Chris Wood Rains More Reality-Based Fire And Brimstone

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.

Comments

[Gimp]

Government intervention has made a mockery of the market system.

Average people will stay away for years to come. Only bots will be left to trade with each other.

[Reflexivity]

Average people will stay away for years to come.

If they are smart, that is.  And I have a question for the ZH community:

If the American people quit deluding themselves that investing in the markets (via 401ks, IRAs and taxable accounts--either active or passive investing) is the easy 'way to financial freedom and retirement', then...

...what is the alternative?  Entrepreneurship (which is not suited to the 'average' personality), adopting a minimalist lifestyle, buy and operate a small self-sustaining farm, elect not to get expensive healthcare treatment (and just take your chances with illness), move in with other family members (i.e. let the young take care of the old), etc.??

What is the alternative to the invest-in-the-stock-market retirement strategy?  'Retirement' as we know it (i.e. living off interest and a sustainable withdrawl rate from a sizable portfolio) is a new phonomenon, not more than a few decades old.

If the stock market is a fool's gamble, then what is the alternative?  Thoughts?

[Mad Max]

In all seriousness, and contrary to this country's cult for the last few decades, americans should learn to be happy with their lives, friends, family and experiences, and not with things.  Even for the wealthy, things don't make them happy.  People should find the best overall employment for their desires - not only pay but also quality of life, type of work, etc., and find out how to make do with whatever that pays.  Of course, this is not very practical if you live in the coastal megacities or you went massively into debt for whatever reason (student loans, bad bet on housing, etc.).

[WaterWings]

not more than a few decades old.

Any correlation to 1971 Nixon-gold "point of no return" signage? Welcome to the big ponzi lie in the sky.

adopting a minimalist lifestyle, buy and operate a small self-sustaining farm

Considering the potential hardness of the impending crash these are very good ideas - best to do it in a welcoming rural community that already has sustainability and mutual self-defense in mind. If you have student loans or made bad bets with housing you can always walk away. We don't have true rule of law anymore, anyway. We have abusive/negelectful parents in DC - fuck 'em. 

[Reflexivity]

Welcome to the big ponzi lie in the sky.

I am reminded of a point made by John Bogle in his book, Enough:  The financial services industry has taken more money out of the economy than it has ever produced for its clients.

The question is, how many financial services providers truly believe in their own advice and how many know that they're selling is a 'big ponzi lie in the sky'.  Perhaps the average is somewhere in the middle.  Just like in law, it all comes down to 'intent':  Did the financial services industry intend to make more money than their clients, or was it an accident?

[trichotil]

"We have abusive/negelectful parents in DC - fuck 'em."

ever heard of the term infanticide?

[Apply Force]

"...what is the alternative?  Entrepreneurship (which is not suited to the 'average' personality), adopting a minimalist lifestyle, buy and operate a small self-sustaining farm, elect not to get expensive healthcare treatment (and just take your chances with illness), move in with other family members (i.e. let the young take care of the old), etc.??"

That is exactly the alternative - and what some are already doing...

A one-worker family, with other spouse self-employed; minimalist lifestyles and selling/giving away of unneeded and unwanted "things"; not a full farm, but a big garden; taking care of your own health - ie. nutrition, exercise, and adequate sleep; and of course moving in with the family to further reduce costs and increase available resources and time.

Not quite into my fourth decade, and I've known for some time that "retirement" will not exist as we know it now for me and mine.  No 401k, no 403b, no IRA... simply freedom.

[Reflexivity]

These are insightful responses.  Thank You.

The more we share ideas on how to reduce our reliance on the fraud-filled markets of Wall Street, the better chance we all have to reach some semblence peace of mind and financial security.

Of course Wall Street in not all bad.  But we need to put this dog back on its (very short) leash.

Your thoughts here are 10x better than what the comments coming from the financial media and other charlatanic experts.

[Charley]

A sharp initial and progressive reduction of the 40 hours work week until all paid work is abolished. This, of course, will be rejected as unworkable. So we will continue to the next likely option: economic collapse. (No kidding)

[SteveNYC]

All of what you listed, however, I do not rule out the stock market as a form of investment at all. It makes perfect sense for regular people to own small pieces of dividend-paying equity in quality corporations.

HOWEVER, a market that booms and crashes twice every 5 years is not acceptable. We need a steady market, where valuations are based on dividend income/cash flow and are kept under control, where investment banks are banned from prop trading for profits, where hedge funds are nuetered.

J6P is not going to keep playing the sucker, as dumb as he is. Burned too many times.

Personally, I'll only ever own equities again when the market is no longer a casino and good companies that pay dividends are valued appropriately. Which means, Ben and his ilk have to go well before I'd ever "invest" again.

[Reflexivity]

Excellent comments.

I agree that stocks are a viable asset class when used in the right way (and by that I mean a smaller % of total assets than the prevailing wisdom recommends).  It does make good sense to invest excess cash in quality investments in very limited instances.

I also agree that the boom-bust volatility is way too high these days.  Half of the 'value' in owning an investment--besides its monetary value--is its psychological value (in that you want to be able to sleep at night and not worry your investments go up and down 50+% every month/quarter/year).

And hopefully J6P smartens up.  What he accepts is ultimately what is allowed to happen.

[WaterWings]

We need a steady market

And "Economists" that are not in lock-step: "We didn't see it coming."

[AnonymousMonetarist]

Won't matter until it does...

and when it does?

Oh mama!

[Ivanovich]

300,000 jobs is the consensus call for March?  What?

How is that going to happen?

[poor fella]

February could be conveniently lowered by 300k before the March number is announced.

We could add a million temporary census jobs, lose only 700k, and be 300k to the plus. 

Or flat out lie - there's so many exciting ways to jigger the numbers!

Let's hear your fresh new ideas on how to make Economics completely irrelevant to government policy. Double-plus-good!  o_O

[crosey]

The malfeasance is epidemic.  Yet the reality is that no leadership (Ben, Tim, Barney, Larry, Hank, et.al.) will ever be prosecuted.  Moreover, they will likely be rewarded, even if they are ever drummed out of their positions, and all of this tomfoolery ended.

So, what's their risk?  Nada!  So they do what they do.  They'll likely feel no pain, ever.

[SDRII]

Hey barney, the banks and insures own the GSE debt. Care to revise that statement

[wpw]

 "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"

I assume he is being sarcastic.   Of course, there are implicit promises of government guarantees from Germany, France etc..  That is how it works.

[threehundredthi...]

"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."

Great scheme. "Turd Market" opens in NY. Turds have no value. SO, you give me your turds. I wll pay you $10 a turd. You can claim the cash on your financial statement, and I will hold your turd. I already stink, so the stench from your turd will blend with mine, and nobody will notice. Then, when the stench clears I will sell you the turd back for $1. Then, you can value it at $10 and show a profit of $9. Then, we will have Moodys declare turds a safe investment, and give turds a AAA rating. Thereafter, we will delfate the dollar to 10 cents, and declare your turd to be an asset of $90. Then we will all be rich!!!!!!!!

Long live WallStreet, the Fed, and the "Turd"!!!!!!!!!

[Cognitive Dissonance]

Yup! Give or take a few turds, that's how a Ponzi works in the 21th Century.

[37FullHedge]

How to hedge for the future?

Its fair to guess for Deflation hold some US Treasuries, I have some cash and short term T bonds to cover for deflation.

To hedge for inflation real assets gold silver platinum in ETFs and physical owned, Some stocks are for me worth the risk to hold but know the company or sector chosen.

A total collapse of the global system needs to be covered. gold coins food and friends isnt a bad start.

I dont know how things will pan out, I am in favour of high asset inflation via tax hikes and currency printing. One bit of solid advice is dont invest/risk your hard earned cash, spend it now and have fun before wall street does it for you.

[mark456]

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