The Big Picture - Macro Perspective on the Capital Markets, Economy, Technology, and Digital Media

Back in April, we mentioned the The Mortgage Netherworld of MERS — the Mortgage Electronic Registration Systems.

MERS is the firm that (technically) holds 60 million US (securitized) mortgages on behalf of the actual buyers. They were created by a consortium of lenders in part to save money (on paperwork and recording fees) every time a loan changes owners. In the era of securitization, these savings amounted to billions of dollars.

But MERS also acts as a shield, making it all but impossible for many borrowers to deal directly with whoever happens to be holding their mortgage at the moment. As the NYT noted, it has “made life maddeningly difficult for some troubled homeowners.”

Now, the Kansas Court of Appeals has called foul. In Landmark National Bank v. Kesler, 2009 Kan. LEXIS 834, the Kansas Court held that a nominee company called MERS has no right or standing to bring an action for foreclosure. (Other than GlobalResearch.ca, I have yet to see any MSM coverage of the issue). The Court stated that MERS’ relationship is not that of a true party possessing all the rights given a buyer. Hence, the court ruled:

“By statute, assignment of the mortgage carries with it the assignment of the debt. . . . Indeed, in the event that a mortgage loan somehow separates interests of the note and the deed of trust, with the deed of trust lying with some independent entity, the mortgage may become unenforceable. The practical effect of splitting the deed of trust from the promissory note is to make it impossible for the holder of the note to foreclose, unless the holder of the deed of trust is the agent of the holder of the note. Without the agency relationship, the person holding only the note lacks the power to foreclose in the event of default. The person holding only the deed of trust will never experience default because only the holder of the note is entitled to payment of the underlying obligation. The mortgage loan becomes ineffectual when the note holder did not also hold the deed of trust.” (emphasis added).

What does this mean for the 60 million people — over half of all US mortgages — whose loans have been securitized, sliced and diced, and are now held by MERS?

To start, it potentially gives a powerful weapon to homeowners who are being foreclosed upon. If their mortgage is held by MERS, they certainly have a strong basis for challenging the action on the grounds of standing. (Note that this was a Kansas COURT OF APPEALS decision, and while it is not binding on other states the way a US Supreme court ruling would be, it is likely to be influential).  I also think the Kansas Court of Appeals could also review this case

I don’t quite agree with Ellen Brown, who in an extensive legal analysis of the decision, writes: “The significance of the holding is that if MERS has no standing to foreclose, then nobody has standing to foreclose.” It may be possible for trustees for the securitized loans to somehow perfect standing, i.e., develop the ability to claim loan ownership (perhaps via a purchase) and then move to foreclose. (Brown also calls it a Kansas Supreme Court decision, but it appears to be the intermediate 3 judge panel of the Court of Appeals that heard the case, not the full Kansas Supreme Court).

But Brown is correct when she states this is a very significant legal development, one that might dramatically impact foreclosure litigation.

This ruling could send the lenders who work with MERS scurrying to resolve this in their favor. Look for a lobbying effort to get some favored congresscritter to pass legislation granting them standing to sue on behalf of loan holders (Congress may be able legislate that legal right, although there are state laws to be contended with).

As foreclosures continue to ramp up, I expect a lot of rhetoric about why we need to stop them (I disagree) and modify mortgages (which have been mostly unsuccessful).

Last, you never know what someother state supreme court might rule. (Any lawyers out there know what is on upcoming dockets involving MERS ?)

Bottom line: It just got a lot harder to foreclose on homes with securitized mortgages in Kansas, and quite probably, the rest of the nation.

>

Previously:
The Mortgage Netherworld (April 2009)

http://www.ritholtz.com/blog/2009/04/the-mortgage-netherworld

Sources:
Landmark National Bank v. Kesler
COURT OF APPEALS OF THE STATE OF KANSAS
No. 98,489
September 12, 2008

http://www.kscourts.org/Cases-and-Opinions/opinions/ctapp/2008/20080912/98489.htm

Landmark Decision: Massive Relief for Homeowners and Trouble for the Banks
Ellen Brown
GlobalResearch.ca, September 23, 2009

http://www.globalresearch.ca/index.php?context=va&aid=15324

See also:
Six Degrees of Separation
Andrew Davidson
August 2007

http://www.securitization.net/pdf/content/ADC_SixDegrees_1Aug07.pdf

Good Evening: After a couple of wobbly sessions on Friday and Monday, U.S. stocks resumed rising on Tuesday. With little in the way of economic news, it was left to a falling dollar to buoy investor risk appetites. The greenback obliged by setting a new low for 2009, and commodity prices understandably reacted by heading in the opposite direction. Interestingly, however, Treasury yields and credit spreads didn’t rise with renewed dollar weakness; they instead fell. Falling interest rates and rising equity values may cause the FOMC to issue a statement of self-congratulations after their two day confab breaks up tomorrow, but what our central bankers may not realize is that one of the important policy linkages for the levitation in our asset markets is the greenback itself. Carry trades are back and the new funding currency of choice is the U.S. dollar.

Stocks around the world were mostly higher overnight. Japan remained closed, and while China’s CSI 300 dropped more than 2%, other Asian markets and most of Europe’s bourses were quite firm. Thus encouraged, U.S. stock index futures were modestly higher as Tuesday’s opening bell approached. The economic data was a non factor in today’s trading. Weekly chain store sales results were disappointing; a government measure of home prices rose; and the Richmond Fed survey reading of +14 in September showed no improvement from August. Stocks opened 0.5% higher and traded mostly sideways until the results of the Treasury’s latest auction results were posted.

Despite a tiny yield of just over 1%, the demand for the $43 billion (a record) of 2 year notes was the strongest since 2007. Central banks took down approximately half the auction and the bid-to-cover ratio was well over 3. The major U.S. stock market averages hit their highs for the day just before these results hit the tape, and they spent the rest of the day hovering within shouting distance of their best levels. The NASDAQ (+0.4%) slightly trailed the other indexes, while the Russell 2000 (+0.8%) sported the best gain. As mentioned, Treasurys rallied and their yields fell between 3 and 10 bps. The greenback was clobbered at the open and never once lifted its head off the canvas. The U.S. dollar index fell 0.9% and set a new low for 2009 in the process. Commodity market participants were emboldened by the hapless buck and they found little resistance as they pushed the CRB index almost 2% higher on Tuesday.

“How”, starts a typical question I’ve been asked this month, “can stocks, bonds, and commodities continue to rise together?” My briefest response is “money printing”, and a more nuanced version of the same reply describes how risk appetites have been rising due to low interest rates and quantitative easing. Only the most persistent readers are unsatisfied by this explanation. “Why?”, or “what’s the linkage between the two?” come the dogged responses, as well as the ever-popular “who is doing all the buying?” In addition to disgruntled shorts and unhappily underweight portfolio managers, the busiest buyers these days are hedge funds and bank proprietary trading desks. They are putting on carry trades, and the latest funding currency of choice is none other than the U.S. dollar (see below).

For the uninitiated, a word of explanation is in order. A “carry trade” is any trade whereby an entity borrows money and uses the proceeds to buy assets. The money borrowed is short term in duration (usually overnight) and the assets purchased are longer term ones — ranging from 30 days (commercial paper) to infinity (equities). In the broadest sense, almost any asset can be bought with borrowed money and end up on the right hand side of the ledger in a carry trade, but the vast majority of carry trades take place in the fixed income world. Banks effect such trades every day, borrowing in the fed funds market and buying 2, 3, and 5 year notes, hoping to earn the yield differential in the process. Almost always, this yield differential is positive, giving an investor what is called “positive carry” (hence the name carry trade). The classic carry trade is done in one’s home currency, and the assets purchased are usually government securities with short and intermediate maturities. If this trade sounds easy, it is. But this trade carries with it the risks that the overnight borrowing rate can rise, that the asset purchased can fall, or, as in 1994, a dastardly combination of both.

Let’s return to the original question of linkage between Fed policy, rising risk appetites, and the role carry trades play in boosting asset prices. If banks borrowing in the fed funds market to buy short term Treasurys is the “classic” carry trade, then it shouldn’t surprise you to learn that hedge funds and the prop desks of large financial institutions often take the carry trade to more sophisticated heights. The desks at these shops will borrow overnight to buy corporate debt, leveraged loans, and even high yield debt. Not content to stay at home, they will also shop worldwide for the lowest overnight rates in which to borrow, and they will likewise engage in a global search for the most beguiling assets. In addition to the risks facing the classic carry trade, these global carry trades have an added one: an inconvenient rise in the currency in which they have borrowed.

Managing these multiple risks requires that traders putting on carry trades in currencies other than their own be confident the borrowed currency will stay weak. For almost two decades, the 98 pound weakling currency targeted for borrowing was the Japanese yen. In the wake of the bursting of their twin bubbles in both stocks and property in late 1989, Japan’s economy has been a basket case and the BOJ has kept short term interest rates at microscopic levels. Except for the occasional eruption and rush by borrowers to cover shorts, the yen mostly stayed weak during this period. The yen carry trade was so profitable it became a prime tool of global speculation. When the global panic of 2008 hit, the yen rallied fiercely as risk appetites shriveled and forced carry traders to sell assets and pay off their yen denominated debts. Why, then, if risk appetites have been rising for months, has the yen not fallen under the weight of new carry trades?

The answer is that the currency getting sand kicked in its face these days is the U.S. dollar. Back in March, our Federal Reserve pushed the fed funds target toward zero. When dollar-based LIBOR rates eventually followed, the cost of borrowing in dollars to effect carry trades fell below the cost of borrowing in other major currencies. According to a piece put out by Capital Economics this morning, “(o)ne explanation for the dollar’s weakness is its increased use as a funding currency. The 3 month interest rate differential between the U.S. and a weighted average of its major trading partners has swung from more than 2% a few years ago to below zero today”. What’s more, the Fed’s quantitative easing program, which involves the purchase of billions of Treasurys and mortgage-related securities, effectively put a floor beneath the prices of these securities.

With the lure of a weak currency, the lowest borrowing rates in the world, and a central bank willing to backstop the bond market, speculative capital the world over is finding its way here. The Fed has turned King Dollar into a source of princely profits for global carry traders. Until the perception of a weak dollar changes — whether due to a shift by the Fed to a more stringent monetary policy or to a sudden cooling in risk appetites — the market moves we’ve seen since March could be with us for a while. In this environment, the greenback could remain friendless — even with bullish sentiment for the buck fetching less than a dime. To answer the original question, the dollar can continue to fall and dollar assets can continue to rally as long as the dollar carry trade continues to live.

Catalysts which might upset this happy state of affairs for our markets and our central bank are numerous, but they include the Fed itself. If tomorrow’s FOMC meeting produces a policy statement which overtly entertains the notion of an exit strategy, it is possible the latest dollar carry trades could start to be unwound. Another potential negative catalyst for risk appetites is this week’s G-20 meeting. If the politicians propose some new and goofy regulatory framework that somehow makes it harder for the hedge funds and prop traders to make money, then this news, too, could set off a correction that sees stocks and commodities fall against the backdrop of a rising dollar. And, of course, there is always the possibility of an exogenous shock that will cause those currently gorging on risk to see some of their positions make a reverse journey through the financial equivalent of the alimentary canal. Until some event occurs, however, rising risk appetites and the dollar carry trades that feed them will be a large influence on asset prices.

– Jack McHugh

U.S. Stocks Gain, Extending Global Rally, as Dollar Slips
Credit Swaps Traders Pay Least for Debt Protection in 16 Months
Hedge Funds’ ATM Moves From Tokyo to Washington: William Pesek

“There’s going to be a flood of bank-owned homes listed for sale at some point.”

-John Burns, a real-estate consultant based in Irvine, Calif.

>

Yes, there certainly will be. Burns estimates there will be a “large numbers of foreclosures” that will drive home prices down 6% next year. Analyst Ivy Zelman pegs the number of coming foreclosures at three million to four million homes over the next few years.

All of the voluntary foreclosure moratoriums have slowed “the flow of properties headed toward foreclosure sales” regardless of deep in distress borrowers are. These delays only work to prolong the mortgage crisis and prevent prices from falling to more natural levels.

Thus, it creates a “growing ‘shadow’ inventory of pent-up supply that will eventually hit the market.”

Here’s the excerpt from the WSJ:

“The size of this shadow inventory is a source of concern and debate among real-estate agents and analysts who worry that when the supply is unleashed, it could interrupt the budding housing recovery and ignite a new wave of stress in the housing market . . . Analysts who track the shadow market have focused primarily on the gap between the number of seriously delinquent loans and the number of foreclosed homes for sale by mortgage companies. A loan is considered seriously delinquent, which typically means it is headed to foreclosure, if it is 90 days or more past due.

As of July, mortgage companies hadn’t begun the foreclosure process on 1.2 million loans that were at least 90 days past due, according to estimates prepared for The Wall Street Journal by LPS Applied Analytics, which collects and analyzes mortgage data. An additional 1.5 million seriously delinquent loans were somewhere in the foreclosure process, though the lender hadn’t yet acquired the property. The figures don’t include home-equity loans and other second mortgages.

Moreover, there were 217,000 loans in July where the borrower hadn’t made a payment in at least a year but the lender hadn’t begun the foreclosure process. In other words, 17% of home mortgages that are at least 12 months overdue aren’t in foreclosure, up from 8% a year earlier.”

This overhang is likely going to be problematic for years to come . . .

>

Source:
Delayed Foreclosures Stalk Market
RUTH SIMON and JAMES R. HAGERTY
WSJ, SEPTEMBER 23, 2009

http://online.wsj.com/article/SB125366552480532521.html

. . .  why the predictions you made yesterday didn’t come true today.

Despair.com via DD

By the time you read this, I will (hopefully) be airborne somewhere over the mid-west. I’m on my way to a WSJ panel discussion in Chicago tomorrow. Its for investment advisors, and I am speaking on the panel with Jack Ablin and Pete Najarian, and WSJ managing editor Dave Kansas.

Meanwhile, some reading for your afternoon pleasure:

• The Pinocchio Recovery (Market Talk)

• Fed Growth Effort May Be Undermined by ‘Tight’ Credit (Bloomberg)

• Households’ net worth rises for first time in two years (Marketwatch)

• What’s Really Wrong With Wall Street Pay (economix)

• Homeowners who ‘strategically default’ on loans a growing problem (LA Times)

• 50 things that are being killed by the internet (Telegraph)

What are you reading that you find: a) interesting b) persuasive and c) off the beaten path ?

Even the most bearish pundits are sounding a bit more optimistic lately: Specifically, they are grudgingly admitting that we may have avoided another Great Depression.

But they quickly point out that we may still steaming full-throttle toward doom, this time as a result of the Fed and Congress removing the cheap money and spending stimulus that saved our necks.

Martin Wolf of the FT, for example, thinks the government will have a devil of a time managing this transition smoothly.

Right now, banks are printing money courtesy of subsidized borrowing rates from the Fed. They’re also dumping their crappy mortgage assets on the Fed’s balance sheet in exchange for fresh cash, thus avoiding further asset write-downs. As soon as the Fed begins to reverse these measures, banks may come under pressure again.

Worse, the Fed is still buying mortgage securities in the open market, thus helping to keep mortgage rates low. If the Fed abandons this crutch, mortgage rates could rise, putting new pressure on the housing market.

Even though the global economy is experiencing the worst downturn since World War II, that doesn’t mean every country is being equally affected. Leaving aside the (big) question of how reliable official statistics are, it’s clear that there’s something of a divide between the developed and emerging worlds.

For now, at least, the economic up-and-comers are at the top of the list as far as growth and inflation are concerned, though there are some interesting exceptions (e.g., Taiwan).

Not surprisingly, the more mature economies feature prominently among those countries with high rates of unemployment, which likely stems from differences in wage rates and labor market rigidities, among other things.

Otherwise, India is a curious amalgamation: high growth, high inflation, and a budget deficit that is second only to that of the U.S. (note: India’s unemployment data was not available from Bloomberg).

No doubt some will claim that “decoupling” accounts for the divergences, but from what I remember, proponents of the theory had argued before the current crisis began that the emerging world would be relatively unaffected by a slowdown in the U.S. Clearly, that has not been the case.

David R. Kotok co-founded Cumberland Advisors in 1973 and has been its Chief Investment Officer since inception. He holds a B.S. in Economics from The Wharton School of the University of Pennsylvania, an M.S. in Organizational Dynamics from The School of Arts and Sciences at the University of Pennsylvania, and a Masters in Philosophy from the University of Pennsylvania. Mr. Kotok is also a member of the National Business Economics Issues Council (NBEIC), the National Association for Business Economics (NABE), the Philadelphia Council for Business Economics (PCBE), and the Philadelphia Financial Economists Group (PFEG).

~~~

A few thousand miles of flying gives one a chance to catch up on some research reports. In this case the stack was about the debt-to-GDP ratio and what it means.

It is clear that the United States is on a borrowing binge. And also clear that the Nancy Pelosi-led US Congress has no will to restore any discipline to its spending habits.

Now we all know that borrowing at increasing rates cannot go on forever. And we also know that it can go on for a long time. And history shows that the adjustment process is non-linear. In other words, there is a period when the increased borrowing in order to finance consumption seems to be painless. We are in that period now.

This usually is followed by a shock. What triggers the shock? When does it occur? These are the types of questions we wrestle with each day as a money manager. And these are exactly the questions without easy answers. A bunch of research reports has proven that to these tired eyes.

Here is what we do know. The total of all government debt in the US has now breached the 100% of GDP level. We get this number courtesy of Ned Davis and by tallying up all the debt of the federal, state and local governments. This ratio has not been this high since World War II. It is climbing in a vertical fashion and can be projected to set a new record each and every foreseeable month.

Unlike World War II, the US debt explosion is not due to military and interest expense. Ned Davis has calculated the spending to GDP ratio without interest payments or defense. Again we are at an all-time high in the post World War II period. We cannot blame the spending spree on the army.

Total credit market debt to GDP in the US is a record 373% as of June 30th. In the UK it is 233%. In Japan it is 225%. We have become the most profligate borrower of the large countries in the world.

Private sector and household debt is not the problem. In the last two months the household debt declined by a huge $37 billion. Non-financial corporate debt is also not the problem. It is barely increasing.

The problem simply is government. It is borrowing at all levels and without restraint.

From Japan we learned that increasing borrowing can continue for a very long time. And that we can get it without much inflation and with persistent very low interest rates. The reason is that borrowing is a way of loading a debt burden on the economy. The larger the debt burden the slower the economy will grow. This is especially true when the borrowing is for consumption purposes. That is the current condition of the United States.

Read the rest of this entry »

Bill King points out that the “LEI, which has increased for five straight months, is heavily weighted to monetary indicators and the stock market. Its predictive value for the stock market has been poor due to over-used monetary stimulus.”

>

chart courtesy of Bill King, Ramsey Securities

>

The LEI trended lower from 1997 to 2000 as US stocks bubbled. It declined from 2004 to 2008 as the monetary medication carried a diminishing effect on the real economy.

Economist Dr. Michael Hudson notes a related pet peeve: We’re in a phase change where the economic relationships, proportions, leads and lags do not operate as they did in the past. So any mathematical model that’s based on this sequence is going to be junk mathematics. The last time we had junk mathematics we had the big financial crises that we’re bailing out today.

The July FHFA Home Price Index rose .3% m/o/m, .2% less than expected and June was revised lower to a gain of .1%, down from the initial report of up .5%. Y/o/Y prices are down 4.2% and are (only) 10.5% below its April 2007 high. According to the FHFA, their index is back to the March ’05 level. This measure only includes those single family mortgages that are backed by FNM and FRE but is well diversified geographically (includes all 50 states). The Case-Shiller HPI index in contrast includes jumbo loans and also doesn’t include data from 13 states. Its 20 city index is down 33% from the all time high. The Case-Shiller index is value-weighted, “meaning that price trends for more expensive homes have greater influence on estimated price changes than other homes.” FHFA’s index “weights price trends equally for all properties.” Thus, take today’s info in conjunction with others to get a more complete picture on pricing trends.