency is going to be determined by a bunch of f**king bond traders??"  The answer was yes then and to a large extent it is now.  This isn't a "Wall Street" vs "Main Street" issue, although I am counting the days until President Obama tries to make it one.  This is an entire global investment community eventually saying, "We're already puking on the bonds we bought last month, we can't take anymore."  It's kind of like financial water-boarding.

Anyway, associated with all this Treasury supply and the Fed's futile attempt to control it, is the $500 billion or so agency mortgage-backed-securities the Fed has been purchasing.  Here's something we wrote back in January 2009;

 I've been watching the Fed wave in $10 billion of Fannie and Freddie mortgage backed securities over the last couple of days and all I see is a lot of money going into originators pockets Fed's MBS Purchase Program Nets BIG GAINS! (my post from yesterday), a small drop in primary mortgage rates and a complete cock-up (technical term) of the MBS market, as a gigantic, long-only fund (The Fed) wades in with a purchase strategy that has nothing to do with relative value.  The money the Fed loses taking down a mere $500 billion MBS by June will outpace any "gains" we achieve in the housing market.  You heard it here first. 

Well, it's nearly June and the average MBS was down TWO POINTS yesterday!  On $500 billion that's a cool $10 billion......in a day!  Here's a little song by the late and great Warren Zevon for "Helicopter Ben".

 

The Fed's Quantitative Easing Strategy - Part II

Ten-Year Treasury note up to 3.64% as Fed buying can't keep up with Treasury selling.

NOBODY but the Fed is buying Agency Mortgage Backed Securities at the insanely tight spreads to Treasury (and the Fed is the one who tightened these spreads to the point where nobody else wants to buy them).   However, with rates going UP sharply, mortgage servicers have to....SELL them.

How we doin'?

Banks Want to Buy Back TARP Warrants? "Show Us a Bid Bro."

Why does everything that government touches have to be so freaking complicated?  Bloomberg has a nice piece out today TARP Warrant Sale Shows Banks May Reap "Ruthless Bargain"

Banks negotiating to reclaim stock warrants they granted in return for Troubled Asset Relief Program money may shortchange taxpayers by almost $10 billion if Treasury Secretary Timothy Geithner’s first sale sets the pace, data compiled by Bloomberg show.

While 17 financial institutions have repaid TARP funds, only one has come to terms with the U.S. on the value of the rights to buy stock that taxpayers received for the risk of recapitalizing the industry. That was Old National Bancorpin Evansville, Indiana, which gave the Treasury Department $1.2 million for warrants that may have been worth $5.81 million, according to the data. If Geithner makes the same deal for all companies in the rescue program, lenders may walk away with 80 percent of profits taxpayers might have claimed.

“For once we’d like to get a fair value when we come into contact with the banking system,” said Representative Brad Miller, a North Carolina Democrat and chairman of the Investigations and Oversight Subcommittee of House Science and Technology Committee. “We don’t want a ruthless bargain.”

Way to go Congressman Miller!  Mr. Warren Buffett got some real nice warrants on Goldman Sachs and General Electric in the fall right?  What do you think WEB would say if the fine folks at Goldman or GE if they came to him and said, 

"Hey, thanks for helping us out in our time of need.  Yeah, about those long dated options we gave you as part of the deal....we want them back."  

WEB would say something like, "Of course gentlemen, this is America and there is a market for everything.  What's your bid?"

The point is, we can reasonably argue over what implied volatility to use and what dividend assumption and rate to use to price the forwards of each of these publicly traded stocks and then arrive at a level that is fair for the taxpayer and doesn't kill the banks looking to get out.  However, we took these warrants because we wanted some freaking upside on the bailout!  That was the whole point.  And lets be real clear, ALL THESE GUYS GOT BAILED OUT AND THAT INCLUDES GOLDMAN SACHS!  If the shyt kept rolling down the hill and over a cliff, we would be left "holding Herman" (technical term).  Now that the bailout has worked in these companies advantage they can't just disregard the benefit we got for saving them.

Our advise to Treasury and Congress is simple.  Ask each bank what Warren Buffett would do if he was the owner of the warrants?  Trust me, they'll understand.

A Preview of The Fed's Quantitative Easing Program Results.

Perfect Stupidity Storm Forming Over Financial System Today!

What a day this is going to be!  We have;

1. Day two of the greatest "he said-he said" since Larry Birkhead and Howard K. Stern staged their epic battle for fatherhood of Anna Nicole Smith's baby daughter!  Our dear friend Rita Cosby chronicled this duel in her best selling book, "Blonde Ambition".  We may ask her to take on the epic Ken Lewis- Hank Paulson- Ben Bernanke saga next!  BofA CEO Kenny Lewis claimed to New York Attorney General Andrew Cuomo that Hank Paulson (then Secretary of the Treasury) threatened his job if he didn't take Merrill Lynch back in December 2008, after Lewis got a early Christmas present from "The John Thain Gang " in the form of a surprise $15 billion loss.  Lewis claims that it was Paulson who "encouraged" him not to disclose these losses to BofA shareholders until after the deal was done.  Meanwhile, Paulson at first told A.G. Cuomo, according to Cuomo, that HE was pressured to do this by Federal Reserve Chairman Ben Bernanke.  Ben Bernanke denied this and Hank immediately recanted.  Chairman Bernanke did not give deposition to the A.G. citing "bank examiner privilege"!  This is amazing.  Firstly, any process that makes Andrew Cuomo look like the "White Knight" is pretty damn heinous!  Secondly, as a perfect lead in to item number two, why would ANYONE trust ANYTHING the government tells us while watching this sh*tastrophe??
2. Today the government will get its first indication of who wants to play ball in Timmy's legacy asset flea market!  Check this out:  Investors are actually afraid to play ball with the government because, paranoid as it sounds, they are worried the government might change the rules on them midstream!  I can't imagine where they got that idea...do you?  Get this, after allowing our financial institutions to mark to model, many institutions may not participate in the cleansing.  Who knew?  Let a guy mark a bond worth 40-00 to 90-00 and then he won't sell it at 75-00?  Crazy.  Additionally, Citigroup says they won't participate, which considering the FDIC has already wrapped $300 billion of their garbage, makes sense.  They've already been cleansed and all it cost them was some preferred stock that they got to convert to common.  Meanwhile, Morgan Stanley says they WILL participate.  They want to buy stuff!  Awesome.  A company that was given a bank charter, had all their new debt guaranteed by the FDIC and got $10 billion in TARP capital wants to sell their assets at the governments pumped up price, THEN buy another bank's assets with the government's generous financing and put option on the asset!  I just wish Timmy would take one of us aside and say, "Look dude, I know it's nuts, I'm not stupid, just corrupt."  That would make me feel a little better.
3. The "Stress Tests" start getting released to the "Gang of 19" today!  This is easy for me because Mark Gilbert at Bloomberg wrote a great piece  Stress Test Scores 'C' If Name Ends in 'itigroup'  Very funny, check it out.
4. Finally there is this also from Bloomberg Bear Stearns, AIG Dumped $74 Billion in Subprime CDOs on Fed.  Ahh yes, Maiden Lane I II & III.  This is the financial markets equivalent to "Area 51" (where we keep all the UFOs and the identitity of the guys who bought the March 30-00 puts on Bear Stearns in March 2008 when the stock was trading at 70-00).  The Fed says they are only down $9.6 billion.  Hah!  Dream on.  The Fed said they are using mathematical models to value the assets.  The guys who don't want to participate in Timmy's plan should call the Fed's model for a better bid!  The article also points out that the Fed has lent about $2 trillion to banks, taking many of the financial creatures as collateral.  I'm sure they took the proper haircut.  Whatever the case, since the Fed isn't allowed to take a loss, we do.

Strap in and don't forget to put on your "I'm With Stupid" shirts on!