Mortgage Debt Purchases on Steroids

In calendar year 2013, the Fed purchased $788.25 billion in agency MBS (mortgage back securities).

In calendar year 2013, according to the Mortgage Bankers Association, total mortgage originations were $1,755 billion.  $652 billion (37.2%) were for purchases while $1,103 billion (62.8%) were refinances. I do not have the data for the percentage of non-agency loans and am using a rough estimate of 10% for the purpose of this post.  In other words, total agency originations should amount to $1,579.5 billion.

The Fed purchased 134% of all agency PURCHASE loan originations in 2013.  

In the first half of 2014, ending July 2, the Fed purchased $260.4 billion in agency MBS. 

In the first half of 2014, also according to the Mortgage Bankers Association, total mortgage originations amounted to $493 billion.  $273 billion (55.3%) were for purchases, while $220 billion (44.6%) were refinances. I am again using a rough estimate of 10% for non-agency loans.  In other words, total agency originations should total $245.7 billion (by the way, you may have noticed, mortgage originations are dropping from over $1.7 trillion in 2013 to a pace of less than $1 trillion annualized in 2014).

The Fed purchased 106% of all agency PURCHASE loan originations in 2014 so far.

The Fed had no choice but to taper.  Had it  continued with 'QE' at the same pace as in 2013, it would have purchased all purchase and refinance originations. What kind of monetary policy is that?  

 

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It Can't Be A Bubble!

Articles claiming that the current situation in financial markets does not deserve the epithet “bubble” are a dime a dozen – we come across several every week since at least late 2013. Before continuing, we should point out that there is a big difference between recognition of a bubble and forecasting the timing of its actual bursting. For instance, we were well aware that there was a bubble in the late 1990s, but not only did it still take a good while before it hit its peak (a peak that was then retested in terms of the broader market half a year later), it also expanded considerably further before it did so, and only started collapsing in earnest in late 2000.

It is important to realize in this context that this particular bubble – the one in technology stocks that peaked in early 2000 – is not some sort of “standard measure” for what constitutes a bubble. It was certainly the most extreme stock market bubble in all of history in a major developed market (in terms of valuation expansion in this particular sector) – beating even the Nikkei's famous 1989 blow-out by a huge margin. Again, only if one compares the tech sector's then trailing P/E of more than 300 to the Nikkei's trailing P/E of more than 80 in 1989.

In terms of the broader market's valuation, the bubble peak in 2000 was less than half as spectacular as the Nikkei's, but it was still the top of the greatest valuation expansion ever experienced in the US stock market. We merely want to point out here that it would be wrong to claim that “well, the year 2000 was a bubble, and therefore anything that doesn't look quite as extreme as this one outlier isn't”.

We came across another article of this type recently and want to discuss what we believe the flaws in its arguments are. The article in question is “Bubble paranoia on S&P 500 is a storm in a teacup”, which was posted at Saxo's tradingfloor.com by Mr. Peter Garnry. Note here that we don't want to make an argument about the likely timing of the bubble's bursting or its potential for further expansion (that is a different subject) – we only want to discuss whether a bubble actually exists or not.

 

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The Dear Departed

Not much action in the markets on Wednesday. So, let us return to the economy. That’s where the excitement is. According to leading economists – notably those paid by the US government to forecast the future – interest rates are going to stay low for a long time.

Perhaps we should pause and say an Ave Maria… or whatever you say when you put a market cycle into the grave. Maybe we should proclaim a day of mourning. Or at least raise a glass or two.

Yes, the feds have pronounced our old friend dead. Dead… dead… stiff dead… cold dead. Immobile. They denied responsibility for the death of the credit cycle, but admit that it was in their custody when it expired.

 

memento-moriHic iacet cyclus fenebris semimortuus

(Photo © Sekitar)

 

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China's 'Eco' Ghost Town

Back in 2006, Hu Jintao was excited when he visited Caofeidian, the “the world’s first fully realized eco-city”, built on land reclaimed from the sea. Since construction began in 2003, it has devoured the princely sum of $100 billion, most of it provided by banks. One million resident were once supposed to live there. It is a ghost town today, sporting only a few thousand inhabitants. Practically no-one has ever stayed in the city, and the buildings are already deteriorating. In fact, many of the buildings have been left half-finished, as credit eventually ran out.

The Guardian has posted a number of haunting pictures of this monument to massive capital malinvestment.

As the Guardian notes:

 

The ‘eco-city’ was made possible through huge bank loans. Once it was half-built, these loans were halted and many projects suspended due to the rising cost of raw materials and a lack of government support.”

 

A few of the pictures are reproduced below:

 

bridge to nowhereThe city's obligatory bridge to nowhere – only the ten pylons have been erected, then the project had to be abandoned.

(Photo credit: Gilles Sabrie)

 

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Legal Tender Renders Planning Impossible

There is much confusion over what the legal tender law does. I have read articles, written by people who are otherwise knowledgeable about economics, claiming that legal tender forces merchants to accept dollars under threat of imprisonment. Recently, I wrote a short article for Forbes clarifying how legal tender law works in the US.

Legal tender law has nothing to do with merchants. If you want to sell steak dinners in your restaurant for silver, you may legally have at it. Unfortunately, the tax code discourages your would-be customers as I wrote in another article.

The legal tender law targets the lender. It grants to debtors a right to repay a debt in dollars. In practice, this means that if you lend gold, the debtor gets a free put option at your expense. If the gold price rises, he can repay in dollars. If it falls, of course he will be happy to repay in gold. It’s a rotten deal for the lender.

The relationship between lender and borrower is mutually beneficial, or else it would not exist. The parties are exchanging wealth and income, creating new wealth and new income in the process. The government is displeased by this happy marriage, and busts it up by sticking a gun in the lender’s face. His right to expect his partner to honor a signed agreement is violated.

Because no lender will lend gold under such circumstances, gold is relegated to hoarding and speculation only. This strikes a blow to savers, because the best way to save is to lend and earn interest. Savers are forced to choose betweenhoarding gold, getting no yield, or holding dollars and getting whatever yield crumbs are dropped by the Fed.

If there’s no lending in gold, what takes its place? The Fed force-feeds credit in ever-larger amounts, and at ever-falling interest rates.

The Fed is supposed to make its credit decisions in order to optimize two variables. First, employment shouldn’t be too high or too low. Second, consumer prices shouldn’t rise too quickly or too slowly. The Fed has little ability to predict employment and prices, and even less control over them.

 

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Not Even the Kangaroos are Hopping Fast Enough …

“Russia is behind it. They were the ones who shot down that plane.”

That was the line given to us by one of our fellow parishioners at the 8 a.m. service, in Maryland, on Sunday. Oh my… he is losing his mind, we thought. How would he know who shot down a plane over 4,000 miles away? And why would he care?

But in the US media… dinner time chat … and after-church conversations, Russia’s president, Vladimir Putin, is condemned. Without trial. Without due process.

The rush to judgment was so fast even the kangaroos hadn’t gotten to the courthouse when the verdict was handed down.

 

Vladimir_Putin_without_sunniesVlad the Terrible briefly removes his ray-bans to give us his unshielded Dr. Evil stare

(Photo source unknown)

 

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Lying Governments

Earlier today, Zerohedge published an article by “Washington's Blog” showing the C-span video of a question and answer session between State Department spokeswoman Marie Harf and the American press, which you can watch below.  As “George Washington” writes, stripped of fluff it basically says:

 

“We’re the good guys who tell the truth, and Russians are liars.

Forget Iraq … that’s ancient history.

Just trust us.”

 

The press corps apparently wasn't prepared to just accept that without question, and rightly so. Here is the video:

 

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Black Boxes Not Hidden After All

The rebels have handed over the flight recorders (a.k.a. “black boxes”) of MH 17 to Malaysian authorities yesterday. Readers who have paid attention to the events may remember that Kiev loudly accused the rebels of “hiding the black boxes in order to give them to Moscow so they can be manipulated”.

The Guardian reported on the handover of the black boxes, and there is one passage in the article we found especially interesting. After the rebels have been accused of blocking access to the crash site, it appears that the Ukrainian military decided that now would be a good time to add a few obstacles of its own. That is however not all. In the course of its “explanations” it was immediately caught in another lie – namely the lie that it “does not use heavy artillery in residential areas” while doing exactly that. It also inadvertently admitted that Pravy Sektor troopers are likely active in the Eastern Ukraine:

 

“While the rebels have been heavily criticised for blocking access to the crash site, it was the Ukrainian army that seemed to be disrupting expert work on Monday as they apparently launched an offensive against rebel positions close to Donetsk railway station, as well as in other towns across the region.

The Ukrainian authorities said they were not targeting residential areas. "We are coming to the city, special assault groups are working there," Vladislav Seleznev, spokesman of anti-terrorist operation, told the Guardian. "Within city boundaries we are not using heavy artillery," he added.

However, there were a number of cases where what appeared to be Grad rocket fire had landed in residential areas. At one school building near the railway station terrified locals hid in the basement all morning, and two men were killed by shrapnel in the playground. A local named Sergei, who lives near the school, said he had helped to load dead bodies onto a truck provided by the rebels.

Adding to the sense of chaos, Andriy Lysenko, a spokesman for Ukraine's national security council in Kiev, denied that the Ukrainian army was responsible for explosions in central Donetsk but said small groups of partisans could be engaging the rebels.

"We have strict orders not to use air strikes and artillery in the city. If there is fighting in the city, we have information that there is a small self-organised group who are fighting with the terrorists," he said.

 

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Property Rights of Money Market Fund Investors Are Weakened

Here is one more reason (as if one was needed …) why one should hold physical gold outside of the system for insurance purposes. We already briefly alluded to the new rules that are mulled with respect to bond funds, but it seems that they are now implemented for money market funds first.

According to Reuters:

 

U.S. regulators are expected to adopt rules on Wednesday that force "prime" money market funds used by large institutions to float their share price. Proponents have suggested that moving from the current stable $1 per share net asset value (NAV) to a floating NAV would help prevent investors from getting spooked by the prospect of funds "breaking the buck," or falling lower than that amount.

The Securities and Exchange Commission is also likely to finalize a second provision that will permit fund boards to lower so-called redemption "gates" or charge fees in stressed market conditions, according to people familiar with the matter.

The reform will impact a wide variety of asset managers, from Blackrock Inc, Fidelity and Vanguard to Charles Schwab Corp, Pimco and Federated Investors Inc. The two-pronged reform for the $2.6 trillion industry comes after a long battle between the SEC, the industry and federal banking regulators.

The industry and the U.S. Chamber of Commerce have warned that any rules that drastically change the structure of money market funds could cut off a major supply of short-term funding for corporations. Wednesday's final rule is expected to carve out exemptions for a wide swath of money funds.

Funds used by retail investors, for instance, will still be permitted to maintain a stable $1 per share net asset value because they are considered less likely than institutional investors to run on a fund if the market deteriorates. The U.S. Treasury Department, which has been working to devise a way to relieve investors in funds with a floating NAV from burdensome tax rules, is also expected to unveil its plan sometime on Wednesday, several people familiar with the matter said.

The Financial Stability Oversight Council, a panel of regulators charged with policing for risks, has been pressuring the SEC to bolster money market fund regulations since 2012.

In 2008, the Reserve Primary Fund's heavy exposure to Lehman Brothers led panicked investors to yank out their money, causing the fund to break the buck when its net asset value fell below $1 per share.

The Federal Reserve was ultimately forced to backstop the industry until the chaos subsided. Former SEC Chair Mary Schapiro initially pushed two potential plans for money funds, including either a floating NAV or a capital buffer requirement.

The majority of the industry and three of the SEC's fellow commissioners, however, rejected the ideas, saying they could kill the product and that more study was needed to justify new rules. After the SEC completed a study and the agency assumed new leadership, sentiment toward a floating NAV softened.

While some funds and industry groups are still opposed to requiring a floating NAV, others say they are fine with it as long as it only applies to prime funds and as long as all of the tax and accounting issues associated with a floating share price are resolved.

 

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Rebel Attack in the Congo

“The rebels attacked our camp. We had to make a run for it. The government troops, who were supposed to be guarding us, ran too.”

“‘Musungu! Musungu!’ I heard them yelling. A ‘musungu’ is a white person. They wanted to capture us.”

This springs not from the fertile imagination of an early 20th century novelist. It came to us yesterday via an email from our youngest son, Edward, who was on a summer job at a mining project in the Democratic Republic of the Congo. (More from Edward in just a moment…)

 

Us-passportUS passport. If you happen to find one lying around in the jungles of the Congo, mail it to Bill.

(Photo by Robert Rexach)

 

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“New Bailout Needed” – That was Fast …

Only a little over two months ago, the IMF approved a $17 bn. bailout package for the insolvent Ukrainian government. If memory serves, the US chipped in with an extra billion, and the EU's tax cows forked over billions as well – in the form of an aid package amounting to €11 billion in toto. Would it be petty-minded of us to point out that a lot of financial support for the Ukraine would have been available at zero cost to Western tax payers? Vladimir Putin offered a $15 billion loan package to Ukraine, which would surely have kept the ship afloat.

Anyway, we read with a mixture of mirth and trepidation that the “Ukraine may need a second bailout” – what, already? This is beginning to sound like Greece on steroids.

 

“The conflict in eastern Ukraine is driving the economy even deeper into crisis, which may force the government to seek another bailout. Ukrainian forces have been struggling to control a pro-Russian rebellion raging in eastern regions since March, when Moscow annexed Crimea.

The International Monetary Fund agreed in April to lend Ukraine $17 billion over the next two years to stave off the threat of economic collapse. But conditions in Ukraine have deteriorated since then, making it harder for the government to meet the terms of the bailout. Making matters worse, Russia has also cut off gas supplies.

Thursday's loss of a Malaysian Airlines plane – which the Ukrainian government says was shot down by rebels — will only ratchet up the tension.

"The conflict is putting increasing strain on the program and a number of key elements of the macroeconomic framework have had to be revised," the IMF said Friday. The IMF now expects Ukraine's economy to shrink by 6.5% this year, compared with 5% at the time the emergency loans were agreed. GDP stagnated last year.

Ukraine's government is spending more than expected on security as it battles the separatists. Having lost control of parts of the country, revenue collection is also falling behind schedule. And state gas firm Naftogaz is struggling to force customers to pay their debts.

In return for the bailout, Ukraine agreed to an austerity program that included shedding 24,000 government jobs, raising taxes, selling off state assets and gradually withdrawing subsidies on natural gas. It also pledged to tackle corruption.

The program was designed for most of the spending cuts to fall in 2015-2016. Ukraine's allies in the West wanted to avoid provoking a backlash and stoking further discontent among the Russian minorities in the east.

But with the costs of the conflict rising, the government has been forced to come up with spending cuts equivalent to about 1% of GDP that will be pushed through this year. Wages and pensions will be capped at the level of inflation next year, and more public sector jobs will go, the IMF said. Even that may not be enough.

"The program hinges crucially on the assumption that the conflict will begin to subside in the coming months," the IMF said. "A significant prolongation of the crisis would seriously strain their ability to [reform the economy] without a substantial increase in external support on adequate terms." 

 

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Behold the Monet

​Economics is like a Monet painting.  Stand too close and all you see is a bunch of seemingly random paint strokes.  Back up a few steps and an image emerges.  

The painting of bubblenomics started with the Plaza Accord, September 1985, where five nations agreed to manipulate the dominant currencies at the time.  Japan enjoyed a 50% devaluation of the US$ vs the yen, artificially enriching its citizens so they could travel the world in busloads with eighty pounds of cameras around their necks. 

The consequences of that bubble have yet to be corrected.  Twentyfour years of fiscal and monetary accommodation led Japan to sport the world's largest public debt-to-GDP ratio.

​The next big one was the US dotcom bubble, which was generating great wealth during the 1990s.  More importantly, it started the era during which income and savings became “old school”. Everyone could live off and retire on never ending asset appreciation.  When that bubble burst, in came Greenspan with the mother of all bubbles – the sub-prime bubble.  

 

San-Giorgio-Maggiore-by-Twilight-by-Claude-Monet-OSA071Monet's famous “Twilight of the Bubble”

(Painting: San-Giorgio-Maggiore by Twilight, by-Claude-Monet)

 

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The Russell 2000 Index and the Modified Davis Method

The Russell 2000 Index (RUT) has spent this year oscillating in a wide range, making very little net progress:

 

RUT

Russel 2000 index daily – no progress this year – click to enlarge.

 

The problem is that it is therefore underperforming the big cap S&P 500 ever more. Given that outperformance by the Russell has been a hallmark of the cyclical bull market since the 2009 low, this development should be of grave concern to investors.

 

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Connecting Dots

There are thousands … millions … gazillions of dots in the universe. Today, we connect two of them.

First, let us note that so Zen-like and calm are investors that the worries of Thursday – triggered by the downing of Malaysia Airlines Flight MH17 over eastern Ukraine – were forgotten by Friday.

The Dow closed up 123 points on the last day of the week. Gold sold off. So, let’s return to our dots. The first one is epistemological. The second is an important observation about investing.

 

black-swan-122983_640

Hi! I'm from Australia and I do exist …

(Photo via Fotoagentur Holgi)

 

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Zero Evidence and an Ever Changing Story

It's Putin's fault! Every Western government and most of the Western media are sure of it, so it must be true, right? As soon as Malaysian airlines flight MH 17 had crashed over the Eastern Ukraine, they all just knew “whodunnit”. The same people who were “completely surprised” when ISIS conquered the entire Northern part of Iraq have solved the puzzle of flight MH 17's crash literally in minutes!

We actually suspect that the oligarch currently running the Ukraine, “chocolate king” Petr Poroshenko, would have personally preferred negotiation over war in the Eastern Ukraine. He continues to be egged on by the US administration, and the more hawkish elements in the EU as well as in his own administration (not to forget, far right politicians continue to hold several powerful positions in the Ukrainian government, including the vice premiership, the ministry of interior and the job of prosecutor-general). Contrast this with Putin, who keeps admonishing Poroshenko to choose peace and negotiation. Of course it is completely unrealistic to expect the separatists to unilaterally throw down their arms and essentially surrender in the “hope” that a victorious Kiev will then deign to listen to their grievances. And yet, this is what is essentially demanded of them.

So Poroshenko has intensified his war (sorry, “anti-terror operation”) and over the past few weeks Ukraine's army has begun to indiscriminately shell cities, killing scores of civilians and causing a growing humanitarian crisis. Russia is currently housing more than 25,000 refugees from the Eastern Ukraine in makeshift camps.  Here is what happened most recently:

 

“At least 20 civilians have been killed during fighting in eastern Ukraine today despite calls from the international community for a ceasefire.   Just hours after flight MH17 was shot down, the eastern city of Lugansk was hit by shelling leaving hundreds of residents wounded.

Pictures show bodies lining the streets covered in blankets in the wake of the attack which was reportedly carried out by Ukrainian forces.

Vladimir Putin has called for both sides to lay down their weapons after the Malaysian Airlines plane carrying 298 passengers was hit by a surface-to-air missile yesterday, but the request seemed to fall on deaf ears. 

[…]

The Russian President said he was in contact with Ukrainian President Petro Poroshenko after the Boeing 777 passenger airliner came down in an area under rebel control. 

He said: 'Direct talks between the opposing sides must be established as soon as possible. All sides in the conflict must swiftly halt fighting and begin peace negotiations. It is with great concern and sadness that we are watching what is happening in eastern Ukraine. It's awful, it's a tragedy.'

Putin, who has blamed the airliner tragedy on Poroshenko for refusing to extend a shaky ceasefire with rebels in the region, said he hoped the Ukrainian president would be able to offer a peaceful way out of the conflict. Kiev accuses pro-Russian separatists of shooting down the airliner with help from Russian intelligence representatives.

Ukraine premier Arseniy Yatsenyuk said pro-Moscow rebels are preventing emergency workers reaching the scene of the air crash, despite promises to the contrary. His allegation raises the fear that vital evidence could be tampered with.

'These bandits do not allow our national agencies investigating the plane crash to reach the scene of the tragedy,' he said. The Ukrainian authorities are working with the OSCE to resolve this problem, he said.

'We are doing our utmost together with the law enforcement authorities and the OSCE to bring the national commission investigating this tragedy to the scene.' Ukraine yesterday opened criminal proceedings into a 'terrorist attack' on the Boeing.

 

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