Housing Doom

“The Fed is reminding the hyperventilating bond market that it needs to relax,” said Chris Rupkey, chief financial economist at Bank of Tokyo-Mitsubishi UFJ Ltd. in New York. “Inflation will be low for some time because the economic weakness will be with us for a time. They are not about to start to thinking about an exit strategy.” [1]

The above is an example of jawboning, the term a wonderful allusion to an Old Testament story. That, combined with an inability to actually do anything is what we at the Castle sometimes refer to as Ben’s state of Flexible Paralysis. Flexible, because when you’re immobilized you have the freedom to head-fake in any direction Notice, for example, that the Bloomberg story quoted above [1] features several obscure technical and mutually contradictory forecasts that serve different audiences. But doing that leads to the Two Constituencies Problem, and it’s why once a fiscal authority gets stuck on a number (like the present near-zero Fed target rate or the 6 month long maintenance of foreign central bank Agency Debt holdings within 1 percent of $810 billion) breaking either up or down from that number becomes a very serious business.

On the other hand, Brad sees cause for optimism [2] in the recent near-record growth in foreign central bank holdings of Treasury Debt, which is the climbing yellow line in the charts below. So it comes as a mild surprise that this week’s Reuters report [3] recorded very little net change in treasuries, along with almost none in agencies. The report was, as usual, based on the weekly update from the NY Fed’s H.4.1 table site.[4] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[5]

This week’s $1.890 billion net treasuries purchase is off more than 80 percent from last week’s figure, while agencies held their own with a sell-off of only $0.486 billion, cutting the size of last week’s modest dump by nearly 90 percent. The total increase of holdings was a mere $1.404 billion.

The agencies flatline continues to flirt with 6-month lows within the Tube of Bogosity.

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This week’s Reuters report [1] might be termed "stabilizing," which is after all fashionable this season. The report was, as usual, based on the weekly update from the NY Fed’s H.4.1 table site.[2] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[3]

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This week’s healthy $10.295 billion increase in foreign central bank holdings of Treasury Debt was actually down almost 5 1/2 billion from last week, but the almost perfectly flat $0.225 billion Agency Debt buy was actually a nearly 4 billion improvement from last week’s modest sell-off. The total increase in cenbank holdings for the week wasn’t too much less than last week’s.

As the agencies flatline approaches a 1/2 year old event, I’m starting to ponder what I’d like to call the "dual constituency problem." Readers who have been with us for a while may remember long periods from late 2006 to early 2008, and again in mid 2008 when the Fed Funds Rate was kept constant for many months at a time. The present era doesn’t count because the number can’t be pushed below zero. Anyway, markets avidly follow prospects for that rate moving. Indeed, during 2007, when the rate was constant, I thought I detected an increasing trend. Both the players who wanted the number to break up and those who wanted it to break down seemed to be getting signals that the rate fairy was constantly on the verge of granting them their wish. As the rate remained unchanged month after month after month I got a sense of increasing pressure on the Fed to do something, but also an increased sense of paralysis because disappointing either party would eventually have negative consequences.

So I’m starting to suspect that a similar dynamic might be going on with the red line in twist’s raw numbers chart. Except that this time the process is unfolding under the covers, as it were. Rather than someone having been "contracted" to keep the agencies figure flat around $810 billion, perhaps there are now two constituencies that respectively want to see it break up or down. And whoever is controlling that number (it’s absurd to believe at this point that we’re looking at anything purely market driven) wants neither of those parties to be disappointed.

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… And the only point I’d make is that in Europe, you’ve got banks in Europe have loans, something like $1.5 trillion to Eastern Europe. If you don’t solve that problem, you’re just going to have another subprime sort of problem in the global banking system, which is going to be the implosion of East Europe. … - Desmond Lachman

Housing Doom is pleased to present the seventh and final installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the Q&A session. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.

back to AEI Subprime V transcript links

PREVIOUS: Panel Discussion

Alex Pollock [1:26:56]: … May I remind you you need to wait for the microphone. Tell us your name and affiliation please, and then ask your question. And we’ll go first to Bert, because the … look at this, the … Karen is right there with the microphone.

Bert Ely: Because she knew I’d ask the first question. Bert Ely, Banking consultant.

This a question, I guess for the entire panel, maybe primarily for Chris and John. We talk about dealing with big institutions, shutting them down. But these are huge complex financial institutions — 10s of thousands, several 100s of thousand employees, … [mic off, several seconds of dead air] … FDIC is ….

Chris Whalen: … going back to my …

Bert Ely: … if I could just add — in doing so without committing economic arson. I mean I realize that we kind of just … shut this thing down …

Chris Whalen: I know … you’re making Larry’s [refers Obama advisor Larry Summers?] …

Alex Pollock: Let — this long question be finished, and then we’ll get your answer.

Bert Ely: … but doing it in a way that minimizes damage to the economy and to the taxpayer.

Chris Whalen: Bert, look. Imagine if criminals, unbeknownst to you, secretly hired a dirty lawyer to put a lien on your house. And then a whole bunch of other people came, and they put a lien on your house, too. So one morning you wake up, and there are 10 collateral liens on your house that have been registered and validated by the court, and they say, "Oh, Bert, you can’t blow these things up, you do that and the whole community’s going to collapse. I’m sorry, you’ve just got to subsidize this."

That’s what the over-the-counter derivatives community is saying to the rest of us. "Oh me, oh my! You can’t do this, you can’t pull the plug. Bad things are going to happen." Well I put it the other way. If we don’t put AIG into receivership and pull the plug on the credit default swaps market for good, which is exactly what that means, then we are in big trouble.

We don’t go back if we make this decision.

Alex Pollock: You don’t mean pull the plug as a metaphor, you mean retrade these contracts.

Chris Whalen: … I mean …

Alex Pollock: … give people a haircut on contracts! …

Chris Whalen: … I mean give it to the Trustee in the Southern District of New York …

Alex Pollock: … and that’s what happens …

Chris Whalen: … and just like Lehman Brothers, exactly. The Lehman liquidation is your model.

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… Because, what scares me is, the Chinese are indicating that they’re not too comfortable with the trillion dollars in US Treasuries that they’ve already got, and what I’m scared about is, when I see the CDS’s on US treasuries going — trading now at close to 100 basis points. The implied probability of the US government defaulting according to the market is now 10 percent. I think that that’s a scary proposition. - Desmond Lachman

Housing Doom is pleased to present the sixth installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the discussion by the panelists that followed the presentations and preceded the Q&A session. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.

back to AEI Subprime V transcript links

PREVIOUS: Makin Presentation

Alex Pollock [1:15:15]: I want to do 2 things. I want to talk about the — before we let the panel jump in some more — I want to talk about the pronoun "who?", and then I want to tell an Irish joke.

The several things in this panel came up with … question of management. And you know — when we talk about policy, we love to talk about institutions and policies, and formulas, and what are inaccurately called mechanisms, when it comes to markets, which of course are really organic behavior –

But we don’t talk enough about the question of "who?". Everybody who is an actual manager knows that more important than the organization chart, although it’s important, is who you have in charge of various functions, and this brings me to one of my favorite characters in financial history, who is Jesse Jones.

Jesse Jones ran the Reconstruction Finance Corporation during the 1930s, which was the bank, and other things — bailout, government corporation of its day. Reconstruction Finance Corporation made investments in more than 6,000 banks during that crisis, which was about 40 percent of all the banks there were. Who was Jesse Jones? Well, he wasn’t even a High School drop-out. Because he never got to High School. He quit school in the 8th Grade to take over one of his father’s cotton farms. He was a self-made man, a very successful entrepeneur, both in politics and business. He was very experienced … getting on towards 60 when he took over the Reconstruction Finance Corporation. He was a tough minded, tough, very financially savvy guy.

And I think it’s generally considered, he did quite a good job, and was highly trusted. So the question I’ve been putting to people is: "where is our current version of Jesse Jones, to run these bailout operations?"

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What the derivatives guys have done to us over the last 20 years is they’ve leveraged the real economy. They’re safe. They’ve already paid the members of Congress to change the laws so that they’re safe, but everybody out there who’s got a real claim on a real company or real asset is absolutely left out to dry.

Housing Doom is pleased to present the forth installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the presentation by Chris Whalen. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.

back to AEI Subprime V transcript links

PREVIOUS: Zimmerman Presentation

Chris Whalen [42:32]: Thank-you Alex, and again let me thank AEI on behalf of Professional Risk Managers International Association for partnering with us on this event.

I’m going to make 10 points and then — what do I have, 15 minutes? — there you go. And hopefully I won’t end up in the Penalty Box again. [laughter]

At about 4 o’clock this morning I was christened by an Irish lady who has just come into our home. She’s only 3 months old, and she’s covered with light fur. But she peed all over me and wished me a Happy Saint Patrick’s Day and … [laughter] … my wife declared that this was a good omen. So here I am.

[laughter]

Where are we? — I should just sit here and tell Irish stories — You’ve already heard from my two colleagues about the residential markets, so I’m going to dive into the banks first, and then talk a little bit about what we ought to be doing. We talked a bit about some of these issues here in various events that we’ve held since the beginning of the year. And I’m very grateful to Alex and others here at AEI for putting these programs on.

As of the end of the year the banking industry was already at 1990 / 91 levels of loss. And that’s measured both by chargeoffs and also by mark-to-market valuation losses that flow through the income statement of banks.

Now, to give you an example of what I’m talking about, there’s about 8,400 FDIC insured banks in the United States. My company rates a quarter in F right now.

Now I don’t think all 2,200 of those banks are going to fail, in fact I’d tell you that less than half of that number of F-rated banks are going to fail or be merged with …

Alex Pollock: … Do you have a lower grade than F?

Chris Whalen: … no … we only have five … [laughter]

And the reason they’ve all failed, and this includes some very good names that I like a lot, like Regions, and some others, is because of the big minus sign on return-on-equity.

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Housing Doom is pleased to present the third installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the presentation by Tom Zimmerman [scroll down]. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.

Zimmerman’s presentation makes use of a slide deck.[2]

Highlights

• … Because this does not get better as each time you turn around, what you thought was your worst case scenario turns out to be the average scenario. That’s the problem.
• What happens though is those loans that are in this pipeline, this delinctive pipeline, takes them 6 months, 9 months or a year to get through to the end where they come … on the market. So the real pressure in terms of the number of homes that end up in the marketplace and the pressure on the housing market is not going to come here, it’s going to come 6 months or a year later in here somewhere. ,,,
• ".. this, by the way is what’s killing real estate development firms, because they can’t roll … the terms to roll are basically liquidation terms, so they liquidate instead …" - Chris Whalen
• If you managed to really lie a lot on your first loan, and really are overburdened and cannot handle this, and you get your loan crammed down to your DTI — the interest rate down to the point where it’s only 31 percent, you’ve won.

back to AEI Subprime V transcript links

PREVIOUS: Lachman Presentation

Tom Zimmerman [24:26]: Hi, Good afternoon. [slide 0 -- refer to note [2] ] I’ll sort of pick up where Desmond left off … more on the housing market. But before I do that just real quickly in terms of a policy prescription …

As we sat here for the past 2 years every 6 months talking about this problem, none of us got it right 2 years ago. We thought … were all pretty bearish, but we had no concept of how bad it would be. My own personal experience in some of the securitized markets, whether it’s residential mortgage-backed securities [RMBS] or now commercial mortgaged-backed securities [CMBS], we always get it wrong. [25:00] And it’s always much, much, much worse than we anticipated.

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Brad and his merry band of readers at the CFR are having a lively discussion [1] on whether Chinese public opinion might turn against their government’s massive holdings of US debt. But meanwhile, this week’s Reuters report [2] documented a redoubling of the surge of foreign central banks into Treasury Debt. The report was, as usual, based on the weekly update from the NY Fed’s H.4.1 table site.[3] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[4]

Speaking of redoubling, the cenbanks’ large $15.757 billion treasuries buy was almost precisely twice last week’s figure. This was partly balanced by a modest $3.643 billion selloff in agencies, which sends the central banks’ Agency Debt holdings towards the lower range of their $810 billion plus-or-minus $7 billion Tube of Bogosity where that number has been living since the last day of 2008.

Two weeks ago Brad indulged in a bit of understatement [5] about the recent agencies anomaly.

The rise in Treasury holdings clearly no longer reflects a shift out of Agencies. Custodial holdings of Agencies have been flat recently.

Indeed, his 13-week change graph immediately following that quote clearly shows there were periods of stagnant Agency Debt holdings levels in late 2002 and 2004, but never immediately following such a historic bout of volatility. Frankly, this situation reeks. If the levels hold for 4 more weeks and we see a resumption of the late ‘08 downward trend starting with the July 8th number it would be just about an advertisement that someone contracted to keep the red line flat for the first half of ‘09.

Twist sends a link that makes this situation sound even weirder.  Yesterday the Fed was riding the Agency Debt market like it was a bucking bronco.[6] The flat cenbank number makes less sense every week.  Could the Federal Reserve itself be a "Foreign Central Bank?"

Well maybe not.  Twist thinks that a simpler explanation is that it’s not a foreign bank behaving oddly but the Fed lending them the money to do something they wouldn’t ordinarily consider. She points at this mid-February speech [7] where Ben himself seems to be hinting at wheels within wheels.

Because interbank markets are global in scope, the Federal Reserve has also approved temporary bilateral liquidity agreements with 14 foreign central banks. These so-called currency swap facilities have allowed these central banks to acquire dollars from the Federal Reserve that they may lend to financial institutions in their own jurisdictions. The purpose of these swaps is to ease conditions in dollar funding markets globally. …

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Housing Doom is pleased to present the second installment of our unauthorized annotated transcript of the American Enterprise Institute’s March 17, 2009 seminar "The Deflating Bubble, Part V: Forecast and Policy Recommendations for the Next Six Months." [1] This is the presentation by AEI Fellow Desmond Lachman. The event site has several resources, including both an audio and a video recording of the 2 hour proceedings. There is a brief summary, but as yet no official transcript.

Lachman’s presentation makes use of a slide deck.[2] He also contributed a copy of some recent Congressional testimony he gave [3] on these issues to the event site.

Highlights

• … And what they missed was that housing is a major component of household wealth, and the second point that they missed was that it’s a very important part of the balance sheets of banks. There’s a $10 trillion loan market, and if you get impairment on that, that can really cause real problems.
• … we look like you’ve got something like a million homes too many sitting there vacant, weighing down on the market.
• To be sure, the government has done something that I think is positive in a way, but my view is it doesn’t go far enough, because what it doesn’t do is it doesn’t deal with, for instance, the negative equity problem, …
• … it escapes me why, when we need the fiscal stimulus right now, more than half of it is back-loaded to 2010 to 2011.

back to AEI Subprime V transcript links

PREVIOUS: Pollock Introduction

Desmond Lachman [10:14]: Thank-you very much Alex. [slide 1 -- refer to the slide deck at note [2]] Thank-you for arranging this. I’m always struck by you foresight, having done this 2 years ago, to pick up that this was going to be the key topic, and you’ve done well this afternoon to start with Ireland.

There’s a joke circulating on Wall Street … Iceland, of course you know, had a huge financial crisis, and there’s a joke circulating now on Wall Street about what the difference might be between Ireland and Iceland. And the answer is: One consonant and six months. [laughter] So Ireland is one of the few places that causes me to be optimistic about the United States economy.

When we gathered last time I think that it was very clear-cut where the housing market was going to go. It was quite unambiguous, everything was pointing in a very negative direction. I think now, 6 months later, you can see that there are certain signs of improvement that one really wants to make note of, and that does indicate that this is going to pass like everything else. Maybe not in 2009, but you could see a bottoming sometime in the middle of 2010.

So there is some good news. The trouble in my view is that the bad news really dominates. And the bad news of course is the state of the United States economy, where we’re heading. And with a bad economy, one really can’t expect the housing market to be vigorous and rebound in any rapid or quick way.

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If there’s a technical term for what we’re presently seeing in this story arc it’s The Fog of Battle.[1] One thing is becoming clearer, though. Brad has found [2] that foreign central banks are increasingly at the short end of treasuries. That means if the yellow line ever starts to reverse, they’re mostly poised to get out of Dodge quite rapidly. This week’s Reuters report [3] waxed strangely poetic over the fact that foreign central banks are still buying Treasury Debt at all. Never mind that this week’s figure was down by nearly 2/3rds from last week’s. The report was, as usual, based on the weekly update from the NY Fed’s H.4.1 table site.[4] Here is Doom’s updated CSV version of the agencies and treasuries foreign central bank holdings data set.[5]

Central banks still did manage to buy a half-way respectable $7.940 billion in treasuries, but dumped a modest $3.504 billion in agencies. In the week, they were well below the billion-a-day+ uptake needed to support the US stimulus. Perhaps just a "breather" from the last couple of huge weekly buys.

The red line is getting silly. The net move so far this year for cenbank holdings of Agency Debt is the size of a typical Yonkers NY strip mall. Agencies are down a microscopic $8 million since Dec 31st. If somebody’s been contracted to offset the actual foreign selling of agencies, they’d better put some variance into their counter-buys. Five months of perfectly flat results aren’t going to fool anyone.

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Americans may not have equity any more, but they’ve still got plenty of mortgage debt:

Even though the amount of home mortgage debt outstanding declined in 2008 for the first time since the Federal Reserve started keeping track in 1945, mortgage debt levels remain distressingly high.

Home mortgage debt outstanding was 73% of gross domestic product last year, according to government data. That’s the third-highest reading on record, after the 75%-plus bubble years of 2006 and 2007.

Getting that ratio down to a more manageable number will mean more lean years ahead, as Americans further cut spending to rebuild their savings and banks struggle to boost their capital amid heavy loan losses.

How long this process might take is a key question for those trying to gauge the prospects for an economic recovery.

To get the mortgage debt-to-GDP ratio down to a more normal level such as the 46% average of the 1990s, Americans would have to cut their mortgage debt to $6.6 trillion from $10.5 trillion at the end of 2008. The last time the national mortgage debt count was below $7 trillion was 2003, according to Federal Reserve data.

We might call this mortgage overhang the $4 trillion elephant in the room for policymakers, who have spent the past year injecting liquidity into the economy - a course of action that will do little to solve the problem of too much debt.

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