Capital Markets

In addition to the phenomenon of "foreclosure stuffing" described here extensively before, one of the main reasons for the artificial drop in housing supply has been the ongoing government-subsidized, GSE/FHFA endorsed REO-to-Rent initiative, through which large asset managers have been encouraged to take advantage of government funded, risk-free financing and purchase foreclosed properties in bulk, with the intention of converting them into rental properties. The REO-To-Rent has traditionally been open to the biggest of financial companies, or at least those who don't have the stigma of legacy mortgage origination resulting in billions in litigation reserves, which means mostly hedge funds and PE firms. One of the main players in the space, Och-Ziff, decided to pull out of the landlord business in October of last year because, as Reuters reported, "the returns it is generating from rental income are less than expected and it is looking to take advantage of a recent rebound in home prices in northern California." In other words, selling while the selling is good. Of course, there is another, far more traditional way to offload risk while preserving some of the upside: dump the balance sheet exposure to others while giving them a fraction of the potential upside yield. This is precisely what the big banks were doing during the last housing bubble when massive residential mortgage-backed security portfolios were packaged, spliced, securitized (sometime without the feedback of firms like Paulson pre-shorting the MBS courtesy of firms like Goldman) and sold off to other yield-starved investors. Everyone knows how that ended. So fast forward to today, when this final missing link from the credit and housing bubble is finally here too, following news that mega-PE firm Blackstone is pushing forward with the first ever REO-To-Rental securitization.

Meetings between public company managements and investors are the bedrock of the fundamental investment process.  The reason for that, however, is often lost in translation.  It is not, for example, because most investors or analysts are systematically better at reading “Body language” about the quarter or new products.  Seriously – they aren’t.  No – the reason that management meetings are useful is because, over time, managements let down their guards and act like regular people.  And in those moments, truth – about character, about wisdom, about judgment – comes rolling out.  Today we offer up a personal highlight reel of examples from +20 years of management meetings. Between the earnings forecast and the actual results sit only two things: time and management.  Time is uniform; management quality is not. 

The markets have begun to wonder whether the Fed (and other central banks) will ever be able to exit from its Quantitative Easing policy. We believe there is only one reasonable exit the Fed can take. Rather than sell its portfolio of bonds or allow them to mature naturally, we believe the Fed’s only practical exit will be to increase the size of all other balance sheets in relation to its own. This “exit” will be part of a larger three-part strategy for resetting the over-leveraged global economy, already underway...

A 2-minute read on developments in the global capital markets. Equity markets are heavy, bonds little changed as is the dollar. Sterling is the big winner on short covering and bottom picking.

Kyle Bass, addressing Chicago Booth's Initiative on Global Markets last week, clarified his thesis on Japan in great detail, but it was the Q&A that has roused great concern. "The AIG of the world is back - I have 27 year old kids selling me one-year jump risk on Japan for less than 1bp - $5bn at a time... and it is happening in size." As he explains, the regulatory capital hit for the bank is zero (hence as great a return on capital as one can imagine) and "if the bell tolls at the end of the year, the 27-year-old kid gets a bonus... and if he blows the bank to smithereens, ugh, he got a paycheck all year." Critically, the bank that he bought the 'cheap options' from recently called to ask if he would close the position - "that happened to me before," he warns, "in 2007 right before mortgages cracked." His single best investment idea for the next ten years is, "Sell JPY, Buy Gold, and go to sleep," as he warns of the current situation in markets, "we are right back there! The brevity of financial memory is about two years."

The topic of Illinois' various insolvent pension systems is not news to regular Zero Hedge readers. One needs but to recall our articles from mid/late 2010: "61% Underfunded Illinois Teachers Pension Fund Goes For Broke, Becomes Next AIG-In-Waiting By Selling Billions In CDS", "Illinois' Pension Fund Death Spiral Revisited: "10 Years Of Money Left" or "Illinois Teachers' Retirement System Enters The Death Spiral: AIG Wannabe's Go-For-Broke Strategy Fails As Pension Fund Begins Liquidations" in which we clearly explained how the state's teachers pension fund was systematically doing everything in its power to mask its massive underfunding, and the fact that it was rapidly running out of money. The retiremnet fund, in turn, took things very personally, prompting Dave Urbanek, Public Information Officer at the Teachers’ Retirement System of the State of Illinois (TRS), to write an impassioned response to Zero Hedge denying all allegations. Today, over two years after the above news, the SEC finally concluded their analysis of one part of the massively underfunded Illinois Pension system and found the Illinois failed to inform investors about the impact of problems with its pension funding schedule as the state offered and sold more than $2.2 billion worth of municipal bonds from 2005 to early 2009. The SEC also said Illinois failed to disclose that it had underfunded the state's pension obligations, increasing the risk to its overall financial condition.

While it has been a while since Charlie Gasparino broke anything material, and is why we urge readers to take this news with a grain of salt, the report that CNBC's Gary Kaminsky would be leaving the Comcast channel and his role as capital markets editor and heading to Morgan Stanley as vice chair of its brokerage division would make sense, and would certainly explain the quite amicable relationship between CNBC, its various anchors, and the B-grade brokerage.

Consensus suggests India is a basket case while China is recovering. We think both views are incorrect and therein lies opportunities for contrarian investors.

Following yesterday's Beige Book extravaganza of mediocrity, ConvergEx's Nick Colas decided to do what the kids today call a “Mashup” – mixing different sources to create a new experience. Instead of mixing popular songs, he compared the Beige Book with Google “Trend” analysis for a variety of search phrases.  Take, for example, the message from the Fed that the housing market is recovering. Google searches for “Get a mortgage” are, in fact, very near record highs and over 100% higher than 2007.  On the Fed’s claim that leisure travel is picking up, the Google data is less supportive. On auto demand – an important factor in this recovery – the Google “Buy a car” trend data does look solidly higher.  Finally, the job picture is still mixed.  Google says that if you are unemployed in Chicago, drive to Dallas.  The Fed’s Beige Book seems to concur. The question is not whether the Fed could engineer this nascent recovery.  The question is “Can it last?”  For that, we’ll need some new songs.  And some fresh data in the coming months.

As Morpheus said to Neo in the film The Matrix:  You still think that is air you are breathing?

One of China's wealthiest men, Zong Qinghou - founder of the privately listed beverage empire Hangzhou Wahaha Group - is hunting fort deals overseas as the WSJ reports, he believes “The capital markets suck in China.” Since China's stock market bubble burst (after running up from 1000 in 2005 to 7000 in 2007), it has never recovered from its collapse, loitering around 2,000 points ever since. Plagued by too many offerings (run by the government) and a slowing economy, WSJ notes that a common complaint is that the only investors who make money from China’s stock markets are those with inside information. The retail investors that fueled the bubble in the first place remain scarred by the experience, and have mostly stayed away, as Zong concludes: "When the ordinary people invest in it, the market should reward them with some benefits. But it does not." This has driven the desire to 'invest' or speculate in real estate - a topic we discussed yesterday - leading to a looming bubble there also.

When the Eurozone crisis first broke some four years ago, most analysts quickly and correctly concluded that the Eurozone was an incomplete monetary union; but, as UBS Larry Hatheway notes, neither rapid integration nor breakup were or are politically feasible options for Europe’s political classes. The 'Merkel-Draghi wager' then began with the determination that capital markets would not dictate Europe’s future: with growth-supporting fiscal transfers or debt mutualisation ruled out by national politics, the remainder of the story is about an ‘Austrian’ solution to cleanse Europe of excessive fiscal deficits, narrow gaps in competitiveness, and shrink external imbalances. The ‘Merkel-Draghi wager’, then, is a political gamble of historic proportions. It is a calculated bet that a policy prescription of robust liquidity buffers coupled with internal devaluation and fiscal consolidation will work. Equally, it is a view that the historical, cultural, economic, financial and political forces that have brought Europe together in the post-war era will prove stronger than those unleashed by the wrenching social dislocations associated with ‘Austrian’ economics that could one day threaten to rip apart the Eurozone. So far, the ‘wager’ is working in economic terms, or at least that's the hope.

Think US is the biggest financial bubble in the world? You are right.

It looks like the Dow Jones Industrial Average will be the first major U.S. equity benchmark to breach new highs, so ConvergEx's Nick Colas breaks down this closely watched measure of domestic stock prices noting that the Dow is a quirky “Index” – price weighted (not market capitalization), compact (30 names) and fundamentally global (lots of brand-name multinationals).  Change just one name in the index, and the outcomes vary considerably.  If Google had been added at the end of last year, we’d be at 14,330 – well over the old high of 14,165.  But if the Dow committee had added Apple instead, the index would have closed at 13,475 yesterday, up less than 3% on the year.  And if Netflix had been the lucky company added for 2013, well…  We’d be saying hello to Dow 15,000, and then some. The point here is that the notion of a “New High” for the Dow is a little arbitrary, by virtue of the price weighting function and stock selection process.

No, American Banks DON'T Need to Be Big to Compete with Bigger Foreign Rivals