Posts filed under “Think Tank”

Early Morning Look

From a major NY Trading Desk 10/27:

Central banker judgment is the ultimate regulatory loophole

Only time will tell how effective the new rules and regulations currently being implemented by policymakers in the Western world will be. I’ll throw my two cents in and say that simply letting bad businesses fail would greatly curtail the quantity of new legislation needed to create a more just, less fragile financial system. I’m arguing, implicitly, for a less activist Federal Reserve (if we insist on keeping this central banking model, although we’ll see how H.R. 1207 progresses) and a more principles-based monetary policy. Ad-hoc judgment from central bankers too often errs on the side of laxity and accommodation, their protestations to the contrary notwithstanding (and yes, even Paul Volcker was accommodative – look into his handling of the LDC debt crisis). This isn’t a criticism of any one individual, it’s an observation on human behavior.

Regulators, legislators take the spotlight
Stepping down from the soapbox, yesterday’s session was dominated by the noise out of Brussels and Washington D.C. First, as we in the U.S. were arriving to work, the European Commission ruled that Dutch financial services giant ING must sell its insurance business and its U.S. banking arm “as compensation for the state aid it has received during the financial crisis,” according to the Financial Times. The ruling will cut ING’s balance sheet nearly in half. The stock fell -18% in Amsterdam and is lower again this morning (though it appears to be rallying as I write).

Meanwhile, our own regulators, if leaks from unidentified “House aides” are to be believed, are taking a different tack. Rather than force “systemically important,” or “too big to fail (TBTF),” financial conglomerates to break themselves up immediately as the Europeans appear to be doing, our regulators would rather allow them to continue doing business until they are teetering on the edge of collapse – at which point new legislation would allow the government to seize the institution (whether it’s a bank or not), “fire directors, wipe out shareholders and force creditors to take big discounts on their debt.” That’s according to the Financial Times. The FT and the Associated Press cite “one person involved” with the new legislation (currently being crafted by House Financial Services Committee Chair Barney Frank) and “a House aide familiar with the plan,” respectively, in reporting that the banks will not have to contribute regularly to any kind of fund that would be drawn on in the event of a seizure/restructuring. Rather, the seized institution would “contribute an amount after the event.” (FT) That sounds to me like profit clawbacks. Okay, I have to step back up onto my soapbox here: doesn’t the European plan make much, much more sense? Don’t we have bankruptcy courts? I get it – they’re systemically dangerous, so you can’t risk a sloppy bankruptcy…so…break them up, maybe? (source: Bloomberg; Financial Times; Associated Press)

Financials have a tough go of it

Stepping back down from the soapbox, the specter of heavy government involvement – in whatever form it materializes – with the biggest banks sent their shares reeling (C -4.3%; BAC -5.1%; JPM -3.1%; WFC -3%). The major financial institutions with the smallest commercial banking presence – Goldman Sachs and Morgan Stanley – fell just -0.6% each. Citigroup added Bank of America to its list of top stock picks midday, an announcement that evoked equal parts skepticism and amusement amongst the folks I talk to. The announcement had a minimal – if any – impact on B of A’s shares. The regional banks were submarined by a downgrade of SunTrust Banks and negative comments on the regional banking sector (“Recognition is developing that many regional banks, SunTrust included, may not show a profit until 2011”) from Rochdale Securities’ Dick Bove. The insurers also fell sharply (most down between -3% and -6%) in sympathy with ING. (source: Bloomberg)

And, finally, the home buyer tax credit

Adding to the woes of a market already skittish over the prospect of a re-regulated financial system, a note from research firm ISI Group that cast doubt on the notion that the $8,000 tax credit for first time home buyers would be extended (in some form) pulled the market off of its morning highs (+1.1% for the S&P 500) and by noon the market was lower by over -1%. Reassuring comments on the matter from Florida Senator Bill Nelson (he told reporters that the program would likely be extended later this week) failed to reverse the decline. Further gains from (+5.2%) and Microsoft (+2.4%) after their stellar earnings reports last week cushioned the blow for the Nasdaq, but all in all it was a very disappointing – and bizarre – session. (source: Bloomberg)

Category: Think Tank

Durable Goods about in line

Sept Durable Goods was about in line with expectations both headline and ex transports. Orders rose by 1% and were up .9% ex transports. Non Defense Capital Goods ex Aircraft were up 2% after the prior two months of declines. Orders for vehicles and parts in particular fell .1% after the two prior month gains….Read More

Category: MacroNotes

2 yr note auction showed solid demand

The 2 year note auction was very strong as the yield was about 3 bps below where the when issued was traded and the bid to cover at 3.63 is the highest since Aug ’07 and well above the one year average of 2.65. Indirect bidders totaled 44.5%, about in line with the previous few….Read More

Category: MacroNotes

Recent Developments in Mortgage Finance

Recent Developments in Mortgage Finance

By John Krainer

As the U.S. housing market has moved from boom in the middle of the decade to bust over the past two years, the sources of mortgage funding have changed dramatically. The government-sponsored enterprises—Fannie Mae, Freddie Mac, and Ginnie Mae—now own or guarantee an overwhelming share of originations. At the same time, non-agency mortgage securitization and loans retained in lender portfolios have largely dried up.


The period following the 2001 recession through 2006 is rightly called a housing boom. House prices and net borrowing by households surged in the early part of the decade, easily outpacing growth in household income. But, with the onset of the financial crisis and the failure of many mortgage market participants, access to mortgage finance declined dramatically. This Economic Letter summarizes some of the key ways that the mortgage market evolved during the boom years and during the ensuing housing market bust. It focuses on changes in the way loans were made and funded and how loan characteristics themselves changed.

Sources of mortgage finance

One of the distinguishing features of the U.S. housing finance system is the role played by the capital markets in funding residential mortgages (see Green and Wachter 2007). The direct link between housing finance and the capital markets is through securitization of home loans in various types of mortgage-backed securities (MBS). The pooling of mortgages into MBS permits the separation of loan origination and funding, as well as the transfer of risk. Also, depending on the type of MBS, securitization can facilitate the separation of credit risk—the possibility that borrowers default on their mortgages—and market risk, defined as changes in the value of a portfolio of mortgages as interest rates move and borrowers prepay. Securitization transforms relatively illiquid loans into highly liquid securities. In addition, pooling mortgages from different geographic regions serves as a way for investors to diversify away from shocks to local housing markets.

With the development of MBS and other types of structured financial products, banking institutions, including commercial banks, savings institutions, and credit unions, have slowly but steadily ceded market share to capital market investors in holding residential mortgage assets in portfolio. According to Federal Reserve flow of funds data, the banking institution share of total mortgage assets declined from a peak of about 75% in the mid-1970s to about 35% in 2008. Much of the decline in banking institution housing portfolios over this period was related to the expansion of the government-sponsored enterprises (GSEs) Fannie Mae, Freddie Mac, and Ginnie Mae. The GSEs purchase mortgages for securitization and guarantee MBS against credit risk.

Fannie Mae and Freddie Mac require that mortgages conform to certain standards to qualify for securitization. For example, mortgages must meet set size limits and underwriting guidelines. Ginnie Mae guarantees the repayment of principal and interest on MBS backed by federally insured loans, such as Federal Housing Administration (FHA) or Department of Veterans Affairs loans. Unlike Fannie Mae or Freddie Mac, Ginnie Mae is explicitly backed by the U.S. government.

Starting in the late 1990s, the GSEs’ near-exclusive hold on residential MBS issuance was challenged by so-called non-agency, or private-label, securities issued by brokerage firms, banks, and even homebuilders. Non-agency securitizations are conceptually very similar to agency securitizations. Lenders sell loans to an arranger, which then packages the loans, creates securities with claims to the cash flows of the loans, and sells the securities to investors (see Bruskin, Sanders, and Sykes 2000). However, in contrast to agency MBS, purchasers of non-agency securities are exposed to credit risk as well as market risk. Also, non-agency securitizations are more complex, involving many specialized parties. In recent years, securities were typically separated into tranches and structured to create different payoffs—more complicated arrangements than typical of agency securitizations. At its peak in late 2007, non-agency securitizations accounted for nearly 20% of outstanding mortgage credit.

An avalanche of research and commentary has examined why non-agency securitization grew so fast during the housing boom. One argument suggests that policymakers were worried that the GSEs were becoming too big and systemically important. These fears led to the imposition of caps on GSE portfolios, giving a boost to alternative sources of mortgage funding as the demand for housing finance boomed. Another story points to the decline in economic and financial market volatility that took place in the 1990s, especially in the first part of the decade. This phenomenon may have led to an increase in lending to previously marginal borrowers—a development that was probably not unique to mortgages but occurred in other asset markets as well.

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Category: Credit, Real Estate, Think Tank

Consumer Confidence down and Present Situation hits lowest level

The Oct Consumer Confidence # was a weaker than expected 47.7, almost 6 pts below forecasts and down from 53.4 in Sept. While the headline figure is still well above the bottom of 25.3 back in Feb, the Present Situation fell to the lowest level since Feb 1983. Expectations fell 8 pts to 65.7 but…Read More

Category: MacroNotes


David Rosenberg is a 20 year veteran of the Street, David most recently was Merrill Lynch’s chief North American Economist, where he correctly warned about the Housing and Credit Collapse and Recession in advance. He is the Chief Economist of Canada’s Gluskin Sheff




What made things so interesting is that in 2007, when I was at Merrill and calling for a recession, it was such an outlier view even though it seemed so obvious to me at the time. To think that it only became a widespread consensus view in the fall of 2008 when the downturn was already in full force for a good eight months. Back then, the bears still felt they had to be vindicated, and of course, the only barometer that seems to matter to anyone was the stock market, which gave absolutely no ‘heads up’ at all for what was to come down the pike. But now, it is universally viewed that the recession is over, that a recovery has begun, and a growing number of commentators are calling for 4%+ real GDP growth for 2010. We have never been a fan of group-think, but that is what we have on our hands today.

The question really is how robust is the economy and what is the root of optimism. It comes down to the massive doses of medication that have been applied by Uncle Sam. Unless we want to sustain state capitalism, which is what we had by the way, throughout the 1930s and 1940s, then this unprecedented public sector incursion into the capital market and the economy is going to have to end at some point.

But when you have a system that continuously extends unemployment insurance, provides subsidies for cars and homes (and the latter is still being considered as an extension at a cost of over $1 billion a month for the taxpaying public) not to mention the credit-boosting initiatives by the Fed and the FHA. The Obama team is now considering a capital infusion into small businesses as a means to bolster employment in this critical part of the economy. Friday’s WSJ also suggests that the Democrats are mulling over tax credits for “additional big ticket items.” Yes, that is true. Despite all the fraud involved in the homebuyer tax credit plan, its extension and indeed expansion is not being discussed in Congress. (100,000 improper claims for the tax credit? Who cares? It’s for a good cause.)

All of this (you have to see the Tim Geithner interview in BusinessWeek) is not being dubbed another fiscal plan — it is only an “extension” of the first. At the same time, we have a system where all the big banks have been safeguarded by the government and the liabilities of the entire system guaranteed by the taxpayer. Deficits continue to be racked up — $1.4 trillion in the past year and over $1 trillion as far as the eye can see and we are still being told that this all the fault of the prior Administration. The question that has to be asked is, while the coupon payments will be made, do the entities who are buying U.S. Treasuries today really ever expect to get their capital back? Without either deep spending cuts or tax increases (a dirty three-letter word in the U.S.A. — remember Bush Sr.’s “read my lips” back in the early 90s that cost him the election?) the only way out of this fiscal mess caused perhaps by the prior Administration and now accentuated by the current Administration will be by monetizing the debt.

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Category: Think Tank

S&P/Case-Shiller home price index

The Aug 20 city S&P/Case-Shiller home price index fell 11.32% y/o/y, a touch less than the expected drop of 11.9%. It’s the smallest y/o/y decline since Jan ’08. On a m/o/m basis it was up 1.18% where 17 of the 20 cities saw prices gains with Las Vegas, Charlotte and Cleveland down. Every city is…Read More

Category: MacroNotes

India moves a step away from ‘unconventional’ measures

Add the Reserve Bank of India to the list of central banks that are moving to take away their extraordinary accommodation. They did not raise interest rates but increased the bank liquidity ratio, which is basically a reserve requirement, thus forcing banks to have a higher % of their capital in gov’t bonds which thus…Read More

Category: MacroNotes

Demand for inflation protection evident in the 5 yr TIPS auciton

The demand for inflation protection was evident in the Treasury 5 year TIPS auction as while the yield was about in line with expectations, the bid to cover of 3.10 is the highest since they were reintroduced in 2004 and is well above the average seen since ’04 of 2.12. The implied inflation rate in…Read More

Category: MacroNotes

Andy Xie: The big burnout

Central banks around the world have released massive amounts of money in response to the current financial crisis. How to exit from the current super-loose monetary environment has become a popular discussion. The central bankers are talking down the prospect of raising interest rates, arguing that the weak economy keeps inflation in check. But the proposition that a weak economy means low inflation is false. The stagflation of the 1970s proves it.

This round of monetary growth has mainly fed speculation, not credit demand for consumption or investment. Speculation has reached a dangerous point with the oil price threatening to reach triple digits again. Its implications for inflation may spook the central banks to raise interest rates quickly and trigger another crash.The excess money supply has created a new liquidity bubble.

The resulting asset inflation (stocks and bonds in developed markets and everything in emerging markets) has stabilised the global economy. The current equilibrium is one on a pinhead. The hope for strong economic recovery led by emerging economies raises investor optimism – and asset prices. This eases pressure on corporate balance sheets, spurs property production and boosts consumption through the wealth effect, making the hope self-fulfilling in the short term.

A rising oil price threatens to derail this recovery. It can trigger a surge in inflation expectation and a major crash of bond markets. The resulting high bond yields may force the central banks to raise interest rates to cool inflation fears. Another major downturn in asset prices would reignite fears about the balance sheets of global financial institutions, leading to new chaos.

The last two times the oil price surged above US$100, it wreaked havoc on the financial markets and global economy. The runaway oil prices of 2006 were the final straw that tipped the US property market. The oil price fell sharply amid the subprime crisis as the market feared a demand collapse. Then, the Fed came to the rescue and began cutting interest rates aggressively in the summer of 2007 in the name of combating the recessionary impact of the subprime crisis.

The oil price rose sharply afterwards on the optimism that the Fed would rescue the economy, and with it, oil demand. It worked to offset the Fed’s stimulus, accelerated the economic decline, and pulled the rug out from under the derivatives bubble. The ensuing demand fear again caused the oil price to collapse.

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Category: Think Tank