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However, sentiment and hard data sometimes are at odds. Barron’s Bob O’Brien comments

5/27/2009

A new regulator has come to Washington, DC to oversee the Fed and the
political class to make sure they abide by certain constraints. His name
is Mr. Market (thank you legendary investor Ben Graham for the metaphor)
and he is finally speaking up and has a very large presence. As with
many govt actions to help the economy, they are paved with good
intentions but with unintended consequences. The question now is how
does DC respond, particularly the Fed as they have their next FOMC
meeting in June. The 7 yr note auction today will be key as it will be
more influenced by inflation expectations than the 2′s and 5′s this
week. Bankrate.com said the average 30 yr rate rose to 5.08% (and will
go higher in coming days) from 5%, the highest since Apr 7th. May Euro
Zone economic confidence rose 2 pts to the highest since Nov and was a
touch higher than expected. Durable Goods, Jobless Claims and New Home
Sales are out today.

One of the comments in a post yesterday (When Will the Recession End?) asked why I am “always dissing on other forecasters?”

As noted many times before, I believe forecasts are folly. I do try to wargame potential outcomes and various surprises, but that is to anticipate the unexpected — the variant perception — as opposed to regularly making bold declarative predictions.

When I do make a forecast, I try to couch them in terms of odds or probabilities. (The data implies; the odds are increasing that). I always want it clear that I don’t trust my forecast any more than I do anyone elses. (My calls aren’t perfect, but they have been better than most).

And for those of you who are fans of the wisdom of crowds, allow me to remind you how poorly the consensus of professionals did last year. As we discussed yesterday:

“Consensus? Why should investors — or homeowners, for that matter — care much about the opinion representing the consensus view? That consensus missed the credit bubble as it formed, wrongly believed the sub-prime issue were “contained,” and utterly missed the top in housing. If you followed the consensus, you lost 50% of your money last year, saw your home value drop 30%, and generally got mangled in most asset classes other than Bonds, Cash and Gold.

Rather than speak generally, let’s have a closer look at two forecasts a year apart by a group of professionals: The National Association for Business Economics:

Here is their perspective as it changed from November 2007 — just before the recession officially began, then in February 2008, when it was a few months old, and then in May 2008, two full quarters into the recession:

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GDP Forecast via NABE

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Now let’s fast forward a year, and see how their forecast are today:

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Quarterly GDP Growth Forecast via NABE

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Bottom line: Not only are they not very good, they are consistently too bullish . . .

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Previously:
Apprenticed Investor: The Folly of Forecasting
Barry Ritholtz
TheStreet.com, June 7, 2005

http://www.thestreet.com/story/10226887/apprenticed-investor-the-folly-of-forecasting.html

All graphs via NABE survey

http://www.nabe.com/graphweek/index.html

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Just as the Great Depression led to the creation of new institutions and financial practices, the Obama administration is on track to impact financial regulations. One of the new concepts involves a financial stability regulator, David Wessel explains.

5/27/2009

Good Evening: After months of seeing equities get most of the headlines, the Treasury market has elbowed its way back into the spotlight during the past week or so. Today this attention reached a fever pitch, as yet another steep drop in long dated government bond prices finally started to impact not only the wire services but also the stock market. Until today, equity investors viewed the Fed’s attempts to control various interest rates with little interest and even less concern. No more. Rising rates of interest for Uncle Sam mean a higher mortgage rates, a rising budget deficit, and a threat to any nascent recovery in the housing market. In short, the green shoots are at risk of being trampled, and investment decisions will only get tougher as 2009 progresses. Investors might be best served by investments that benefit from uncertainty itself.

Wednesday started innocently enough, with the only economic data points more or less matching expectations. Mortgage purchase applications rose a tad, though refinance applications did take a tumble during the latest reporting week. This piece of news was taken as no more a threat than North Korea’s announcement that it would henceforth ignore the 1953 armistice ending the Korean war. As for equities, Monsanto disappointed its shareholders with a lower full year outlook, and GM announced that its debt for equity swap proposal was doomed. That GM is now likely to enter some form of bankruptcy should come as a surprise only to those investors who willingly suspend their disbelief, and I believe the GM news had little, if any, effect on today’s outcome.

Analysts and economists also tried to dismiss the existing home sales data as unsurprising, but a peek beneath the surface reveals otherwise. Though existing sales rose a bit and just about matched consensus expectations, the source of the small uptick in volume was troubling. As BAC-MER points out in their piece below, volumes were boosted by foreclosures, and the supply of unsold homes actually rose. More worrisome, at least for Jim Cramer and others who expect a bottom in housing any day now, is that the April figures were flattered by low mortgage rates. The huge drop in bond prices over the past week and the accompanying rise in mortgage interest rates bodes ill for future home demand. BAC-MER economist, Sheryl King, says, “So far in May the numbers suggest the upturn in sales has stalled-out as, mortgage rates have edged higher and mortgage applications for purchase are down 2.4% compared to the April average”.(source: BAC-MER piece below)

Higher interest rates may unravel hopes for a bottom in housing, but these concerns were nowhere to be seen as stocks opened for trading in New York. After opening near the unchanged mark, most of the major averages stayed within shouting distance of yesterday’s close until just after lunchtime. The notable exceptions were a beta-chasing 1% gain in the NASDAQ, and a slow leak of equal measure in the Dow Transports. The Treasury then announced the results of what turned out to be a decent 5 year note auction, but it didn’t stop longer dated government securities from falling further. Nor did it matter that Moody’s affirmed the U.S.A.’s AAA rating (see below). The 10 year note yield spiked 17 basis points by day’s end, bringing the yield on this benchmark security to 3.72% (see chart above). As you can see, today’s closing yield compares to just over 2% in December and 3.2% just last week. Confirming the growing concern among long term Treasury investors, the spread between 2 and 10 year notes widened to a record 275 bps (according to Bloomberg; see below). And the final ignominy on the interest rate front belongs to mortgage rates, which, despite large mortgage purchases by the Fed, have now risen an unscripted 50 bps or more during the past six trading days. Bernanke and company may convene to consider additional purchases, but what they may well decide is that they are trapped.

The increasing burden of these higher rates finally caused equity investors to sit up and take notice this afternoon. The S&P 500 dropped 1.5% from its high in the early afternoon, pausing briefly to test support at the 900 level. When that support gave way late in the session, the S&P fell a further 1% to close with a loss approaching 2%. The damage to the other indexes varied, with the NASDAQ losing only 1.1%, and the Dow Transports shedding almost 3%. The carnage in the bond market left currency traders a bit perplexed. Would falling bond prices cause investors to shun the dollar, or would higher interest rates attract them? This conflict was resolved by a smallish gain in the greenback. Commodities were surprisingly unruffled by all the motion in the other markets. Precious metals were mixed, but new post-panic highs in crude oil helped the CRB index post a modest gain of 0.4%.

During most of the 1980′s and 1990′s, the so-called bond vigilantes ruled the Treasury market. The Fed may have kept either money supply or short rates on a tight leash during this period, but large institutional investors (think: PIMCO, et al) would shun longer dated Treasurys if growth spurted, if inflation perked up, or if the politicians monkeyed too much with the federal budget. When inflation was later deemed to be conquered and when our nation’s budget deficit briefly went into reverse ten years ago, this breed of bond investor went on extended leave.. Given the savage beating the Treasury market has taken in recent months, it appears the bond vigilantes are back at their posts. One of the original vigilantes, Bill Gross, seemed to issue a call to arms only last week when he described the potential funding perils facing our government. If so, shouldn’t we all just become vigilantes ourselves and load up on shares of the TBT, the “ultra-short” Treasury ETF?

Given my previous rants about the structural mess we’re getting ourselves into with all the massive bailouts and Treasury issuance, readers may be surprised when I say “no”. The TBT and all the other “double” and “triple” exposure ETFs are not proper investments. They are rank speculations, and they tend to track poorly over time. Plus, I think there’s a chance that both Treasurys and the U.S. dollar enjoy a short term bounce before the week is out. The TBT has been on a one way tear higher lately, and today’s volume pushed past 10 million shares (by way of comparison, the volume was less than 1 million per day until 6 months ago). It’s simply been too easy to make money being short government securities in recent days, and the fact that Bloomberg was plastered with bond market stories today tells me the short side is getting crowded. I’m NOT saying Treasurys are a good long term investment at these levels, and I truly believe we face funding issues on the horizon. But I am saying that TBT longs are at risk if bonds find a bid later this week.

If I’m wrong, and Treasurys continue to sink, then equities will likely follow. Rising long term interest rates will stifle both the economy and corporate profitability. So what’s an investor to do in this dicey environment? Rather than messing around with leveraged ETFs, investors who worry about a potential funding crisis and other less than happy outcomes would be better served buying precious metals and the companies that mine them. These investments, too, can suffer nasty spills from time to time, but I see them as a lower risk way of investing when facing uncertain outcomes. If Treasurys keep heading south until chaos reigns, then gold itself should shine. If all the stimulus should somehow work and the economy recovers, then stocks will rally and carry the miners with them (especially if inflation perks up). My point is that we don’t know what will happen next. Since the precious metals and their equities benefit from uncertainty, they are a decent choice for a portion of one’s portfolio. The only way they will really get hurt is if the imbalances disappear and tranquility returns to the global economy. I’m comfortable taking the other side of that trade.

– Jack McHugh

U.S. Stocks Retreat as Treasury Yields Climb, Monsanto Slides
U.S.’s Aaa Credit Rating Is Stable, Moody’s Says
Treasuries Fall on Concern Record Sales Will Overwhelm Demand
Mortgage-Bond Yields Jump, Jeopardizing Fed’s Housing Effort
Home sales up but so is supply

The green shoot theorey continues to wilt under close scrutiny. Yesterday’s low volume boom gave way to today’s whimpering reversal.

What gives? What are you looking at, what’s interesting and worth reading?

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What Say Ye?

Arthur Samberg, among the best-known hedge-fund managers, is closing down his firm amid an ongoing investigation into possible insider trading

WSJ:

“Public disclosures about the continuing investigation have cast a cloud over the firm and have become a source of personal distraction,” Mr. Samberg wrote in a letter that was sent to investors of his Pequot Capital Management Inc. late in the day on Wednesday. “With the situation increasingly untenable for the firm and for me, I have concluded that Pequot can no longer stay in business.”

Thanks, Kev!

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Source:
Samberg’s Pequot Capital to Close
GREGORY ZUCKERMAN
WSJ, MAY 27, 2009, 5:25 P.M. ET

http://online.wsj.com/article/SB124345809322059817.htm

Founders Closing Letter

http://online.wsj.com/public/resources/documents/PequotLetter052709.pdf

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The first mainstream review on Bailout Nation is out, and its from Bloomberg (Europe).

I am not disappointed:

“Ritholtz waltzes the reader though the decisions and missteps that landed us in this morass, including the Federal Reserve’s power grab over the years, notably during the leadership vacuum of 2007 and 2008, when markets melted like a Salvador Dali timepiece and President George W. Bush went AWOL . . .

Along the way, the book supplies useful sidebars, charts and textboxes on subjects ranging from funky mortgages — when did “liar loans” supersede “fixed-rate” in American real- estate chatter? — to the now notorious Commodity Futures Modernization Act.

His verdict on former Fed Chairman Alan Greenspan is as astute as it is merciless. A telling moment comes when Ritholtz shows how Greenspan drew the wrong conclusion from the first crisis during his tenure, the crash of ‘87 . . .

Ritholtz rocks along with a raucous, sometimes crude voice that transcends his occasional cliches about cowboys and cattle wrestlers. He’s smart, sassy and often amusing. . . If you’re looking for an all-in-one place explanation of what went wrong and why, this is the book for you (or your confused neighbor).”

How cool is that?

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Source:
Greenspan Flunks Test, Bush Falls Into $15 Trillion Pit: Books
James Pressley
Bloomberg, May 27 2009

http://www.bloomberg.com/apps/news?pid=newsarchive&sid=amoZezYyYwFA

First we need to say congrats and then some to Barry for the publication of Bailout Nation.  His experience with the swarm of arschlochs who inhabited his first publisher should explain to the many people who ask why I never write a book. 

It is bad enough to do all of that work, but then to have some idiot from a “publisher” whose literary opinions are formed by watching daytime television judge your work is intolerable.   I’d rather publish our comic strip. This is not a minor decision for me having grown up as the child of a famous author, but I no longer cringe when people ask me when I am going to write a book. As Dad taught me years ago, the only free press is your own. Kudos Barry.

And speaking of serial truth telling, we have a real dandy this week.  I met Achim Dübel through some friends in the mortgage origination market.  He is a courageous and very intelligent guy who knows the EU banking system and mortgage market from the inside.  Like our representatives in Washington, the Germans are in denial HUGE regarding the impact of subprime assets on their banking system. 

Achim lays out some data that is really scary — but such is life when you focus on reality instead of spin.  He figures that nobody in the German government is going to be willing to actually talk about the situation until year-end elections are done.  Like the Bush/McCain wipeout, it looks like the ruling coalition is toast and that Germany may be headed down the road to political radicalization — like the US.

Germany’s Subprime Crisis: Interview With Achim Dübel
The Institutional Risk Analyst
May 27, 2009

“The United States is solely to be blamed for the financial crisis. They are the cause for the crisis, and it is not Europe and it is not the Federal Republic of Germany.”

Peer Steinbrück
German Finance Minister
September 25, 2008

“Excessively cheap money in the U.S. was a driver of today’s crisis… “I am deeply concerned about whether we are now reinforcing this trend through measures being adopted in the U.S. and elsewhere and whether we could find ourselves in five years facing the exact same crisis.”

Angela Merkel
German Chancellor
November 27, 2008

First a housekeeping note. On June 9, 2009, IRA CEO Dennis Santiago will be participating in a panel presentation and discussion sponsored by the UCLA Andersen Alumni Network. The event will be held at the UCI Faculty Club in Irvine, CA, from 6:30-9:00 PM. For more information or to register, please go to:

http://alumni.anderson.ucla.edu/events/details.aspx?itemnbr=2089

Second, on June 10, 2009 The IRA editor Chris Whalen will be making opeing remarks at a conference sponsored by PRMIA entitled “Regulation of Credit Default Swaps and Collateralized Debt Obligations.” The event will be held in Downtown Washington and will feature a panel discussion on the proposal by the US Treasury to reform the credit default swap markets. The panel includes Joseph Mason from Louisiana State University, Ann Rutledge from RR Consulting, Michael Greenberger from University of Maryland Law School, Christopher Laursen of NERA, Kevin McPartland of Tabb Group, and is moderated by Gary Kopff of Everest Management. For more information or to register, please go to:

http://www.prmia.org/events/view_events.php?eventID=3461

Speaking of reforming derivatives, we want to send a big “high five” to our friends at Bloomberg News for the May 26, 2009 report by Matthew Leising, “Wall Street Derivative Proposal Adopted in Treasury Overhaul,” that Treasury Secretary Tim Geithner essentially took his OTC reform proposal verbatim from the large banks and called it his own. The Bloomberg News article seemingly confirms our worst fears that Geithner’s agenda continues to be a function of the wants and needs of the large NY dealer banks led by JPMorgan Chase (NYSE:JPM).

We could pretend to be surprised, but we’re not really. It just goes to prove that everything that Mark Twain every thought or wrote about American politicians is more true today than ever before. Twain observed in 1873: “I never can think of Judas Iscariot without losing my temper. To my mind Judas Iscariot was nothing but a low, mean, premature, Congressman.” Amen.

While the situation in Washington regarding the financial crisis and attempts to “reform” the discredited regulatory framework for supervising banks and financial markets goes from the sublime to the ridiculous with each passing day, it could be worse. We could all be living in Germany, a nation we have long held in great esteem from our days working as a dealer in German government bonds or bunds at Bear, Stearns International in London. Unfortunately, the Bear is gone and so too the political discourse in Germany today regarding the financial crisis is just about nil. Indeed, the silence in Germany makes the unseemly political free-for-all in Washington seem positively vigorous by comparison.

Foreign observers of Germany might be tempted to believe that the largest nation in the EU avoided the worst aspects of the crisis through a combination of prudent financial regulation and good old fashioned conservatism. But such a view is very far from the truth. In fact, Germany faces an financial crisis in its private and state sector banks that, relative to the size of that nation’s economy, could be every bit as serious as the US crisis.

To get a better understanding of the situation in Germany and the growing financial crisis affecting that nation’s banks, we spoke last week with Hans-Joachim (“Achim”) Dübel, CEO of FINPOLCONSULT (http://www.finpolconsult.de ) in Berlin, one of the leading and relatively few independent voices in the German housing finance community.

The IRA: Tell our readers about yourself and why your views on Germany and the financial markets there are well informed. We worked in the market for German bunds and other European government bonds from London years ago, so we know a little about the local banking scene.

Dübel: I started my professional career working in housing policy and eventually began to focus on housing finance. I worked at the World Bank focused on housing finance policy globally and even worked for Westdeutsche Landesbank for a few months where I had a pretty traumatic experience. The traders basically dismissed all of the bank’s economists and risk managers. They said they were running the bank properly using purely tactical, short-term trading methods. They would draw triangles on charts of market data and call that risk management. These were the types of strategies that eventually sunk the bank. You will recall from the 1980s onward that WestLB was recapitalized every few years, they have four historic state aid cases with EU competition authorities from the last 15 years. I got a very quick introduction to the real role of an economist in a German financial institution.

The IRA: Well, maybe the German traders have it right. Most contemporary risk management tools used in banks were designed by financial economists and are entirely ineffective. The whole Basel II framework, for example, is an economist’s model, that is, a fantasy that has no link to the real world of finance and commerce. Professor Dick Richardson of the University of Texas wrote in 2001: “Economics is an artifact of human imagination, and the agreement among certain humans who “play the games” together — thereby it is a social technology.” But we digress. What did you do after WestLB?

Dübel: I pursued the housing field as a private consultant economist to agencies such as the World Bank and the EU Commission. My role here in Germany is somewhat that of the critic. Since I have worked outside of Germany and have relative freedom, I decided to use my perspective to provide an independent voice here. The sad fact is that there is virtually no discussion in the policy community in Germany regarding the financial crisis. Most of the professors in the universities in Germany that work in finance have their chairs co-sponsored by banks, so they are effectively gagged in many cases. It is easy to become a critic in Germany because there are so few independent voices. The political parties are deeply involved in finance through the state sector banks, (Landesbanken and Sparkassen ) and the private financial community takes its lead from Deutsche Bank (NYSE:DB), which has decided not to make a public issue out of the problems in the state sector institutions.

The IRA: Wait a minute! Was it not DB that sold most of the toxic waste to the Landesbanks? Our recollection is that it was DB, Merrill Lynch and Lehman who were the key perpetrators in stuffing the Landesbanks with toxic waste. No wonder the DB does not want to talk about it! We have the same problem in the US, namely that the larger banks have taken control over the federal government, leaving the real economy and the population at the mercy of Wall Street. Our colleagues who work in the financial world are mostly employees and thus are cowed into silence. The lack of critical debate in the US financial community regarding the crisis is stunning.

Dübel: I am familiar with the problem in the US from colleagues who ran into problems with the GSEs, particularly Fannie Mae. Funnily enough, we have the same problem in Germany with most bank lobby groups, and public banks are not different from private in that respect. They are very aggressive in going after independent economists to attack their reputations if they have the temerity to criticize them. I think both countries have a serious oversupply of bank lobbying groups, which mostly are staffed with aggressive lawyers.

The IRA: We used to get a lot of flak from Fannie and Freddie, but this is not a problem now. In fact, after we published a brief comment about the role of Peer Steinbrück in creating Germany’s financial crisis, we started getting calls from the German press before we even ran this interview. One reporter from the German edition of the Financial Times called last week demanding to know the identity of our sources. We gave our usual reply: “Foxtrot Oscar.”

Dübel: What Fannie Mae did in her worst days, which I think are behind us, was to put indirect pressure on people who were critical, usually to try to get them fired. German banks play the same games, some as direct as Fannie, but most are more subtle, working behind the scenes to undermine critics. The fact is that everything in Germany is public; all of the data that I use in my work is freely available, yet nobody looks at it or uses it in the public debates. The Brussels declaration of 2001 that allowed the Landesbanken to issue dozens of billions of state-guaranteed bonds without any other purpose than regulatory arbitrage clearly names the German politicians who were the negotiators. Each of these men are also the key figures in creating the problems within the Landesbanks in each state, but still there is virtually no debate in Germany regarding these issues.

The IRA: You stated that you think that the Germans are not given sufficient credit for their role in creating the subprime crisis. Start from the beginning of the story and explain for our readers how Germany reached its present predicament. We notice that Germany has moved forward with a very watered down version of its own plan for dealing with problem toxic assets in the banks. We also saw that Günter Verheugen, the EU commissioner from Germany, has been attacking the German banks and Finance Minister Peer Steinbrück. Is he a critic?

Dübel: Verheugen is at the end of his career. German politicians only speak up before retirement, if at all. It must be added here that we are currently in a state of “omertà” to use the Sicilian term – i.e. no politician of the coalition government will speak about the scandal before this fall’s Bundestag elections. Both main parties are afraid of another Berlin. After the Bankgesellschaft Berlin scandal earlier this decade the CDU was reduced from governing party to near-oblivion status. It is a classical prisoners dilemma, nobody wins politically from a debate. And what the main political parties do not want to be debated does not make it into the public media, and even most private media.

The IRA: Sicilians say: “He who is deaf, blind, and silent will live a hundred years in peace.” What was the condition of the German housing market in 2005? Was there a boom in housing prices or was the crisis purely caused by poor investment decisions by the state banks?

Dübel: The level of housing prices in Germany was relatively stable and – as German economic conditions in general – had no serious impact on the Landesbanken. During the current decade, the Landesbanken were not lending at home, but rather converted themselves into mutual funds to invest in international securities. The crisis started with the decision in the 1990s by the EU Commission, which had launched an EU Treaty violation process against Germany after the protest of German private banks against one of WestLBs recapitalizations. The EU argued that the state guarantees for the Landesbanken were illegal. Many publications such as the Financial Times and The Economist wrote about this extensively. We had the great Milan-based economics professor, Mario Monti, as the head of the EU competition authority. He pushed through the proposal against the combined weight of the German public bank lobby and both levels of government – state and federation. There was a protracted debate and finally, in early 2001, the EU decided to terminate the use of state guarantees by 2002. However, the public bank lobby in Germany continued to fight the proposal and basically sent federal and state government representatives to negotiate with Brussels.

The IRA: Was the counter-attack successful?

Dübel: Partly. The result was a postponement of the end of issuance of state guaranteed debt for all banks from 2001 to 2005, where the last bonds guaranteed would have to mature by 2015. The salient point is that there was only a time limit set in the agreement, but there was no volume limit, so the German state banks started to issue massive amounts of state-guaranteed debt after 2001. This money was not used to finance German or even European lending but simply to park funds in investment vehicles and make more money on it to boost their bottom lines. A nice euphemism they found for this is ‘Kreditersatzgeschäft’ (credit substitution business). If you look at research reports in the period, you will see that the volume of guaranteed bonds shot up dramatically after 2001 and especially during 2004 and early 2005. Critically, every guarantee given by the Landesbanken themselves would benefit from the guarantee standing behind the Landesbanken , so they kept guaranteeing ABCP-conduits and other off-balance sheet vehicles such as SIVs that boomed precisely during the critical period.

The IRA: So the German Landesbanks started to issue debt and buy toxic assets from DB, Merrill and Lehman? Great. Was there any legitimate purpose for this debt? How much are we talking about?

Dübel: The direct extra issuance by the banks following the EU transition period decision was already massive and totaled probably €100 billion. However, if you consider guarantees given by Landesbanken you might well end up at €200, perhaps €300 billion in total exposure. Those guarantees were called upon when the banks and investors funding ABCP and SIV called in their capital during 2007. Moreover, there was a considerable balance sheet shift inside Landesbanken in particular from interbank market exposures to securities holdings. All in all, the data leaking out of various sources suggest that Landesbanken today sit on problem assets of €300-500 billion, much of them funded effectively with German government debt. Individual banks, such as WestLB, LBBW, BayernLB, HSH Nordbank sit on high double-digit € billion exposure positions. Compare these pictures to peak outstandings of US high-risk markets in €, e.g. Subprime RMBS of € 575 billion in 2007, and you get an idea about to what extent the Landesbanken funded Wall Street. Take all high-risk securities markets at peak levels together – from leveraged loan CLOs to Alt-A RMBS, and I think we are looking at some 15% of the Buy Side demand.

Click here to read the rest of the interview with Achim Dübel.

A few more interesting Housing related charts: (click or larger/original charts)

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Real Estate Changes by State

via Mint

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Annual versus Quarterly Changes

source: Jim Bianco Research

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House Price Tracking Adverse Stress Test

via Calculated Risk

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