Wednesday 23 March 2011

"the more it changes, the more it's the same thing" - Review of the ongoing economic issues

"plus ça change, plus c'est la même chose"—"

Jean-Baptiste Alphonse Karr (November 24, 1808 – September 29, 1890)
French critic, journalist, and novelist.

Ireland 10 year bonds are trading now north of 10% for the first time since December 1992.
As I previously posted, we are in a time machine and just made a quick trip to the past:

European Government Bonds - Back to the Future?
"From 1991 until 2010 Ireland's Government Bond Yield for 10 Year Notes averaged 5.72 percent reaching an historical high of 10.47 percent in December of 1992 and a record low of 3.06 percent in September of 2005."

The yield on Ireland’s two-year securities rose 57 basis points to 10.44 percent. The 10-year yield exceeded 10 percent for the first time since the euro was introduced in 1999.

The problems is that the Irish financial sector troubles are just too big now for the Irish Government to cope with.

According to a recent article in Bloomberg by Joe Brennan published on March 18, "Ireland Said to Weigh Allowing Banks to Set Up Asset Warehouse"
Ireland is finally giving in setting up an Irish "Resolution Trust Corporation".
Joe Brennan commented:

"Irish authorities are considering allowing the country’s debt-laden lenders to set up a company to warehouse more than 60 billion euros ($84.8 billion) of loans that would be wound down or sold over time, according to three people familiar with the matter."

The reality behind this move is that the deposit outflows experienced by Irish banks since last year is making them increasingly dependant on funding from the ECB.
From the same article:
"Irish central bank Governor Patrick Honohan said the ECB wanted to accelerate deleveraging, Ireland has “put in the condition of no fire-sale losses because the state cannot afford it,” he said."

On the 31st of March we will get the results from the capital and liquidity stress tests on Irish Banks.

Joe Brennan added:
"So-called viable lenders, including Bank of Ireland Plc, Allied Irish Banks Plc (ALBK), Irish Life & Permanent Plc and EBS Building Society, need to cut their loan-to-deposit ratios to 122.5 percent, “which is acceptable to Europe,” Finance Minister Michael Noonan said March 14. The average loan-to-deposit ratio is currently about 170 percent."

From TBTF (Too Big To Fail) to TBTB (Too Big To Bail)...

Joe Brennan also indicated in Bloomberg news the following sobering fact:
"Irish Credit Bureau Chief Executive Officer Seamus O’Tighearnaigh said that 9.5 percent of loans registered with the company are at least one month in arrears, up from 0.75 percent in 2006, the Sunday Times reported."

The example of Ireland clearly showed the issue, where Ireland's public finances were put in disarray due to the massive bail out need of its financial sector (please see previous posts on that subject: The European Vortex, The Irish Black Hole, Ireland in the need of a lucky Shamrock).

5 years CDS on Portugal stands at 536 bps and Ireland 5 years CDS increased by eight basis points to a seven-week high of 625 bps, according to CMA.

Portugal's government as well is collapsing, given parliament is not willing to bite the bullet and to accept the latest austerity measures proposed by the government. Another EU member bites the dust as I type this latest post. You can expect another bumpy ride in the Eurozone.

The housing hangover issues are still the biggest problems plaguing not only the Irish economy but the US economy as well.

U.S. New-Home Sales fell to the lowest level on record:

Yes indeed, the more it changes, the more it stays the same...

Bank of America CEO Brian T. Moynihan said:
"The problem of delinquent mortgages and falling home values is the most stubborn, entrenched and damaging economic problem our country faces today."
Bank of America's CEO is correct. I touched on the subject of the impact of real estate on the US economy in my post "Extend and Pretend" - Banks bloated balance sheets and the Impact of Real Estate crisis.

January home prices in the U.S. fell 0.3 percent from December, according to the Federal Housing Finance Agency. Prices nationwide fell 3.9 percent in the 12 months ended in January.

So big is the issue that Bank of America had to segregate almost half of its mortgages Into ‘Bad Bank’ according to Bloomberg report from Dawn Kopecki published on the 8th of March:

"The legacy portfolio will hold 6.7 million loans with outstanding principal balance of about $1 trillion."

"Of the 13.9 million loans Bank of America services, about 3.5 million are held by the company on its balance sheet. The rest are owned by other investors."

"Bank of America services 14 million mortgages, or one out of every five in the U.S., and its loan-servicing portfolio exceeds $2.1 trillion in size. Of its mortgages, 10 million came from its 2008 acquisition of troubled California lender Countrywide Financial Corp. More than 80% of its delinquent loans were acquired through Countrywide."

Bank of America is also actively selling its exposure to commercial real estate:
BofA Is a ‘Very Active’ Seller of Commercial Real Estate to Limit Losses
The US Treasury is as well reducing its portfolio of Mortgage Backed Securities, looking at selling 142 billion USD worth of MBS guaranteed by Fannie Mae and Freddie Mac at the tune of 10 billion per month.

As I wrote in "Resolution Trust Corporation II - the unavoidable Sequel", 1 out of 4 US Household is already in negative equity, "Desperate times need decisive action and setting up a new RTC would definitely be the right move in the right direction".

For more on the difficult situation for the US economy and the impact of households in negative equity please look at the following post:

The end of the American Dream, the call for trade barriers and the rise in populism...

So far 25 banks failed in the US in 2011. 157 banks failed in 2010 according to FDIC. Increasing loan losses on commercial real estate are expected to result in hundreds of bank failures in the coming years.
The Unofficial Problem Bank list on the 19th of March stands at 982 institutions with assets of 430.4 billion USD, up from 964 institutions with assets of 420.7 billion USD as per the excellent CalculatedRisk blog.

For Robert Burney, a banking and finance professor at Coastal Carolina University:
"It's a race between deteriorating portfolios and recovering economies,"
Read more:

The US need more job creation but negative equity weights heavily on job mobility:
Non Farm Payrolls from 1992 onwards.

At the same time inflation in the UK keeps creeping up, no surprise there. It was expected previously on numerous posts on this blog.

UK inflation from January 1989 until March 2011:

Mervyn King at the Bank of England doesn't seem to be able to keep the ink dry, yet another letter to the Chancellor.

The Bank of England purchased around 165 billion GBP of assets by September 2009 and around 175 GBP billion of assets by end of October 2010.

Any coincidence with the rise in inflation in the UK is of course purely fortuitous given QE started in March 2009...

As a reminder of the risk of QE:
"Quantitative easing may cause higher inflation than desired if it is improperly used, and too much money is created. It can fail if banks are still reluctant to lend money to small business and households in order to spur demands. Quantitative easing can effectively ease the process of deleveraging as it lowers yields. But in the context of a global economy, lower interest rates may contribute to asset bubbles in other economies."

Consumer confidence in the UK is still at the lower end:
January 1992 - March 2011

Are we seeing asset bubbles in other economies? China? Brasil? Etc.
Most certainly. QE is exporting inflation first in emerging markets then back to developped countries:

Both the UK economy and the US economy are in "The Hurt Locker".

As a reminder from previous post The Endgame - Fin de partie:

Inflation, Not Deflation, Mr. Bernanke
By Andy Xie 08.16.2010 18:12
"The globalization reality is that developed economies like Europe, Japan, and the U.S. will suffer slow growth and high unemployment. Stimulus is the wrong medicine for solving problems. Believing this will lead to excessive stimulus, which causes inflation and bubbles in emerging economies first and inflation in developed economies later. The wrong policy prescription pushes the global economy through unnecessary gyrations, stagflation and possibly another major financial crisis in the emerging economies. It's high time for Mr. Bernanke to wake up from his stimulus obsession."

Can we expect QE3?

Thursday 17 March 2011

Fool me once, shame on you; fool me twice, shame on me...

My thoughts are with all the Japanese people following the ongoing tragedy.
"kami sama ga mamoru youni"
"May God protect you."

"Japan is a very rich country and has a high savings rate and has the capacity to deal not just with the humanitarian challenge but also the reconstruction challenge they face ahead."

US Treasury Secretary Tim Geithner
Tuesday 15th of March 2011.

Geithner does not believe that there is a risk Japan could sell their US Treasuries to raise cash in order to respond to the damages caused by both the earthquake and the tsunami.

And the reason why according to US Treasury Secretary is that "Japan has a high savings rate":

Japanese getting older = Bad for savings Tim...

Yeah right Tim! Spot on!
This is purely and simply incorrect to stay polite. Get your facts right...I am not surprised to hear this from the man who was in charged of regulating the US banks while at the New-York Federal Reserve Bank from 2003 until 2009.

Are we witnessing at this very moment the demise of the US dollar?

Japan might be finally calling another bluff from the US by dumping in size their US Treasuries to rebuild their economy.

I previously wrote about the Bluff Call of 1971 - the Nixon shock and the collapse of the Gold Standard.

Is it payback time for Japan following the disaster of the 1985 Plaza agreements? (please refer to the post: Analyze this!).
As a reminder from my previous post, another former quote from Tim Geithner:

"On June 1, 2009, during a question-and-answer session following a speech at Peking University, Geithner was asked by a student whether Chinese investments in U.S. Treasury debt were safe. His reply that they were "very safe" drew laughter from the audience."

China is not stupid. I wrote specifically on the fact that China is well aware of what happened to Japan with the Plaza Agreements of 1985: The end of the American Dream, the call for trade barriers and the rise in populism....

Please find enclosed the link to the Chinese view on what happened to Japan following Plaza in 1985:

Revaluation of Japanese Yen, a historical lesson to draw: analysis

Maybe Japan has no choice but to cash in on its holdings to rebuild its country and repatriate Japanese Yens. At least this is what the FX market is betting on, given this evening huge price action and surge in JPY versus the USD from around 80 to an amazing 76 JPY for one USD to now back to 79...Crazy...

Japan selling their US Treasuries would be driving up interest rates.

Prior to the dramatic events happening in Japan, Bill Gross, from PIMCO, the authority on bonds, announced to the world he had dumped all his US Treasuries from his flagship fund: “Yields may have to go higher, maybe even much higher to attract buying interest,”
Yes, Bill Gross expects a sharp increase in interest rates within the next few months. If Japan starts dumping some of its US Treasuries holdings (around 885.9 billions USD as of January 2011), you can be assured Bill's expectations could materialise. China cut its holdings of US treasury bonds by 5.4 billion USD to 1.15 trillion USD in January, reported, citing the U.S. Department of Treasury.

During the 1995 Kobe earthquake, the Japanese repatriated 30 billion USD worth of U.S. government bonds, equivalent to about 13 per cent of its Treasury holdings at the time.

This time is different?

Monday 7 March 2011

"Extend and Pretend" - Banks bloated balance sheets and the Impact of Real Estate crisis

Extend and Pretend. Welcome to the "new normal".

In a previous post "Resolution Trust Corporation II - the unavoidable Sequel", I argued that in order to fix the difficult situation relating to Real Estate in the US, the set up of a new RTC, was necessary. I also discussed how Banks were "extending and pretending" in relation to their Commercial Real Estate exposure. The suspension of foreclosures is also a strategy to kick the can down the road and gain some time to resolve the hangover linked to the burst of the mega housing bubble.

In my post relating to the RTC, I reviewed the current mortgage mess plaguing the recovery of the US Economy in general and the US banking sector in particular.

I highly recommend you purchase this week's "The Economist" latest issue where you will find a very interesting 14 page special report relating to Property.

I came accross Barry Ritholtz's excellent recent post relating to the game being played by banks in relation to their ongoing Housing issues and exposure which is a subject I discussed previously on various posts. Barry sums it up accurately in his post:

"Rather than go Swedish, and force a shorter painful pre-packaged bankruptcy process, we have opted to take the long slow route:

1) Banks are slowly rebuilding their capital by borrowing from one branch of government and lending to another. This is a slow process, but its less well unerstood (and hence more politically acceptable) than merely giving Banks capital outright.

2) FASB 157 allows banks to carry all of these structured products made of bad mortgages on their books indefinitely.

3) Banks are carrying lots of housing inventory waiting for a better residential market to emerge 5 or 10 years down the road.

Under normal circumstances, the bad mortgage process goes Delinquency (late payments) Default (90 days behind), Foreclosure (legal proceedings to enforce the note).

Once a home goes into foreclosure, the accounting changes: It is now a loss that must be written down immediately. That hits the banks capital levels. Consider what the next 3-5 million foreclosures will do to banks’s capital cushions.

Once a foreclosure occurs, not only does the capital write down take place, but the local property tax liability accrues to the bank; prior to foreclosure, the liability is to the nominal home owner and/or property. Once the bank takes possession, its on them.

Hence, you can see why “Extend & Pretend” is so attractive to the large institutions sitting on massive REO inventory, enormous bad loans and CDOs, and huge future local tax obligations."

Now it is getting more official, the SEC has launched an investigation relating to the "Extend and Pretend" practice as per this link to a WSJ article published recently.

"Banks sometimes break up a troubled loan in order to place a portion of it on "performing" status, a sleight of hand that reduces the reserves needed to be set aside."

In October 2010, when I wrote about the need for a new RTC, I highlighted the restructuring game being played in the CMBS space.

As a reminder:

The slice and dice game runs unabated.

The WSJ article indicates some sobering facts:

"U.S. banks hold an estimated $156 billion of souring commercial real-estate loans, according to research firm Trepp LLC. About two-thirds of commercial real-estate loans maturing at banks from now to 2015 are underwater, meaning the property is worth less than the amount owed.

As of Dec. 31, 7.8% of commercial-property loans held by banks were delinquent, down from 8.6% a year earlier, according to Trepp."

The recovery in the US is very fragile:

Little is beeing charged off:

For more on the subject of the US Commercial Real Estate mess:

CRE Primer On CRE Pretending- I Mean Lending

A wall of maturities needing refinancing...

As The Economist put it bluntly in its special report on property:

"Property is widely seen as a safe asset. It is arguably the most dangerous of all, says Andrew Palmer"

It can be argued that the most toxic of all bubbles is a housing/property bubble. They also always generate a financial crisis when they burst due to the leverage at play. How the risk can be mitigated? By forcing players to have more skin in the game.
Recently Sweden passed a law limitating the maximum Loan to Value (LTV) to 85%. In effect, Swedish people will need to put down a minimum of 15% of deposits to borrow 85% of the remainder.

I was shocked to read recently that Northern Rock, which became infamous for lending people up to 125% of the value of their home before the credit crunch (the product was called "Together Mortgage") has launched a range of riskier 90% mortgages. This is coming only three years after the collapse of Northern Rock! Northern Rock made an underlying loss of 140 millions GBP in the first six months of 2010. It looks like the British Government is eager to cut corners to boost its revenues by selling early its stake and is ok with Northern Rock taking on more risk.
For more on Northern Rock, see my post "Solid...Solid as a Rock..."
On the 9th of March we will have a clearer picture on Northern Rock when they will publish their latest results for the whole of 2010.

Following closely Northern Rock, Skipton Building Society has launched a 95% LTV product especially aimed at first-time buyers.

Why? Because buyers are struggling to raise large deposits required to secure a mortgage. If they are struggling to save, is it prudent to lend to them in the first place?

"Both mortgages have an application fee of £195. The 95% deal has no completion fee, but the 90% deal has a completion fee of £995."

And the icing on the cake:
"At the end of the two years, both revert to bank base rate plus 4.45%."

It seems to me that some of the lessons of the recent financial crisis were never taken on board at all.

As The Economist special report put it nicely:
"Given the state of residential property around the rich world, perhaps the victims are suffering from post-traumatic amnesia."

Anterograde Amnesia or Retrograde Amnesia? Or both?
As per my post from May 2010:
Anterograde amnesia refers to the inability to remember recent events in the aftermath of a trauma, but recollection of events in the distant past in unaltered.

Retrograde amnesia is the inability to remember events preceding a trauma, but recall of events afterwards is possible.

For an intereractive experience on Property prices around the globe, you can play with their very interesting tool using the following link:

The Economist house-price indicators

Using the above tool, and having a look at Real Estate Prices against rent, a few interesting points come up:
Germany is cheap using 2003 as a reference point, relative to rent, so is Italy and Netherlands and Denmark. (For more on Denmark's mortgage market: "Are Fannie Mae and Freddie Mac on the path to a crash à la Thelma and Louise?").
UK appears to be still overpriced, prices relative to rent taken into account, as well as taking into account prices against average income, using 1996 as a start date and 2000 as well.

Prices against average income from 1999 to 2010, for Britain, Ireland, Spain, and USA (in Black):

A matter of Gravity: Ratio of House prices to Rent

The Special Property report from The Economist comments:
"PROPERTY can cause huge problems, but the sector also traditionally leads economies out of recession. Housing is far bigger and more important than commercial property. Residential investment, which is driven by new housing starts, makes up a large chunk of the volatile bit of the economy. That means changes in residential investment have a disproportionate impact on rates of GDP growth. It has played a big part in driving previous post-war American recoveries, and many assumed the same would happen this time round. Things have not worked out that way."

We are still in a deflationary environment.

In this report The Economist also make a very important point:
"Work on the relationship between housing supply and bubbles by Edward Glaeser of Harvard University and Joseph Gyourko and Alberto Saiz of the Wharton School suggests that places with relatively elastic supply have fewer bubbles, of shorter duration, than those where the supply is more restricted."

Two-thirds of the outstanding mortgages in Britain are adjustable-rate mortgages that move in step with changes in official interest rates.
This is why the rise inflation is such a nightmare for the Bank of England. The impact of rising interest rates in the UK could have serious implications on already stretched household's balance sheet, putting additional pressure on the downside for housing prices in the UK.

Property remains the biggest financial purchase people ever make during their lifetime.
A quarter of US mortgage holders are in negative equity but, at least in the US, prices are back to their long term average compared with rents as displayed above.

The more exposed an economy is to housing, the more dangerous the burst in a housing bubble and serious the consequences for the banks. We have seen the dramatic results of the burst in the US, Ireland, Spain and others. The political rationale for encouraging home ownership is a dangerous game which can have dire consequences. The mortgage lending business should be very conservative, as it is the case in Denmark, as well as in Germany. Renting is not always a waste of money after all.

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