Mortgage Backed Securities Monetization and the US Dollar
Stock-Markets / Credit Crunch Aug 09, 2007 - 12:43 PM GMTBy: Jim_Willie_CB
Fannie Mae is being groomed to be the central clearing house for mortgages and their bonds, sponsored by the USGovt and the US Federal Reserve. Fannie Mae (FNM) just requested permission to take on much greater volume of mortgages, in order to alleviate the secondary market flow of capital funds. Since the accounting scandal which peaked in September 2004, a limit was imposed on FNM on its holdings at $727 billion. In today's climate, marred by credit seizure to some degree, FNM is deeply missed in its former prominent centrifuge role.
A key question arises on the general inflation impact, if and when FNM expands its role and is the nexus (surely a hidden basement) of grandiose illicit monetization of mortgage bonds. If the banking maestros undertake to put a secretive floor on mortgage backed securities (MBS), a solid bid to prevent further breakdown, then vast amounts of new printing press money will enter the system. The mortgage finance sector desperately needs a bid on subprime MBS bonds so as to clear them upon liquidations. The bank wizards could start monetizing them, and work their way up the quality ladder toward Alt-A loans which are also in trouble.
### OVERNIGHT PANIC UPDATE ###
Overnight, in the US wee hours of Thursday morning, the Europeans suffered a shock wave. The Euro Central Bank added €94.8 billion (US$130.2 billion) into the money market funds as retail depositors forced a run on their banks, in a MILD PANIC . The overnight rates that banks charge each other to lend in dollars jumped to the highest level in six years. The dollar London Interbank Offered (LIBOR) rate rose to 5.86% today from 5.35% and in euros rose to 4.30% from 4.11%. The ECB response to the fastest increase in the dollar bank rate since June 2004 signals that lenders are reducing the supply of money as losses triggered by the US mortgage slump spread worldwide. In addition to BNP Paribas halting withdrawals, and Dutch investment bank NIBC Holdings said it had lost at least €137 million on subprime investments, more evidence that credit markets are not stabilizing. A Commerzbank commercial bond trader summed it up. “Liquidity in the market has completely dried up as investors are not recycling their money back because of subprime concerns. Levels have shot up dramatically since yesterday as issuers are trying to entice investors back.” The ECB provided the largest amount ever in a single fine-tuning operation, exceeding the €69.3 billion provided on 12 Sept 2001 , the day after the terror attacks on New York . The US Federal Reserve accepted $12 billion in overnight repurchase agreements overnight simultaneously.
PNB Paribas, the French bank conglomerate closed three funds associated with US subprime toxic mortgages. The company made a bold plainly worded comment, a severe criticism of this fraud-ridden credit sector. “The complete evaporation of liquidity in certain market segments of the US securitization market has made it impossible to value certain assets fairly regardless of their quality or credit rating. The situation is such that it is no longer possible to value fairly the underlying US ABS assets in the three above mentioned funds,… therefore unable to calculate a reliable net asset value (NAV) for the funds.” Export of US bond fraud to Europe has led to renewed shock waves.
Back in the Untied States, American International Group (AIG) announced that residential mortgage delinquencies and defaults are becoming more common among borrowers in the category just above subprime. AIG, the world's largest insurer and one of the biggest mortgage lenders, said total delinquencies were 2.5% in its $25.9 billion real estate portfolio. It offered details. They cite 10.8% of its subprime mortgages were 60 days overdue, compared with 4.6% in the category with credit scores just above subprime, indicating that the threat to the mortgage market may be spreading. This no longer just a subprime problem, clearly.
The financial market effects were huge overnight. The USDollar DX index benefited with a 59 basis point rise to 80.81 in the Sept2007 contract. Also in Sept contracts, the euro fell 105 bpt to 137.11, the pound sterling fell 131 bpt to 202.20, the yen rose 89 bpt to 84.86, which at the same time forced gold down 12.7 to 667.2 on the October contract. The indicator on the Fed Funds futures expectations changed dramatically. Up through the last few days, the December contract had priced in roughly a 100% chance of a 25 basis point interest rate cut by the USFed. Last night, the October Fed Funds contract jumped to a similar level, pointing the way to a USFed rate cut of 25 bpts before October. In the first two hours of Thursday New York trading, the Fed Funds indicator has not changed. But the pound sterling gained back half of what it lost in Europe , with the rest of the currencys gaining minimally.
Art Cashin of UBS is astute, able to sum things up succinctly. He said yesterday “We don't know what it is we don't know.” Today he added “We don't know who doesn't know.” The sentiment among some pundits reeks of confusion. People who are paid to know what is happening with the bond market are largely unaware. One cannot believe what major banks are telling the public anymore. We have vast mispricing of bond securities. My view is that we are seeing outsized down then up then down moves, much like preliminary earthquake tremors.
Before the charts for the October and December Fed Funds futures charts are displayed, a final note. The major Wall Street broker dealers like Goldman Sachs, Morgan Stanley, Lehman Brothers, and Bear Stearns are getting away with corporate bond murder. The Wall Street broker dealers have credit default swaps trading at three to five levels below investment grade , yet their corporate debt ratings remain of investment grade. How much do they pay the debt ratings agency for that??? The false pricing of asset backed bonds extends far beyond the mortgage bond market, to the corporate bond market. Given the colossal statistical fraud stated routinely by the USGovt on the condition of the USEconomy, one can assuredly conclude that the USTreasury Bond market is also falsely priced. With price inflation running over 10%, according to Shadow Govt Statistics after removing basic obvious gimmicks, the long-term USTBonds should not offer anything close to a measly 5% yield. The October contract does not indicate a 100% chance of a September rate cut, as mentioned on CNBC. It is almost 70%, a sharp move up though.
FANNIE AS MONETIZATION FUNNEL
My take is that Fannie Mae will eventually become a funnel for monetization, after functioning as a centralized efficient clearing house. If new money is run off the press in the middle of the night, and it enables redemption of a funnel of lower quality mortgage bonds, what is the impact on inflation? First, inflation is technically the rise in the money supply, the monetary aggregate. So obviously the system would experience an influx of monetary inflation. The effect on price inflation is not so clear. The objects of the influx of new money, euphemistically called ‘liquidity' by the financial markets, are many. Would price inflation in the consumer sector flare up, enough to hit the Consumer Price Index? Which of the many object targets would see a lift of an artificial nature?
Fannie Mae is being set up to be a facilitator in the absence of CDO & MBS bond issuance in the secondary mortgage market. Funds for loans are in short supply, as minor but widespread seizures are occurring in a system which cannot seem to adapt in the current climate. Investors are losing trust in the pricing of the MBS bonds. Lenders are choosing not to originate a loan which they are likely to be forced to hold and not pass on. A solution is sought, and raised limits on Fannie might do the trick in such a solution. We are moving back to the centrifuge concept. Jumbo mortgages used to be deferred to Freddie Mac, which are defined as loans over $417k in size. Given the similar limits on Freddie Mac, jumbos are seeing their mortgage rate rise. They popped above 7%, roughly 40 basis points higher than conforming 30-year rates. Strain is being seen throughout the system.
NEW IMPROVED FANNIE MAE
One must wonder to what extent true reforms have taken place since their executive corruption came to light and their phony accounting was exposed. Fannie Mae admitted a mere $11.3 billion in accounting errors, and were widely accused of committing fraud for the benefit of executive stock options. Do not expect any honest or informative financial statements, maybe just a sham annual report, hardly with complete accounting and full disclosure of any illicit mortgage bond shenanigans for the greater good executed and enabled by the banking leaders. The authorities are likely growing in desperation to fix the system which went amok under their endorsement of the housing boom, better labeled as the bubble it always was. The fact that the FNM stock trades at all or has avoided delisting is a total joke, since it does not satisfy basic SEC rules. Muckymucks are heavily involved in the Fannie Mae enterprise, whose board has been a country club of political and other corporate henchmen.
Fannie Mae is in possession of a vast array, a cornucopia of credit derivative contracts. They gathered them in an uncontrollable fashion, from poor management, attempts to participate in almost every conceivable so-called protection. Imagine kind of like Uncle Charlie's garage after 40 years of packrat accumulation of items, gathering like corrosive clutter, with vast cobwebs linking types and insects eating away at the works, with possible ooze of decomposition breaking down things on a chemical level. The investment community has been almost totally in the dark on the vast supply of credit default swaps, interest rate swaps, and REMIC derivatives (leveraged off MBS bonds) that Fannie & Freddie own. Credit default swaps act like loan portfolio insurance contracts, protecting against default. Interest rate swaps enable a delicate balance to be struck between long-term and short-term interest rates, paying a benefit upfront to the higher yielding security. My guess is FNM accounting will change from a dark place to an apparent reformed entity, but with a vast black hole, never to require full disclosure. It will never face liquidation of its worthless mortgage bonds or of its deeply underwater derivatives. FNM will be a bond cemetery which nobody can visit.
TARGETS FOR MONETIZATION
Fannie Mae will become the device to fund mortgages, just like what it originally did a few years ago. They will recycle money back to the lenders and bankers, but more responsibly, we will be assured. In the process, however, FNM lies in the path of official but undoubtedly denied federal monetization, in progress for some time, if rumor is true. To accomplish the task, the USFed and Dept Treasury would print money and buy their MBS bonds, replacing them with valuable cash. Whether FNM takes on the leveraged subprime CDO bonds is a big big question, my guess NO. Why? Because all subprime mortgage CDO bonds are worthless, or soon to be recognized as worthless. It is unclear whether FNM will take CDO bonds of supposed 'AAA' rating, since they contain so much toxic sewage derived from subprime fecal droppings. If FNM supports the MBS bonds, then the CDO bonds can sort out their prices effectively. The subprime CDO bonds will all get killed off, but 'AAA' CDO bonds will retain some equilibrium value.
WHO PAYS? WHAT PAYS?
Many folks in private communications have shared their disgust that taxpayers would foot the bill for the whole monetization enterprise. What a grand misconception! They have not paid for anything in years. For twenty years, the Asians and Persian Gulf nations have paid, by means of lending money via USTBond purchases. Trade partners have been the vast credit supply source, as part of the baseless Macro Economy mythology promoted and justified by Sir Alan Greenspan. This is the essence myth of what my previous work has dismissed in the Bretton Woods II, to provide firm backing of the USDollar. The backing was more like a thin sheet of paper built on trust, which is fast disappearing. By holding gigantic mountains of USTBonds, they hold the markers just like an unhappy syndicate lender. To the extent that they continue to purchase USTBonds, they are indeed paying the US bills! The ultimate cost is born in the indirect effect doled out to the USDollar. It relies more than we know on trust and faith in the US system and its custodians. Both are on the run, as their handiwork looks more like a blight on the landscape.
MISCONCEPTION
Some mistakenly believe in the gold community that the fast US$ money growth automatically sends the gold price upward due to more supply weighing down US$ value. This notion, in my view, misses most main factors. If the majority of new US$ money is devoted to bubbles which get killed off quickly, then destruction of money is the intermediate term outcome of monetary inflation, in bizarre US style. Inflation has been exported for three decades. It just aint that simple. The debt deflation underway has a climax ring to it. The main wellspring for the launched gold price has been believed to be the US Federal Reserve and its unbridled monetary inflation. The gold price will zoom higher from the lost confidence in the US financial system and failed integrity in the USFed and Dept of Treasury. They have failed. The monetary crisis will lift gold, not so much price inflation from the flood of money. The recent events point to continued asset losses in debt securities, with associated shocks which eat at system confidence and leadership confidence.
WHERE DOES THE MONEY GO WHICH RESCUES MORTGAGE BONDS ???
DESTINATION OF NEW MINTED MONEY
If scads of USDollars fly off the printing press, created for the purpose to buy mortgage bonds, strange mechanisms are to play into the totally discombobulated financial sector of the USEconomy. Homeowners are not involved in this game, only financial entities. A modest attempt will be made here to take a hack at the avenues taken for the upcoming infusions.
Fannie Mae owns MBS bonds, which when purchased by phony US$ printed money, will serve as a powerful secondary mortgage market supply of available money for loans. The primary result of monetization and redemption of their MBS bonds, which constitutes a new firm floor by means of an official artificial bid, will be money sent back into the lending industry. The beneficiary will be borrowers who need to close a home loan, lenders who need to fund a loan, home sellers who need to realize cash from the sale of their homes, and homeowners who need to draw on equity. The result is support to the housing prices and mortgage bonds, not broad systemic price inflation. The deflation in housing will be lessened, maybe abated, but not stopped.
Numerous types of financial firms will be shipping their damaged mortgage portfolios and conceivably their damaged mortgage bonds to Fannie Mae. The investors of bonds transferred to Fannie Mae are impossible to fully catalog, but principal players can be identified.
BANKER BROKERS like Goldman, Merrill, Lehman, Bear Stearns own MBS bonds. They will use the money from MBS bond sales to Fannie Mae to buy their own stocks, to buy USTBonds, to meet credit derivative margin requirements, to reduce their asset to capital ratios, to invest in credit market hedges to protect themselves from this shaky situation.
BIG BANKS will use the money to issue new loans, to reduce their asset to capital ratios, to invest in hedges, and to buy back own stocks, since they are far more corrupt.
LENDERS will use the money to issue new loans, to stay in business, to meet debt to asset creditor requirements, to invest in hedges which protect their ongoing business. Rather than buy their own stock, they might even short their own doomed stocks (just kidding).
HEDGE FUNDS will use the money to meet creditor margin calls, to pay down their huge debt, to invest in wise conservative hedges like credit default swaps, to stave off liquidation.
PENSION FUNDS & INSURANCE FIRMS will use the money to buy shorterm USTBonds as they move backward on the risk scale, to buy short-term EuroBonds (nice euro currency premium lift over time), and short-term UK Gilt bonds which contain a higher yield than TBonds (nice sterling currency premium lift potential), as they swear off risky MBS bonds altogether, even AAA perhaps for a period of time.
FOREIGN BANKS & FUNDS will support the USTBonds, and swear off all US-based asset backed bonds like mortgages, since they perceive them to be ridden with fraud. They might refuse to purchase US corporate bonds and commercial bonds. They too are dealing with asset to capital ratios and debt to asset ratios.
FOREIGN CENTRAL BANKS will use continue to support the USTreasurys in their traditional USDollar support as the world reserve currency.
END: WRECKED CONFIDENCE IN USDOLLAR
The conclusion is that the monetized MBS bond money, if and when redeemed by the US banking authorities, will not directly cause price inflation. The money will be devoted to other things to keep the system running, to protect their own individual interests. However, the entire process will become revealed. What is highly likely, more akin to a dire dark cloud, is that the the international reaction will be to lose confidence in the USFed and Dept of Treasury. If the USGovt and USBank system installs a formal or hidden bid on MBS bonds, integrity will slowly vanish as leadership is globally challenged. MY EXPECTATION IS FOR A SLOW BLEED, A GRADUAL EROSION IN THE USDOLLAR, NOT A COLLAPSE. The initial stages of the panic will be a move into what is perceived as SAFE HAVEN. The USDollar and the USTreasurys are neither safe nor stable, certainly no haven.
The impact ultimately will not be a burdened taxpayer from heavy taxes to pay for MBS bonds. Instead, the USDollar will decline for another 2 to 3 years at least. The effect will be imported cost inflation for another several years, the opposite of the exported inflation the USEconomy has gotten away with for two decades. The most visible cost will be higher energy costs and higher metal costs. To the US consumers, food prices are just a consequence of higher energy costs to farmers. Food prices will rise, aggravated by the fruitless attempt to produce ethanol, more than a few drops in the bucket.
The US will continue to be a global powerhouse in farm production and export. In fact, with finances resembling Third World , and with debt like Third World , it might expect the USEconomy to revert back to an Agrarian Economy. The recent Minneapolis bridge collapse accentuates the infrastructure resembling the Third World also. An Assn of Civil Engineers recently rated the US infrastructure which includes bridges a ‘D' and estimated the total upgrade cost to be $1.6 trillion. That amount is roughly what has been blown in the Iraq & Afghan Wars. Priorities for the United States are moronically directed. Economic guidance for the United States has been destructive, since reliance upon inflation has been the central cog. We are fast entering constant crisis mode, which erodes confidence in all things related to the US financial system. The gold market will eventually be the sanctuary.
Investors will pursue gold, not because of price inflation, but because of the pervasive sense of lost control. The many produced bubbles are breaking apart. The creation of new unbacked money to fix the system, to plug the holes in the many bond dikes, to address the need to paper over the mushrooming problems, are fast resembling the Weimar Republic . Now that bubble architectural engineer Greenspan has left town, the policy bagholder is Ben Bernanke, the mumbler, the hamstrung chairman. In futility and benign neglect, he awaits further assured destruction before taking action. Its custodians seem a cross between Keystone Cops and Crime Syndicate thugs and Ideologue Heretics and Ivory Tower Morons.
TRADE PARTNERS
Lastly, foreigners are not standing still. China cited their ‘financial nuclear threat' option, to sell vast blocks of USTreasurys in response to Congressional trade sanctions. They focus on currency reform, when unfixable wage differentials is the problem. Then there is Iran , which sells crude oil in euro terms nowadays. They demanded last month that Japan pay for oil no longer in USDollars. Then there is the entire Persian Gulf group of Gulf Coop Council members. Kuwait broke ranks in moving away from a direct US$ peg. Lately, the United Arab Emirates has embarked on a rally cry mission to urge all GCC members to abandon the US $ peg. Look for Persian Gulf support of USTBonds to be on the wane in coming months. The only sizeable USTBond support coming out of Asia has been China . US leaders choose to step on their toes and spit in their faces. Then there is Russia , angry over US missile deployment in Eastern Europe , a violation of a treaty.
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