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Thursday, March 28, 2024

Chris Wood Rains More Reality-Based Fire And Brimstone

Courtesy of Tyler Durden

One of the more vocal economic skeptics (as pertains to the developed world at least, China not so much), CLSA’s Chris Wood, chimes in with his latest weekly observations on the economy, which are not for the faint of heart, in the latest edition of GREED and fear. Let’s dig in.

First, Chris discusses the “oh so much improved” Greek situation.

The Greek bullet has been dodged for a while with a suspiciously easy sale of €5bn worth of 10-year Greek bonds last week at a yield of 6.25%. So suspiciously easy in the sense that the Greeks are now reportedly rushing to sell another €10bn worth of Greek bonds. The buyers would seem to be European state related banks adopting a buy and hold strategy. At least that is what is suggested by the apparent lack of trading in the recently sold bonds and by the apparent banning of hedge funds from the sovereign bond sale. GREED & fear has no idea whether implicit promises of government guarantees have been made or not by the most relevant government. But the suspicion lingers. Meanwhile, GREED & fear is convinced that the last has not been heard of Greece’s fiscal problems or those of the related PIIGS. Investors for now should assume continuing weakness of the euro against the US dollar.

Next, Chris discusses the expectations for a substantial improvement in March payroll numbers, which the consensus has at a whopping +300,000. The

If all this indicates improving cyclical prospects, and therefore the potential for a renewed pick up in Fed tightening expectations, GREED & fear would also like to draw attention to the continued fundamental sickness of the all important US housing market; most particularly when federal government support actions are taken out of the equation. The  fundamental weakness of housing can be seen in the continuing rising tide of mortgage delinquencies and foreclosures. Thus, US residential mortgages 90 days or more past due rose from 4.38% of all mortgage loans in 3Q09 to a record 5.09% in 4Q09, according to the Mortgage Bankers Association. While foreclosure inventory increased from 4.47% to a record 4.58% of outstanding mortgages over the same period (see Figure 4). The weak state of housing can also be seen in the collapse in the shelter component of the core CPI which captures the falling trend in rents. Thus, the shelter CPI index fell by 0.5% MoM and 0.1% YoY in January (see Figure 5). This is the biggest month-on-month decline in shelter costs since December 1982 and the first year-on-year drop since the data series began in 1953.

Some more on the sorry state of housing. And yes, there is just $20 billion left in Fed MBS purchases.

It is also clear that policymakers in the Obama administration remain very concerned about the state of housing. Thus, the New York Times reported on Sunday that the administration, with its eye on the mid-term Congressional elections in November, will in early April commence a scheme where the federal government will start paying defaulting homeowners to leave their properties (see New York Times: “Program will pay homeowners to sell at a loss” by David Streitfeld, 7 March 2010). This marks a departure from the current failing attempts at “mortgage modification” which aim to try and keep defaulting homeowners in their homes. So far the record of this scheme demonstrates that many borrowers who have their mortgage modified in terms of interest payments subsequently default again. Thus, the 3Q09 Mortgage Metrics Report issued by the Office of the Comptroller of the Currency in late December revealed that more than half of all modified loans made between 2Q08 and 2Q09 re-defaulted, measured as 60 or more days delinquent or in foreclosure, within six months of modification (see Figure 6). The result is that mortgage modifications, of which there have been nearly 1m so far, have only succeeded in delaying foreclosures rather than preventing them.

On what housing policies mean for bank balance sheets.

Speaking of those grotesque elephantine monstrosities which continue to chalk up massive losses courtesy of Tiny Tim, GREED & fear is pleased to report that they are finally performing one service in the interest of the longer suffering US taxpayer. This is that they are putting mortgages back to banks where they can demonstrate, as is often the case, that the original mortgages were not processed in the correct manner, for example if the borrower lied about his or her income or if there was a faulty appraisal.


Given the excesses of the US housing boom in terms of the then prevailing farcical underwriting standards, it is not surprising that Fannie and Freddie are reaping dividends from this policy as securitisation gone wrong boomerangs back on to the commercial banks’ balance sheets, in terms of them begin forced to buy back loans they thought they had long since sold via “disintermediation”. Remember that politically correct term used by the apologists for securitisation. Thus, the Wall Street Journal reported in an article on Monday (“Repurchased loans putting banks in hole”, 8 March 2010) that Wells Fargo’s annual report showed that it bought back mortgages with balances of US$1.3bn last year, triple the amount of 2008. For the whole of the banking industry the sum came to around US$20bn, according to the article.


What is prompting this re-recognition of losses?

This process is being driven by Fannie and Freddie now anxious to reduce their losses. Thus, Freddie Mac returned US$4.1bn to lenders last year, up from US$1.8bn in 2008. These efforts will continue. All this is a threat to banks’ earnings since when banks are forced to buy back loans they normally do up at a significant loss. As a result, banks are  having to make growing provisions. Citigroup’s reserve for repurchases rose to US$482m at the end of last year, up from US$75m at the end of 2008. Likewise, JPMorgan had US$1.7bn set aside to meet repurchase claims from investors at the end of last year, up from US$1.1bn a year earlier. While Wells Fargo’s reserve for repurchases rose from US$589m at the end of 2008 to US$1.0bn at the end of 2009 (see Figure 7).

All of this also means continued pain for Fannie and Freddie. One can look at the staggering losses at FNM and FRE as a harbinger of what happens to the banking system in general once the liquidity spigot is removed. Remember, China is already doing so, with last night’s massive liquidity extraction procedure of CNY83 billion taken out of the system via 28 day repos.

This planned “exit” from the Fed’s critical role in supporting the mortgage backed securities market is probably the biggest macro risk facing Wall Street correlated world stock markets in the short term now that the Greek problem has been dodged for a while; though it will help that the Fed has no plans as yet to start selling its MBS holdings. It is also undoubtedly the case that the US housing market would be in a far more disastrous condition today if it were not for the continuing loss making activities of Fannie and Freddie which continue to own or guarantee US$5.5tn worth of mortgages or nearly half of all outstanding mortgages in America. Meanwhile agency MBS, a category which includes Fannie, Freddie and Ginnie Mae, accounted for 96% of the total MBS issuance in the first two months of this year.

This is of course why Tiny Tim removed the Congressional constraint on Fannie and Freddie’s ability to lose money on Christmas Eve (see GREED & fear – Pro cyclical speed bumps, 21 January 2010). It is also why Geithner said last week that there were no plans to come up with new legislation to define the role played by Fannie and Freddie going forward until next year at the earliest.


The reality is that Fannie and Freddie remain a politically convenient off-balance sheet dumping ground for the detritus of the US housing crisis. Still the constitutional legitimacy of this process where massive red ink is being accumulated is questionable to say the least. Fannie and Freddie have recorded combined net losses of US$21.6bn in 4Q09 and cumulative net losses of US$211bn since 3Q07 (see Figure 8). It is also questionable for how long the fiction can be maintained that Fannie and Freddie are off the federal government’s balance sheet. It will certainly be interesting to see if S&P and Moody’s, in their new role as guardians of the sanctity of sovereign credit, have anything to say on this subject. Meanwhile, it is also worth noting that House Financial Services Committee Chairman Barney Frank warned last Thursday that “people who own Fannie and Freddie debt are not in the same legal position as those who own Treasury bonds”, and that he would expect “to preserve the right to give people haircuts” as the government considers how to overhaul Fannie and Freddie. This prompted the Treasury Department quickly to issue a statement on Friday restating that “there should be no uncertainty about Treasury’s commitment to support Fannie Mae and Freddie Mac as they continue to play a vital role in the housing market”. This would be funny if it was not so serious.

For all this, as well as some more optimistic view on developing countries, read the full note below.

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