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Why A Record Steep Curve Means The End Of The Fed's Subsidies To Banks
Over the past week, one of the less noticed and more notable developments, was that the 2s10s quietly climbed back to just short of all time record wides: at 273 bps, the curve is just 13 basis point away from the all time record 286 bps achieved on February 2, 2010. For those who still don't understand how this most recent gift to the banks by the Fed and the government works, the math is that for every 100 bps in spread widening, banks make profits by borrowing free at the 2 Year and lending out at the 10 Year spread (on a Price x Volume basis, although as we will discuss momentarily while the price (i.e. spread) may be there the volume is missing), even as home prices decline by about 12% for each percentage point. In other words, in the past year the entire double dip in home prices can be attributed to the spike in long-term rates, which have in turn caused mortgage rates to jump to year highs. All of this has been predicated by increasing concerns that the Fed will allow runaway inflation, as a result pushing 10 and 30 Year spreads (and gold) ever higher. And while traditionally, a steep curve implies substantial bank profits, this time it is really is different, as demand for mortgages, by far the biggest bank product beneficiary from rising LT interest rates, is non-existent - recent new and refinancing mortgage applications are plumbing 15 year lows, meaning that even if banks make exorbitant profits on a spread basis, there is just not enough of them to go around, which in turn means that banks once again have to rely on accounting gimmicks such as declining reserve provisions to pad their books. And unfortunately for the banks, every incremental basis point increase from here on out only means accelerating home price deflation (regardless of how many days in a row cotton, wheat and whiskey closes limit up), which will wreak havoc on myth of any "recovery." This is in fact the most salient point of Scott Minerd's of Guggenheim latest letter: while the bulk of his latest thoughts is focused on Europe, we believe that the critical part if really that dealing with US interest rates. As he concludes: "The story in housing remains a compelling reason yields on the 10-year note above 4 percent are simply not sustainable at this juncture." We complete agree, which also means that the strawman of higher bank earnings due to the yield curve is now dead and buried. Alas for all the bank bulls, from this point on the only direction the curve can go is down... Unless of course the Fed really loses control of the long end in which case all bets are off and QE3 is sure include purchases of MBS.
From Scott Minerd:
In terms of interest rates in the United States, my view continues to be that of a period of sustained low rates with only marginal room to rise. The core of the story for why rates must stay low has to do with the continued depression in the housing market. Estimates for the current level of shadow inventory – i.e., the number of homes in some stage of default or foreclosure – broadly range from 4 million to 8 million units. Specifically, on November 17, Fed governor Elizabeth Duke told Congress that the Federal Reserve expects an additional 4.25 million foreclosure filings in 2011 and 2012.
When long-term interest rates rise, housing activity slows. Rates above 4 percent would create a myriad of issues for the housing market, not the least of which would be hamstringing the ability of financial institutions to work through the backlog of foreclosures on their balance sheets. Since the backup in interest rates began approximately eight weeks ago, we’ve started to see housing activity wane and housing prices decline again. If housing prices decline meaningfully, there is significant risk of another wave of mortgage defaults. The story in housing remains a compelling reason yields on the 10-year note above 4 percent are simply not sustainable at this juncture.
Further evidence against rates rising meaningfully comes from the historic relationship between the Fed funds rate and the 10-year Treasury yield. Over the past 30 years, the 10-year note has never been able to sustain a spread to the Fed funds rate greater than 375 basis points without precipitating a major rally. Currently, a spread of 375 basis points would translate into a 4 percent yield on the 10-year Treasury, which further leads me to believe that this is a pretty hard ceiling. I don’t necessarily think yields will get to 4 percent, but I do think they may test 3.80 before coming back down to the 3 percent range in the second half of the year.
On the other hand, Bernanke is not stupid, and we are confident that should long rates continue to surge which will make his precious banking cabal even stronger in the eyes of the propaspintura, the Chairman will simply do what Bill Gross has been telegraphing for months now: launch QE 3 with a muni and MBS focus. And if the S&P dares to dip even a little as a result, ETFs and REITs as well, as the US takes one more step toward becoming a Japanese style economic catastrophe.
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This keeps getting unreal. I'm ready to go to Chile.
now that's funny
The Ben Bernank is EVIL, not stupid (even though he does look stupid).
Is Bernanke evil? Probably.
Do the vaste majority of PhDs support Keynesianism? Absolutely.
My guess is that he is both, stupid and evil.
EVIL is what stupid does.
Amoral? Yes. Smart? Yes. Evil? No. Trapped? Yes. IMO he's the "fall guy" that Greenspan selected to inherit the mess. Same as Obama was selected as the fall guy for the political mess created by Bush/Clinton. I'm sure both Bernanke and Obama shit their pants when they recognized what they got handed...
Banks probably don't need a steep curve anymore to make money. I can tell you first hand that lending is finally picking up, depositors are less prone to rate shop for CD's, and REO properties are starting to sell.
Pretty much a momentum play right now, banks are finally back on a roll, and no longer fighting fires.
Hiring of experienced bankers has increased dramatically here in Los Angeles, getting tougher now to find good people who are available.
And, of course, all of this is being reflected in the price action of the RKH, KRE, etc.
Does that include all the HELOC loans and residential and commercial real estate that is NOT marked to market? I don;t believe so. It is still a rigged accounting game, and the banks are a bunch of big fucking liars when it comes down to "true" asset valuations and "true" market value. The HELOCs and 2nd lein mortagages are worth nothing, and are just being ignored on the balance sheets as well as the crappy mortgages and commercail RE paper.
I have not seen any massive writedowns from these banksters, nor are they slowing on the foreclosures as well.
There is much pain being hidden by the illegal accounting practice as well. I hope bankers get it in the side of the head.
The worst of the worst assets have already been sold to vulture funds or written off. Now they are probably owned by the Fed.
And since the Fed is never audited, is unaccountable to no one, they can simply buy an unlimited number of bad loans, and print an unlimited amount of fiat.
As documented by Doug Noland this weekend, credit continues to increase and become even more plentiful.
It is like 2008 was just a blip, probably long forgotten in a couple of years.
BTW, I did not junk you, just for the record. I think you are junked to many times for making good posts.
The HELOCS are stuck with the banks though, the FED is NOT biuying those assets, because they are empty. PLus they are going to have to do something about the empty MBS and CDOs, that are sold, because the notes or the titles are split. That means a cram back to the banks, and I hope the choke on it.
The Banks need to "man up" and take their losses. They want "earnings" on risk, but want the taxpayers to bail them out from their risk. Bullshit business acumen, and really whimpy. If the do not want to lose, then don't play. "Capitalists" they are not. Ciminal socialists are what bankers are now.
I hate all those fucking assholes.
Excellent Post Everyman. I can only say Ditto to all you said. Robo and yourself have taught me that keeping a open mind is a good thing. Plus, you can make money too. Robo does take too many junk hits. But that's O.K. too. Sometimes if one listens it can be the ultimate contrary indicator.
I agree with Robot. We will all be saved by the Federal Reserve. They know what they're doing, contrary to most doomers here.
Bernanke just has to print enough to pay back all the doomed mortgages, and it will be like nothing ever happened. America will come out of this crisis richer and stronger.
LOL, you almost got me Hamy, I was getting ready to tear into you after reading Harry's dangerous bullshit on another thread...
Exactly. Just leave it to Dr Bernank. The master.. My Fiance invested in Ford at $2.00 and has been a Bernank fan ever since.
harry gave you the benefit of the doubt, but your drinkin to much kool-aid
As long as you find greater fools to buy your debt you're fine, until you're not... Hello Zimbabwe! The financials, munis and states will buy it no matter what to maintain the status quo. I'm not so sure about the households and the foreigners. '.'
Talking about the foreigners:
http://www.zerohedge.com/sites/default/files/images/user5/imageroot/have...
http://www.zerohedge.com/article/can-sovereign-debt-crisis-happen-here-c...
Playing with fire anyone? '.' Not saying we'll see hyperinflation in the US tomorrow morning, but it just can't be ignored. Even improbable does not mean impossible...
It is like 2008 was just a blip, probably long forgotten in a couple of years.
Hell, many have already forgotten it. It was the "black swan" event everyone was waiting for. It happened, it's pretty much over and it's time to move on. Until people figure this out, they'll continue to make doomsday market calls on this and like forums. And they'll continue to be wrong.
And yeah everyone, deficits don't matter. Dick Cheney said so.
Plus, everyone knows that banks take risks and blow up economies. It's no big deal. The middle class is stoopid. Just can't let them disappear entirely, or too fast. We'll need em for TARP 6 and 7, not to mention QE 17.
Dollar hegemony bitchez!
<sarcasm off>
Someone tell me where I screwed up here... Tentative Timeline for Death of the US Dollar
http://thetaildoesnotwagthedog.blogspot.com/2011/01/tentative-timeline-f...
That sounds like a sharp increase in bank payroll costs, which are cash and not concealable, and a consequent hit on earnings.
"I can tell you first hand that lending is finally picking up, depositors are less prone to rate shop for CD's, and REO properties are starting to sell."
I'd LOVE to see that data! Where's it printed, the back of sugar packets? Nice claim without a warrant.
Yeah, these Banks are so profitable that Geitner is already talking about another bailout for them:
http://online.wsj.com/article/BT-CO-20110113-713467.html
It will be interesting to see if they can get another bailout through Congress.
Edit: It looks like that link works if you go through google news, but not from here. Here's a summary from the WSJ, 1/13/2010:
Geithner Warned That Future Bailouts Possible - TARP Overseer
By Alistair Barr
SAN FRANCISCO (Dow Jones)--Treasury Secretary Timothy Geithner warned that the U.S. government may have to bail out major financial institutions again if there's a crisis as big as the last one, according to a report released Thursday by a group overseeing the Troubled Asset Relief Program.
"We may have to do exceptional things again if we face a shock that large," Geithner told the Office of the Special Inspector General for TARP in December.
SIGTARP, as the oversight group is known, spoke with Geithner during its investigation of the government bailout of Citigroup Inc. (C) . The group's findings were released Thursday.
The Geith knows how loathsome that sounds to American taxpayers. This is a setup to get our blood up. What do these reptiles have in store, one wonders...
I like you, you're funny.
If the new banking model is to just receive it free from the Fed, that would imply near infinite expansion of the money supply, with the resulting hyperinflation and loss of purchasing power for the remaining 80% of the workforce who actually still have a job/income.
Citation needed.
Citation needed.
Citation needed.
Ooooooooooohhhhhhh, you live in SoCal. The mystery is finally solved as to why you are delusional.
Lending is lame to weak. That's very evident
from the latest beige book release and JPM's
revenue line.
I will be more than happy to see the value of my home drop another 20% if it means JPM thugs, goons, and criminals can get larger bonuses. After all, Where would we be without them. (hint: much closer to utopia)
" A Strange game, the only winning move is not to play. How about a nice game of chess?"
Nf3
Yeah really, getting it in the back of the head just doesn't seem to do it anymore.
Japan an economic catastrophe? Hardly. One of the strongest and most sound economies in the world, in fact. Good article, but claiming Japan is an economic catastrophe really hurts your credibility. Japan is what we should be striving for in America. Not Zimbawbwe like we're heading.
30 years of deflation, and a complete collapse in the stock market is your definition of a strong and sound economy? Interesting...
Yes. Deflation is a good thing. Lower prices are good, don't you shop at Wal-Mart?? Who cares about the stock market, Japanese deflation has given Japanese a rising standard of living, relatively full employment, and some of the best quality infrastructure in the world.
I don't know how you can think these are negative. Most Americans would give their left nut to enjoy the same standard of living as is enjoyed by the Japanese, despite their so-called "complete collapse".
Great to see you made this point before I had to. Your second paragraph is spot on and is something most here just "don't get."
Yeah, no surprise that participants on a financial blog, are enamoured with the idea of unearned wealth, when, in fact, the Japanese have too much honour to let banksters run amuck.
Heaven forbid, financial hucksters would have to get real jobs. Instead of doing the hokey-pokey of trying to figure out which pieces of paper to buy or sell like we're all obsessed with in the USA.
Isn't this site loosely based on "Fight Club", where the characters in the movie hatched a plan to burn down the system of credit and free themselves from bank slavery? That's exactly what they've been working towards in Japan, and its been a phenomenal success.
Perhaps Zero Hedge's many Japanese readers should weigh in here. Kudasai.
Nihon no ginko wa genki desu ka?
it's "amok," btw.
And Japan *has* zombiefied their financial industry just as we have.
Deflation? WTF...look at the Yen POG or prices in Japan before talking stupid shit about japanese savings buying more now than before. Yeah, the yen buys more of the N225, lolz.
Japan is doing everything in their power to arrest any deflation
Now goddamit they gotta get this deflation myth from someplace. If you go and ruin it in their "in a far off land" narrative you are going to leave them with nothing.
oh harry[sighhhh]...
Gold bulls and Ben the chopper are united on their love for inflation. Doesn't stop Chinese pensioners from admiring their Japanese counterparts - Japanese savings are stretching into more purchasing power while Chinese pensioners face uncertainty and runaway inflation.
Most Americans left nut is "foreclosed" and BELONGS TO THE BANKS!
BALLS OF AMERICA!! BUY THEM NOW WITH A 90% DISCOUNT!!
del
At least they are still a net exporter with a high technology production base.
As far as government debt, obviously, their metrics suggest insolvency. The Yen carry is what is keeping their financial system afloat for now
Once again, NFL sports wagering junkies were blown out today.
Virtually every handicapper that runs infomercials on Fox Sports Radio 570 this weekend were pumping the Falcons and the Patriots.
Only a matter of time before these guys figure out that they are getting fleeced, and they will eventually take their money and head over to the NYSE casino.
Korea now printing new, world record, lifetime highs right now.
Over 2100....
How about charting the new, world record, lifetime highs of the US federal debt. The numbers look something like this...
http://www.usdebtclock.org/
Enron broke some records too. Till worldcom came along and kicked thier ass.
Yield curve.. Will this affect POMO?
Tyler also points out why the Bernank can't easily just increase interest rates to fight inflation when it starts to heat up. Besides the economic downturn it will cause it will also be an instant devaluation of all home values as higher rates mean each $100k of mortgage becomes more expensive,
Seems to me he's trapped in a box unless real organic growth materializes from somewhere.
Sightings of Recovery have been greatly exaggerated.
The government’s number one mouthpiece, the AP, has been forced by legitimate news sources, such as Shadowstats, to admit that 2010 Christmas sales failed to signify spending was back to pre-recession levels. Even factoring in the government’s gimmicked changes to inflation indexing since 1980 to keep the official CPI artificially low, the $462 billion in holiday spending would have had to clear $478 billion to best the $453 billion peak reached in 2007.
Also, the population of the U.S. has grown by 8 million people since the previous record was set, meaning spending per person this past Christmas was down.
And speaking of the elite stealing pennies from the peasants to maintain their lifestyles , the whole housing affair has been a total burglary of the American people—skillfully planned and executed. Nor was it necessarily just a burglary of those who lost their homes, or who are currently underwater. The Fed and its duplicitous bureaucrooks have used price inflation (running more than 8 percent according to the SGS-Alternate CPI pre-1980 methodologies) coupled with the loss of $11 trillion in household wealth, stagnant wages and negative interest earnings, to extract the value from everybody’s home. As for recovery, how can a young couple or a small businessman save for a down payment on a new home or a new business venture on negative earned interest rates – particularly in an environment where America’s future is being deliberately offshored to profit the few?
In California, the San Jose Mercury News reported Friday (Jan 14), that bankruptcies in San Jose hit an all-time high last year, as 13,366 people and businesses were "overwhelmed by debts for the third year of the Great Recession."
Said the Mercury in Debt Filings at Record Level, the flood of filing is a 16 percent jump over 2009.
California bankruptcies were up 25 percent from a year earlier, according to the American Bankruptcy Institute. Nationally, the number of bankruptcies was up 9 percent over 2009, with 1,530,078 in 2010 compared with 1,407,788 the year before.
Wayne Silver, whose practice is mainly referrals of complex bankruptcy cases and fraud, told the Mercury: “I have never been as busy in my life, including the 1980s savings and loan scandal and the dot-com years.”
The H1-B visa and its effect on suppressing the price of top-end labour in the Silicon Valley is probably a larger impact than poor interest rates. Engineers graduating in the past decade simply haven't been getting hired. Instead, Indians on H1-B's have been hired, and they don't start new businesses with their money -- they just ship it back to India for their eventual retirement.
Get rid of the H1-B and deport all the low wage scab labour, and much of the Silicon Valley's problems would dissappear.
The double dip in housing wasn't due to interest rates going up. It's due to the crappy job and wage situation. Interest rates at 4.25 vs 5.25 don't mean that much if you don't have people with a downpayment. There just aren't that many people with enough money to buy a house, interest rates be damned.
zirp 4evah! qe to infinity and beyond! AAAOOOHHH!!!
I would say the US is in a far worse position than Japan, Tyler. The Japanese at least had savings, the US is more like Zimbabwe.
"..as the US takes one more step toward becoming a Japanese style economic catastrophe."
Japan must regret the day when they took the advice from the US Treasury and the Fed.
@Pitz and Wanker
Glad you guys are happy about becoming
Japan. Course, to be "holding" and happy
about becoming Japan is to be more
clueless than my Aunt Sally.
Anyone who wants to emulate Japan's successes in life needs to have their head examined and has conviently forgotten history.
The Japanese had a massive deflationary event in the 80's and has NEVER recovered.
Owners of property do not default, so they have been underwater for 30 years. They have an aging demographic, no population to pay the massive debt off, high suicide and alcoholism rates. They also have a miniscule quality of life and live in postage stamps that they are still trying to pay off. Japan will be the first casualty of a disasterous ponzi inversion since there are no new suckers to work off their benefits for them. Entertainment for them are pachinko parlors, call girls and too much electronica.
The yield curve inverted in 2006. 6 months later it reversed to steepening which blew up Bear Sterns and the rest is history. The yield curve will probably not invert this time around because despite what Robo says by hearsay, there are no borrowers of cheap money that the banks have access to. The banks would prefer to take the free interest, play the casinos, forex etc. Not loan to people who want it.
You cannot force people people to borrow in a deflationary delevering event- the economy will not support payback of loans so people do not borrow unless they are no good for it and the banks know who they want to lend to.